Money to burn; why Wall Street loves NFLX
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Y'all want to go to the flyest secret underground party in the entire Bronx? You follow me. Back in 2014, we started hearing a lot of buzz around an exciting and mysterious new Netflix project. It sounded cool. Say one, two, three. Say that you want. Let's get down, brothers.

The show was going to be ambitious, it was going to be expensive, and a big-name director was already attached. Cynthia Littleton is a business editor at Variety. She remembers all the hype. There had been a lot of rumors about a big project blending music and drama set in the birth of hip-hop culture in New York. A couple years later, we finally got to see The Get Down. The Get Down!

It was made by Baz Luhrmann, the visionary director behind Moulin Rouge! And true to his style, the show was bright and fantastical and full of dancing. And just wait till you see him dance, girl. He wins the dance-off like every single week. It had incredible elements, and those kinds of things take lots of rehearsals and lots of additional...

and creative disciplines that you don't have on a typical cop show or lawyer show. Its vision and scope seemed like a statement. Netflix was giving people big bags of money and letting them make whatever they wanted. But sometimes it doesn't work at all. From the start, The Get Down was a production nightmare. The Get Down

The nickname of the show became The Shutdown. There's nothing more expensive, nothing starts the ka-ching, ka-ching, more so in production, film or TV, than an unplanned shutdown of production. And that really just added cost, cost, cost.

The Get Down had a lot of shutdowns. And when you throw in the singing and dancing coaches, and a showrunner with lots of movie experience but no experience making a big TV show, The Get Down went out of control. By the time they were done, it cost an estimated $120 million.

That's Game of Thrones-level expensive. And at the time, it was the most money Netflix had spent on a show. Spending enormous amounts of money on a show isn't necessarily a bad thing. But it is when very few people watch or care. It's definitely one of their biggest flops to date. We don't know exactly how many people streamed The Get Down because Netflix only tells you about its viewership when it wants to brag.

But what we do know is that Netflix canceled the show after just one season. And at that time, everything at Netflix was getting renewed for multiple seasons. It includes duds like Hemlock Grove and Marco Polo. But the get-down did get people's attention in Hollywood. It showed that not only was Netflix willing and able to spend a lot of money without really understanding what it was doing, but it was probably going to do it again.

No one from Netflix ever had to own up publicly to the show's failure. No executives got fired. Netflix had taken a big swing, it missed, and then it just moved on. Which is not how it would work at a regular media company.

But as we've been learning, Netflix is not a regular media company. I don't think any business can spend at this level and have also the, you know, have no commercial return and very little creative return. Netflix is a unicorn. It is different. And, you know, Wall Street so far has not punished it for that difference. In fact, it's kind of celebrated it.

Cynthia Littleton is right. Wall Street doesn't really seem to care that Netflix has been on a crazy spending spree, or that it has a reputation for paying way more for stuff than its competitors, and with borrowed money, too. Actually, Wall Street seems to love this strategy. But what happens if this flow of money that lets Netflix spend and spend were to suddenly stop?

Welcome to Land of the Giants, the Netflix effect. I'm Peter Kofkin. Today, we're going to talk about money. And specifically, we're going to talk about revenue and profits and accounting and investing. But wait, don't leave. Seriously, we're going to make this worth your while. Because we're not just talking about regular old money. We're talking about Netflix kind of money, which is kind of a magic trick. Every year, the company burns through billions of dollars it doesn't have. And every year, it gets rewarded for that.

with even more money. It's as if the basic rules of economics and finance don't apply to Netflix. And there are lots of people who think that can't last forever.

There's sort of two camps on Wall Street when it comes to Netflix. Tara LaChapelle is a finance columnist for Bloomberg. One group that thinks that Netflix can do no wrong, that they need to keep spending. We're going to call these people the Netflix bulls. There are a lot of them, and they think Netflix has it all figured out. And then there's this other group of folks who think that Netflix's debt is terrifying. These are the Netflix bears. These people think Netflix is doomed. And the future of Netflix, well, a lot of it depends on which side is right.

So let's start with the Bears.

