Netflix can compete as Disney, Warner Bros. enter the streaming space, but it won't be cheap

Key Points
  • Comcast, Warner Bros. and Disney are the latest entries in streaming, signifying a major shift in strategy for traditional cable television companies.
  • Netflix could lose about 20 percent of its total content library in terms of programming hours, according to Ampere Analysis data.
  • This potential loss is a major factor in Netflix's decision to bolster its lineup of original content and shows that can't be seen on any other platform.
Netflix CEO Reed Hastings speaks during an interview on day two of the Netflix See What's Next: Asia event at the Marina Bay Sands on November 9, 2018 in Singapore.
Ore Huiying | Getty Images

Disney made big waves in 2017 when it said it would remove its movies from Netflix by 2019 and launch its own stand-alone streaming service. A year later, Warner Bros. said the same. And then Comcast joined the fray.

The streaming service landscape is growing. The industry, once dominated by a few companies, is now more than a dozen strong, and more players keep entering the game. Comcast, Warner Bros. and Disney are the latest entries, signifying a major shift in strategy for traditional cable television companies. In the past, these giants have licensed their content to services like Netflix, Amazon and Hulu. However, that's about to change — and it could be bad news for Netflix, in particular.

"And, as invincible as Netflix may seem to be, it ain't," Peter Csathy, founder of Creatv Media, said in a newsletter last week. "Disney, Apple and WarnerMedia SVODs [subscription video on demand] are coming later this year — joining Amazon, DirecTV Now and a host of others that are already hell-bent on taking Netflix down a notch ... or several. So, this year Netflix will be challenged like never before. And, investors will feel it."

If traditional media companies like Disney, Warner Bros. and Comcast do make good on their promise to retract content from Netflix and not renew licensing deals, the company could lose about 20 percent of its total content library in terms of programming hours, according to Ampere Analysis data.

Netflix's big draw with consumers has been its exclusive content, shows like "Umbrella Academy," "Stranger Things" and "Unbreakable Kimmy Schmidt," and its lack of commercials. Having access to Disney films from franchises like Marvel, "Star Wars" and its catalog of animated features only bolstered Netflix's reputation for having a wide variety of quality content.

"There's a billion hours of television content being consumed today [in the U.S.]," Netflix CEO Reed Hastings said during a conference call in January. "We're winning about 10 percent of it. ... Disney, they have great content. We're excited for their launch, and maybe they grow over a couple years to 50 million hours a day, but that's out of the billion."

Without a brand like Disney, Netflix doesn't necessarily lose that prestige, but it must now figure out how to replace the shows and movies that it will lose when these contracts expire — and that process isn't cheap.

The content wars

Netflix, since the beginning, has offered a strong selection of content from major Hollywood studios and television companies as well as its own Netflix-only shows and films.

"House of Cards" and "Orange is the New Black" were the gateways for many subscribers to sign up with the platform. There was the promise of not just high quality productions, but the chance to binge them at their leisure. Customers could watch the entire season in one sitting or pace out the episodes over time.

As Netflix grew, it was able to secure licensing deals with major companies and even purchase some shows and films outright.

However, competition in the streaming space has heightened. The companies that once licensed their content to Netflix are deciding to cut out the middleman and go direct to consumer.

By the end of 2019, Disney+ will become available to consumers. The streaming service will feature new content from "Star Wars" and Marvel and likely classic films from Disney's archives as well as titles from its pending $71.3 billion acquisition of Twenty-First Century Fox.

This launch is going to cost Disney $150 million because it will no longer be licensing its content to Netflix. "Captain Marvel" will be the first film withheld from any output deals, Disney CEO Bob Iger said during the company's February earnings call.

This disintegrating relationship between Disney and Netflix is also likely the catalyst for Netflix's cancellation of half a dozen Marvel shows over the last few months — "Daredevil," "Luke Cage," "Iron Fist," "Defenders," "Jessica Jones" and "The Punisher." While the shows appeared on Netflix, the streaming service didn't own them. Instead, it paid ABC Studios a hefty licensing fee for each season for each show.

Disney announced in 2017 that it would pull all of its Marvel feature films from Netflix and has indicated that these canceled shows could live again on its Disney+ platform in the future.

"Our network partner may have decided they no longer want to continue telling the tales of these great characters ... but you know Marvel better than that," Jeph Loeb, president of Marvel Television, said in a letter to fans Sunday.

Jon Bernthal attends 'Marvel's The Punisher' Season 2 Premiere at ArcLight Hollywood on January 14, 2019 in Hollywood, California.
Rachel Murray | Getty Images Entertainment | Getty Images

But, Disney isn't the only company that has made plans for a stand-alone streaming service. Time Warner's owner AT&T said in November that it would soon offer customers a three-tiered service. The first would be an entry-level movie-focused package, then a premium service that would feature original programming and blockbuster films and then a third option that would bundle the first two tiers and give access to an extensive library of Warner Media content.

The biggest piece of content that Netflix currently owns from Time Warner is the popular sitcom "Friends." It was the second-most watched show on Netflix during the first 11 months of 2018, according to Recode, citing Jumpstart data.

Netflix paid $100 million to keep it on its platform through 2019. Netflix could renegotiate that contract, but it would likely cost quite a bit more to keep the show, or AT&T could decide to have "Friends" on its new streaming service to entice viewers to sign up.

Netflix could also lose NBC-owned shows "The Office" and "Parks and Recreation," which were the most watched and third-most watched shows on the platform from January to November 2018. Comcast, which owns NBC, is expected to launch its streaming platform in 2020 and will likely take this content with them.

"The big players are coming into the game and coming in hard," Csathy said. "Winning doesn't mean they have to be bigger than Netflix, winning is taking share away from Netflix."

