Oh, Now I Understand How Netflix’s Business Operates – They’re Deeply In Debt

In an interview with KCRW’s The Business, Boyhood director Richard Linklater discussed the often shady realities of dealing with private equity funds and random producers to secure film financing, “There are so many people – I don’t know how they live, or what they do for a living – but they sure put themselves out there as real […] Only in Hollywood, in the arts, can you kind of just b.s. your way through. And you don’t know what game they’re really playing because they’re like, ‘Oh, well, if I get you to commit then I’ll go raise the money, or I’ll fake it like I have the money but if you can get this star then I’ll run out there and hope I can actually get the money.’ It’s so crazy.”

Well, right now Netflix is putting itself out there as a real player in film and TV production, and no one’s really doubting it. After all, this is Net-freakin’-flix! Even your grandma has heard of it. This isn’t some Entourage-esque group of young turks, like Red Granite Pictures, which is bankrolled by the son of the Malaysian Prime Minister nor is it some random investment firm that funds a Best Picture nominee (Birdman) only to then see its CEO ousted due to “corporate theft.”  These aren’t the film-loving children of a billionaire, like producers Megan and David Ellison whose dad is the chairman of a multinational computer technology corporation. This is Netflix, which seems to be flowing in money, handing out lucrative four picture deals to Adam Sandler, partnering with The Weinstein Co. on a Crouching Tiger, Hidden Dragon sequel, committing to five different TV shows with Marvel Studios, and inking mumblecore pioneers and directing/writing/acting duo The Duplass Brothers to a four-picture deal, just to name a few of their major deals for original programming.

Of course, around the time last month that Netflix was announcing an 8 episode order for a live action sitcom created by and starring Will Arnett they were also shouting down their own customers who were incensed to learn that Doctor Who and a bunch of other British shows were set to disappear from the streaming service at the end of the month. That particular crisis was averted; Netflix managed to hold on to Doctor Who. However, that type of midnight hour negotiation with content rights holders is increasingly common as Netflix’s priority increasingly leans toward producing original content.

But how are they able to afford all of this? I only pay $7.99 a month for my Netflix subscription, less than $100 for a full year. A cable subscription can cost more than that in a single month. So, because Netflix is such a comparably cheap service it is sometimes confusing to understand how they have so much money to throw around. After all, a Hulu subscription carries roughly the same monthly fee as Netflix, and that company seems to constantly be up for sale and unable to find a buyer. As a result, all of their original shows (Deadbeat, etc.) look like they have only slightly more money than something on Adult Swim. Netflix, on the other hand, produces shows with HBO-esque production values. Is the difference in quality really just because Netflix has so many more subscribers?

Well, that doesn’t hurt. However, it seems as if it’s also because Netflix is taking on a ton of debt to finance its shows. They have $900 million in existing borrowings, and their goal is to raise $1.5 billion to fund new projects, content acquisitions, and other services. Small problem: They can’t actually afford to do that, even though they keep adding new subscribers and expanding into new countries. According to Forbes, their international operations are not even profitable yet due to the heavy investment required to launch in so many countries. As a result, Netflix is just going to raise the money by incurring seemingly monumental debut. According to Netflix CEO Reed Hastings and CFO David Wells’ latest earnings report to investors, “Over the next few years we expect to continue financing our original content expansion with long-term debt. As long as the maturities are spread out, and the interest cost is built into our content budgets, we think long-term debt is the best way for Netflix to finance the production of content.” Standard & Poor’s – Remember them? They’re the ones who downgraded the United States’ credit rating during the debt crisis – immediately downgraded Netflix’s credit rating. This matches a downgrade previously delivered by the ratings agency Moody’s.

Of course, I am not a Netflix investor, and I’d be fool to pretend like I totally understand junk bonds and the like. What the heck do I care if ratings agencies think Netflix looks like a risky bet now? It’s Netflix. They’ve always been around (even though, actually, they haven’t been around that long in the grand scheme of things), and they’ll surely make all of this money back and then some. They already own the majority of the streaming market, with over 50 million subscribers worldwide and plans to launch in Australia and New Zealand next month leaving China, Japan, Spain, and South Korea as the next big markets on their wish list. Their recent price hike to new subscribers apparently “did not materially impact the subscriber numbers” just as it didn’t when they did the same thing in 2011 meaning it’s now assumed they can safely raise prices once every two or three years.

They will launch 320 hours of original content in 2015, triple the amount of 2014’s original programming. This will include Daredevil (and maybe AKA Jessica Jones), new seasons of House of Cards, Marco Polo, and Orange is the New Black, an original Adam Sandler comedy, and the premieres of new shows like the Wachowskis’ Sense8 and Tina Fey’s Unbreakable Kimmy Schmidt . Ultimately, Netflix plans to build up a roster of 30+ original series by the end of 2016 (that’s against like literally thousands of older shows and movies the service already has). They are going the same route of cable networks like HBO, USA, and AMC before them which began as content (i.e., re-runs and old movies) delivery services before realizing the true way to stand out was to produce compelling original content. After all, so many of the old TV shows on Netflix are also on Hulu and Amazon Prime, and now Amazon Prime is in the familiar position of having a stand-off with the BBC over Doctor Who.

I personally view Netflix’s originals as a bonus, though. For example, I didn’t sign up to watch the new season of Arrested Development; I watched the new season because I already had a membership and welcomed new episodes of a show I loved. You need look only to the outcry over the prospect of losing Doctor Who to see what a vocal portion of Netflix’ customer base truly wants from them: a cost-efficient way of owning our favorite shows without having to actually pay for them individually. It’s also been a boon to many a filmmaker. Mark Duplass explained as much to Variety, “My first movie made a grand total of $220,000 in theaters but about 5 million people have seen it on Netflix because they can click on it and they can try it out. And so I really recommend you get your goddamn movie on Netflix. It made my career.”

In that Richard Linklater interview I mentioned earlier, the host, Kim Masters, offered her own opinion on film financing, “That’s the frustrating thing about Hollywood – you never really can tell who is a player.” Netflix is a player, even if they are literally taking on over a billion dollars in debt to do it, debt which will presumably be paid back with money from new subscribers and inevitable price hikes. I was an early Netflix adopter meaning watching them morph into a mini-HBO feels much like it did when AMC suddenly went from the place to watch Halloween and Rocky marathons to the place of the best shows on TV, Mad Men and Breaking Bad. I have binged on BoJack Horseman and Orange is the New Black. I can’t wait for Unbreakable Kimmy Schmidt, and I am morbidly curious to see what an Adam Sandler Netflix movie looks like as well as more genuinely curious to see what a Duplass Brothers Netflix movie looks like. However, when they almost lose Doctor Who I have a kneejerk reaction of, “How dare you!  That’s the stuff I’m really paying for!”

What about you? What do you want from Netflix – Cool, new shows, hip indie films, or a catalog of old, beloved films and TV shows? Or all three, but you favor one over the other? Let me know in the comments.

Sources: KCRW, CinemaBlend