Here's the top line. Netflix spends way, way, way more than it makes. If you spent the way Netflix spends, you'd have real problems. What Netflix is doing is they're the equivalent of a household that earns $100,000 a year and spends $115,000 a year. Meet Michael Pachter, an analyst at Wedbush Securities. He's what we call a Netflix bear. You can do that by putting the extra $15,000 that you didn't earn on your credit card

And after a year, you owe $15,000 and you have a lot of nice things, but the things you bought, the sofas and the clothing and the carpeting, don't necessarily have the same value that you spent on them. And if you do it a second year and a third year and a fourth year, the credit card companies start to wonder when you're ever going to pay them back. Back in its early days, Netflix spent all of its money buying DVDs and getting those DVDs to you. But now, in the streaming era, Netflix spends its money on content.

First on stuff other people made and now stuff it's making for itself. And if you're listening to this tape, you're one of the reasons why. That turns out to be very expensive. Netflix is technically profitable, but not in the way you and I think about profitable because year after year, it costs more to make all those shows than the money Netflix brings in.

Last year, that difference was $3 billion. So to fund all of that programming, Netflix borrows money, a lot of money. As we're recording this, Netflix owes at least $15 billion. And one day it has to start paying that money back.

This approach is a key reason for the success of Netflix and a key difference between Netflix and the media business it's disrupting. For years, it seemed like Netflix was willing and able to spend more than anyone else on projects that it wanted, like the $100 million it plunked down for House of Cards back when it was getting started. Which, by the way, the media people who compete with Netflix are happy to complain about, but not on the record and not for this podcast. The short version of their argument goes like this. If you let me spend money the way Netflix spends, I could do what Netflix does, but

But I can't because I need to run a business. This sounds like a weird criticism to make of a company that brought in $20 billion in 2019. Except, again, that $20 billion wasn't nearly enough to cover Netflix's costs. And the market's reflecting that in its concern and the fact that Netflix doesn't make any money and Disney does. All this debt is one of the big reasons Netflix has frequently been targeted by short sellers.

These are investors who bet against a company, hoping that its stock price will go down instead of up. Years ago, when Netflix was in the DVD business, shorts would call me and tell me that the company was going to fail because the U.S. Postal Service was going to raise its rates. And today, Netflix remains one of the most shorted companies in the world. What do you think is going to happen next year?

Netflix, I'm hugely bearish on. Competition for both subscribers and content, I think it's going to destroy them. But it can be really lonely to bet against Netflix. Michael Pachter has been doing it on and off since 2004, back in the blockbuster days. And back then, he was arguing that Netflix's stock was overpriced. Netflix was worth about four bucks a share back then. Today, it's worth more than $400 a share. But even now, Pachter will tell you why he wasn't really wrong.

Blockbuster allowing people, you know, unlimited access to DVDs by mail was going to be the end of Netflix and it was mutually assured destruction. And I was actually right. It's just that Blockbuster, you know, failed before they actually put Netflix out of their misery. Remember, Blockbuster failed in large part because it had $1 billion in debt and Netflix has $15 billion.

Packer is a fan of Netflix, the company that brings him TV shows. He just thinks they can't keep spending more money than they bring in. The technical term for the extra money a business is supposed to have after accounting for all its operating costs, by the way, is called free cash flow. I love the service. I love the product. There's plenty there. My sell thesis is solely based upon free cash flow.

Free cash flow is the basis for valuing companies. And these guys don't have any. They have negative free cash flow. Here's another complaint from the Netflix bears. They say Netflix is doing some kind of weird accounting that means they never tell you when they've screwed up, which pretty much everyone else in media has to do. Take Disney, for instance. You are John Carter of Earth? Yes, ma'am.

John Carter was a movie with CGI Martians and that guy from Friday Night Lights. Disney spent more than $300 million on it back in 2012. It's now regarded as one of Hollywood's biggest bombs. Usually, when a bomb's really big, a big company tells investors that that happened by taking a right now. That's a finance term for that thing we thought was worth a lot isn't really worth anything after all. After John Carter, for instance, Disney had to tell Wall Street it was taking a $200 million right now.

But Netflix, which has been betting on content for nearly a decade, has only taken a write-down once, and for a very particular reason. And you will serve on in my cabinet, and we will forget that any of this ever happened.