This potential loss is a major factor in Netflix's decision to bolster its lineup of original content and shows that can't be seen on any other platform. Having exclusive movies and television shows is an important strategy for services like Netflix.

Competitor HBO is the only service that shows "Game of Thrones," "Westworld" and "Last Week Tonight with John Oliver," while CBS All Access is the only platform shows "Star Trek: Discovery." If fans want to view these shows, they have to sign up for these services.

The cost of doing business

Netflix does not own everything it brands as "original" on its platform. The term refers to Netflix being the first market that the show has aired in.

For example, the BBC's "Peaky Blinders" aired in the U.K., but did not air on BBC America. So when it was put on Netflix, it was the first time the show was in the American market, allowing Netflix to call it an original in the U.S.

Often Netflix will work with another network to create a show, pay the production fees and then a licensing fee to keep the show on its platform. The streaming service has done this with shows like "The Crown," "House of Cards" and "Ozark."

Michael Pachter, analyst at Wedbush, estimates that Netflix owns less than 10 percent of the content it had dubbed as original. Netflix licenses the rest, including popular series like "Daredevil," "Orange is the New Black," and "Unbreakable Kimmy Schmidt."

That means, Netflix has to pay an annual fee to keep these shows on its platform.

"The biggest issues as I see it for Netflix going forward is the cost of content, which is being driven up by competition," Mark Tepper, an analyst at Strategic Wealth Partners, said on CNBC's "Trading Nation" last week. "HBO's 'Game of Thrones' costs $10 million per episode and it's arguably one of the most popular series around. Netflix is paying $13 million per episode for 'The Crown' and I don't know much about that series, but I don't like the fact that it's costing Netflix 30 percent more than HBO pays for 'Game of Thrones.'"

Of course, not everyone is convinced that the entrance of Disney and other competitors into the space will be a death knell for Netflix.

"The market is embedding that NFLX will achieve 335 million subscribers by 2028," John Talbott, an analyst at Credit Suisse, said in a note to investors last week. Netflix currently has more than 148 million subscribers.

According to Talbott's calculation, the market also foresees Netflix taking hold of 42 percent of all global broadband households, excluding China.

Netflix looks the best of all FANG stocks, says strategist
Netflix looks the best of all FANG stocks, says strategist

"Subscriber growth is expected to slow domestically, but [Netflix] is more than offsetting that with their price hikes," Tepper said. "International growth is still high."

Netflix in January announced price hikes across all of its plans by 13 to 18 percent.

The company's cheapest and most basic plan now costs $9, up from $8; its most popular HD standard plan costs $13, up from $11; and its 4K premium plan costs $16, up from $14.

"I think the model we've got is a fairly simplistic one where we think our job is to effectively invest the money that our subscribers give us every month so that we can give them incredible content and a better and better product experience," Gregory Peters, chief product officer at Netflix, said during a January conference call. "And if we do that well, we create more value for our subscribers and then occasionally, we'll come to them and we'll ask for a little bit more money so that we can actually start that next cycle of investment."

Luring in major talent

Netflix has worked to not only grow the number of exclusives available on its platform, but also the prestige of those programs. StreamingObserver, an organization that analyzes the latest trends in streaming technology, determined that Netflix had the highest concentration of Rotten Tomatoes "certified fresh" films in its library when compared to its competitors.

The company even purchased Alfonso Cuaron's film "Roma," which after a brief debut in theaters has become exclusively available on Netflix. The film picked up 10 Oscar nominations, including for best picture and best director.

In addition, Netflix has contracted high profile writers and producers like Ryan Murphy ("Glee," "American Horror Story"), Kenya Barris ("Black-ish") and Shonda Rhimes ("Grey's Anatomy," "Scandal"). Murphy signed a five-year deal worth up to $300 million, Rhimes' five-year contract is worth $150 million and Barris' three-year deal is worth $100 million.

Netflix even has a multiyear deal with former President Barack and Michelle Obama for original programming.

Not everyone has been keen to showcase their products on Netflix. In 2017, Netflix tried to purchase the Academy Award nominated film "I, Tonya" about Olympic figure skater Tonya Harding, but was rebuffed in favor of a more traditional distribution model. Pachter said Margot Robbie, who played Harding, had veto power when it came to the sale of the film and that the "Suicide Squad" star vetoed the offer.

"She's basically telling you, really talented people don't want to be on Netflix," Pachter said.

At the time, Netflix wasn't seen as a place to launch a film that would seek Oscar glory. Netflix has long balked at the traditional theatrical release windows that movie theater operators expect. Traditionally, Hollywood studios, and even Amazon, have adopted a 90-day theatrical release window, which means the film will run in theaters for that time period before being available on video-on-demand or on a streaming service's site or app.

In fact, when Netflix released "Roma," it rolled out the film to theaters on Nov. 21 and then released it to Netflix's streaming service on Dec. 14, just long enough to be considered for an Oscar nomination. If "Roma" does take home top prizes at the Academy Awards on Sunday, some filmmakers could seek out the platform to air their features.

Netflix is doing this limited theatrical release for other films like "The Highwaymen," which will come out on March 15 at select theaters and then a wide release on Netflix on March 29.

Netflix's Hastings said in January that competition in the streaming space is really about winning time away from other entertainment activities like Xbox, Fortnight, YouTube and HBO.

"And so we compete so broadly with all of these different providers that any one provider entering only makes a difference on the margin," he said. "And so, again, that's why we don't get so focused on any one competitor and really think our best way is to win more time by having the best experiences, all the things we do, and that's helped us a lot."

Netflix did not respond to CNBC's request for comment.

Disclosure: CNBC's parent company NBC Universal is owned by Comcast.