A few years ago, after Kevin Spacey was accused of sexual misconduct, Netflix ended up with a $39 million write-down because Kevin Spacey wasn't going to be in any more episodes of House of Cards. And also because Netflix had put a lot of money into a movie that Spacey would have starred in and which no one is ever going to see. But that's it. Besides that, Netflix has never told investors that it got something totally wrong.

No write-downs for the get-down, not for anything, which is hard for lots of people to believe. They've canceled a boatload of shows. So they've canceled shows like Bloodline and Marco Polo and Hemlock Grove and taken no write-downs.

And that's unusual. This is the kind of stuff that drives Netflix bearers like Pachter nuts. I mean, go look at HBO when they made the show Vinyl. They made Vinyl and The Brink the same year, canceled them both, took a $122 million write-down when they canceled them. ♪

When Netflix canceled Bloodline, I actually called them and said, where's the write-down? I don't see it. And the get-down, remember that show? And those were super expensive shows. And the answer I got back was, no, we didn't take a write-down because the content remains in our catalog available for people to view, so we think it still has value. Well, if you canceled a show, it doesn't have the same value as if it's still going. Sorry, that's a truism.

The Netflix bears have lots of other reasons they think the company is going to fall over someday. Like, what happens if the economy keeps sinking during the pandemic and people start looking for ways to cut costs and they start dropping Netflix? And what about the other guys who are all gunning for Netflix? Please lower your blaster. We have you four to one. I like those odds. For the first time in years, Netflix faces real competition. There's HBO Max and Amazon and Hulu and CBS All Access and Peacock and Apple TV and Disney+.

But in the meantime, to keep growing, Netflix keeps borrowing so it can make more stuff. And for the time being, the company seems to take an approach to money that no one else in Hollywood does. And it's an approach that you can't get away with. Go ahead. Try and borrow a couple billion dollars this year. And then announce that you're going to need to do it again next year and the year after that. So how can Netflix continue to get away with this? Up next, we hear from the Bulls, who tell us why Netflix gets to play by different rules.

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On September 28th, the Global Citizen Festival will gather thousands of people who took action to end extreme poverty. Watch Post Malone, Doja Cat, Lisa, Jelly Roll, and Raul Alejandro as they take the stage with world leaders and activists to defeat poverty, defend the planet, and demand equity. Download the Global Citizen app to watch live. Learn more at globalcitizen.org.com.

So we've heard the Netflix bear case. Netflix spends too much. It has too much debt. There's a lot more competition that could steal away subscribers. And to each of these, the Netflix bulls have a response. But here's their main argument. Sure, Netflix is spending a lot of money, but it's not just throwing it away. It's using it to buy stuff it can show its subscribers. And maybe some of that stuff will turn into giant hits.

Stranger Things isn't just a popular show. It's the best case scenario for Netflix. It's a show it built on its own for not a lot of money and is now a franchise, just like Star Wars or The Avengers. If Netflix had a theme park, Stranger Things would be its main attraction. You want to see a movie?

You want to kill that thing with fireworks. Do you have a better idea? Uh, yeah, 11. If Netflix keeps making more Stranger Things, the fact that it's spending money it doesn't have now won't be a problem, because it's going to make a lot of money for years to come. Spencer Wong, who heads up investor relations for Netflix, makes these arguments all the time. Netflix is basically a studio making our own movies and TV shows. We have to invest upfront to make the show and the movie.

So, for example, you know, very simplistically, when we make Bird Box and Sandra Bullock and the cast order catering, you know, for lunch on the set of Bird Box, we have to pay for lunch. And that consumes cash. And the movie is not done yet. It's not generating any sort of viewing or associated revenue, but it is consuming cash today. So it's really more of a timing thing. But every movie and TV company has to spend money in advance and then hope that the thing they're making will be worth something down the road.

A big, big difference for Netflix is that unlike a TV network or a movie studio, it says it doesn't really care if people love something right away because Netflix doesn't care about nightly ratings or box office receipts. It just wants people to watch its stuff eventually.

So in theory, Netflix argues that Get Down is still worth something because you can still watch it on Netflix four years later. And if you buy that argument, then you'll buy the main Netflix argument. If Netflix makes more TV shows and movies, it can attract more subscribers who will give it more money to make more TV shows and movies. And when those subscribers show up, they'll find all this other stuff Netflix has and they'll keep subscribing and Netflix will get more money to make more stuff to attract more subscribers.

That argument is convincing for Rich Greenfield. He's a partner and analyst at Lightshit Partners, and he is a big Netflix bull. You're borrowing money to fund more content to grow subscribers faster. If they didn't believe they were growth subscribers and have confidence in that at higher and higher prices, you'd be crazy to put debt on this company.

So the argument goes, as long as Netflix's subscriber numbers keep going up, Netflix can keep spending more money than it makes, and eventually it's going to work out. And by the way, Netflix doesn't say it's going to burn money forever. It says that last year, when it spent $3 billion more than it brought in, will be the worst of it. And that number is going to start shrinking and that one day they'll be set. The key is creating addicts. If you can create addicts at a very compelling price point, you're going to be insulating.

The Netflix bears expect competitors to steal away Netflix subscribers and that a bad economy is going to be bad news for Netflix. But we haven't seen that happen yet. In the first half of this year, when people around the world got sent home because of the pandemic and unemployment skyrocketed, Netflix added 26 million subscribers. A year earlier, it had added 12 million. So big, fierce competition? Check. Brutal economic slowdown? Check. And yet, Netflix is doing really, really well. Check.

But no one can predict the future, not even the smart people who run Netflix. So let's say, like other tech companies that said they were going to lose a lot of money now but make a lot of money later, things don't work out the way Netflix thinks. What happens if the subscribers don't grow the way they hope and that money they need doesn't come in? Then maybe Netflix has to get more disciplined about the money it spends.

What would that look like? Matt Ball, who used to be head of strategy at Amazon Studios, has a pretty good idea. The advantage is they have an enormous subscriber base. They've already funded the next two years of content. They're likely to have more subscribers in each of those years. And so if you said in the worst case scenario, we need to stop marketing.

Losing money, which means we have to raise prices and spend less. It's likely that they have a lot of tailwinds behind them. The thing is, we're kind of seeing that happening now. Even though Netflix spends more and more every year on content, it has actually started to stop making some stuff that doesn't work. Even when they're not spending get down money on it. Okay.

I would like to do less, not more. That's the thing. I'm going to be less ambitious or maybe not ambitious anymore. Lady Dynamite is one that is sad for me every time I think about it. Cindy Holland, who oversees original content at Netflix, loved Lady Dynamite. It was the kind of weird, quirky show that other people wouldn't make and Netflix did. For a little bit. It was canceled after two seasons. No work for Maria D'Amelio.

This really makes my job easier. A tad less in income, perhaps. I mean, I wouldn't work a little, but just smaller things. Maria Bamford is an incredibly gifted comedian and actress. And it's a version of her true story and struggle with mental illness and sort of trying to fit in in life and in Hollywood.

And critics loved it, but audiences, I think it was a little too surreal and a little too much for a big audience. And that was hard for all of us who loved it so much. Netflix used to be known as the kind of place where niche stuff that couldn't work other places could thrive. But as Netflix gets bigger, it seems to have less tolerance for niches. More subscribers equals more money, but it also means you have to make stuff for much bigger audiences.

which means something that felt special to some people about Netflix may be going away. We all died and we all chose to return. The OA is so good. Do you want to just do like a type five on the OA? My colleague Emily Vanderwerf is a critic at Vox and she is very excited to talk about the OA.

The OA was a sci-fi drama about a young blind woman who disappears and then reappears seven years later with the ability to see. And there's also apparently a bunch of interdimensional stuff going on. For someone like me who did not watch the show, hearing people describe it is amusing. There's like a thing where she goes into the afterlife and then at the end of the season they stop a school shooting through interpretive dance. I have the will.

Can't you feel it? And I was like, what is happening? Anyway, I gave it a bad review.

But I couldn't stop thinking about the show. Like, literally, like, I've thought about it probably at least once a week ever since I watched that first season. This is another niche show, but it was a passionate niche. The people who are into the OA were really into the OA. One time, a bunch of OA fans gathered for a flash mob in front of Trump Tower, and they did this OA dance in hopes to, I'm going to quote them here, create a protective force field of love and light from the dark forces at play in our country. But again, after two seasons, Netflix canceled the show.

It was inevitable. They couldn't keep spending more and more money and throwing more and more money after shows that weren't performing. I mean, I get it. I don't think anybody was watching it besides people who like just truly weird television. But some people love truly weird television. Imperial Young, an OA fan living in LA, was one of those people, and she was distraught when it ended. Not only did Netflix cancel her favorite show, it canceled it after a huge cliffhanger. A little happy.

This story is too beautiful to leave completely unfinished. Like, you have to know what happens next, and we have to know. Maybe you lost a favorite show, too, but you probably haven't done what she did next. At first, Young complained online. Then she made a sign and took to the streets. Hi, everyone. It's Imperial at the corner of Sunset and Van Ness, right in front of the Netflix building and...

You won't believe what's happened. This is a surprise live stream. Everybody, save the OA! And then things escalated even further. So you're on day five of your hunger strike? Yes, I have not eaten. The last thing I had was Sunday night. Note to the audience at home, do not do what Imperial Young did. She says she went on a hunger strike for 13 days.

Young found she wasn't the only one heartbroken about the OA. Protesters joined her in L.A. and in New York. And we will spoil this one. Young didn't get Netflix to change its mind. And she is eating again. But as she told my producer, Zach Mack, she's still hurt by all this. All right. Last question. If you could say something to Netflix now, what would you say? Can I have a second for that? Sure. Take your time. I love your service.

And you have so many wonderful titles, and I don't want you to lose one that has such immense value that could be part of your back catalog in its complete form for years to come. That is a reason for people to subscribe to your service. I have an HBO subscription because I want to support the people who made The Wire possible. And I want you to be that kind of a company that...

Yeah, you have this catalog that everybody can find some weird niche title that will appeal to them. But you also have something like the OA that just stands a testament to time in terms of quality and that people will always look at your brand and think, yeah, Netflix, they're worth it.

So Imperial Young's story is not usual, but it gets to something that we expect to continue happening, which is that Netflix may very well cut your favorite show, especially if it isn't doing numbers like Stranger Things. I think a lot of people bought into the idea that Netflix was going to be genuinely different and was going to genuinely change the way TV was made. But like,

money still exists. Again, this is Emily Vanderwerf. You still have to exist within the strictures of capitalism as we understand it. And like a hit show needs to have viewers to be able to pay for itself somehow. And shows that don't have viewers are just like throwing good money down a drain. Even Netflix, the company that spends $15 billion a year in programming and has $15 billion in debt, can't make everything for everyone.

And it has decided it would rather spend some of the money that goes into the Lady Dynamites and OAs, which a few people love a lot, and move it to things like Bird Box or Spencer Confidential, things a lot of people watch and aren't necessarily great. Maybe that'll work, but better because the pressure is on Netflix to make sure the money it is spending is getting at something a lot of people like.

In the old days, Netflix showed you movies and TV shows you'd heard of before. You knew what you were getting, and we probably liked it. But the days where other media companies let Netflix show you Marvel movies or Friends or The Office are gone, and they're not coming back. And if Netflix makes more get-downs instead of more stranger things, it's going to have problems it can't solve with money. Not even Netflix money. ♪

Okay, so Netflix used to have streaming to itself, but those days are long gone. In our next and final episode of the season, we're going to tell you how the company is taking on everyone. And we'll take you behind the scenes of the streaming wars you've been hearing about, which aren't exactly what you think they are. That's next week.

This podcast is a production of Recode by Vox and the Vox Media Podcast Network.

This episode was produced by Bridget Armstrong, Zach Mack, and Ronnie Mola. Our editor is Charlie Herman. Gautam Srikashen engineered and scored this episode. Zach Mack is our showrunner. Nishat Kerwa is the executive producer. We hope you like this show. And if you did, you probably do because you're still listening to me speak right now. We'd love it if you rate and reviewed and shared this episode. Quick disclosure, Vox.com and Vox Media make shows for Netflix. None of the people working on this season of Land of the Giants are involved with production of those shows. I'm Peter Kafka.

Thanks for listening.