As AI Looms, Netflix Opts For Valor’s Better Part, And Profits

Netflix today walked away from spending more than $83 billion for the prized assets of Warner Bros., leaving to Paramount Skydance the possibly poisoned chalice of a far more expensive, debt-soaked acquisition of all of Warner Bros. Discovery at a time when artificial intelligence threatens to upend the industry.

It’s telling that Netflix’s announcement came after Co-CE) Ted Sarandos met with White House officials. The company’s regulatory prospects may have indeed been insuperable, as many opined, but the bigger challenge is a familiar, having helped shape Walt Disney Corp.’s board choice for Bob Iger’s successor.

There, the Disney board opted for the well-regarded parks and resorts executive over the well-regarded entertainment executive, tapping Josh D’Amaro to run Hollywood’s biggest traditional studio.

And the reasoning was likely stark. When Iger finally announced nearly a year and a half ago that he was finally departing, AI was still seen as a somewhat distant threat to studio profits. By the time Disney’s board made its choice, that threat was no longer distant. Disney’s Experiences unit under D’Amaro, was generating the majority of the company’s prospects, and climbing.

The House That Walt Built is no longer driven mostly by the company’s many movies and TV shows; instead, it was the Enchanted Castle and all the in-person, premium experiences of Experiences. You can thank AI-created content for clouding the prospects for even Disney’s admirable collection of intellectual properties, which it routinely cycles through films, TV shows, streaming, and Experiences offerings.

For Netflix, the realities were about to become similarly pressing. Instead of pursuing an $82.7 billion acquisition (including debt) of the film and TV production studios, library, lot, HBO and HBO Max – an understandable impulse given that those are Hollywood jewels – Netflix retreated, perhaps simultaneously acknowledging the looming shifts in the economics of making long-form entertainment.

Investors certainly raised concerns about Netflix’s acquisition plans. They sent share prices into the ground, but also didn’t express much interest in Paramount Skydance’s repeatedly shifting (upward) proposed deals.

For Netflix shares, a one-year high of $133 on June 30 plummeted almost 43%, to as low as $76 earlier this week. Netflix’s deal-killing announcement sent shares up 13% today in after-hours trading.

One good reason: Instead of laboring under $60 billion in debt from a completed WB acquisition and months of distractions navigating the regulatory gauntlet of Trump cronies and skeptical European overseers, the company has a full quiver of resources to deal with AI’s challenges.

Instead of paying down billions in debt, the company is left with its previous $5.5 billion in debt, with a blue-chip debt-to-EBITDA ratio of .5.

Netflix announced it would devote $20 billion to make more programming, a very good way to use suddenly freed-up capital to fend off future AI competition. For comparison, over the past few years Netflix has spent $17 billion a year on programming, though the mix has shifted from traditional movies and TV series as it has signed deals with the NFL, WWE, various one-off live events, video games and in-person live experiences.

Even sweeter, Netflix will receive a $2.8 billion deal-termination payment financed by Paramount Skydance as part of its latest, winning bid.

And Netflix will need the additional programming . Some of the company’s biggest franchises have ended or aren’t stirring the cultural conversation as they once were. Stranger Things wrapped, with creators the Duffer Bros. headed to another studio. The Witcher couldn’t navigate star Henry Cavill’s departure. And Shonda Rhimes’ fourth season of Bridgerton has been meekly received.

To break through the distractions of free, good-enough AI slop, Netflix must develop other must-watch franchises that grab audiences in a competition for eyeballs that’s about to get stouter.

Hollywood studios and trade unions came down hard on Chinese tech company ByteDance the past few weeks for its Seedance 2.0, which a little-known filmmaker used to spin up a widely viewed, 15-second scene of Brad Pitt and Tom Cruise fighting on a rubble-strewn rooftop. The video wasn’t real, nor was it perfect. But it was good enough to remind Hollywood denizens that the clock is ticking.

ByteDance this week updated Seedance with more guardrails against copyright infringement, much as OpenAI did last fall after a similar contretemps over its Sora text-to-video social app.

The Hollywood studios and guilds also have come to a workable relationship over AI, after spending half of 2023 in actor and writer strikes that led to a new series of AI limitations for signatories that include Netflix.

With those contracts expiring again this year, there’s little appetite on either side for another strike. Entertainment lawyer Kenneth Ziffren, one of the town’s most connected power brokers, said Wednesday at the DEG Entech Fest conference that he was “nervous but optimistic” about labor relations this year.

“In 2023, all the guilds in essence established a principle that a machine is not human,” Ziffren said. “Therefore, whatever the machine produces will not affect the talent that’s involved, whether that’s a writer, who won’t lose a separation of rights or credit, a director, or obviously an actor. The good news about all that is that since agreements were reached in November of 2023, no complaint has been filed by any guild or union against any studio.”

That “potentially gets into the second phase” of dealing with AI in Hollywood, Ziffren said.

“I know all of the studios, whether the three pure streamers or the four studio streamers, are all doing extensive work in terms of trying to figure out how to simplify their development/pre-production/production/ post-production activities. That will continue the new few years. Experimentation will follow from that.”

The problem, Ziffren acknowledged, is all the production companies and creative minds out there who are not guild members or employees of the signatory entertainment companies. Without better government regulation, he suggested, Hollywood’s establishment, including Netflix, will face a phalanx of challengers with none of the burdens/protections of the contracts.

“The worst scenario is inaction on the part of governments,” Ziffren said. “Whether we end up with more of a Trump administration solution or a Democratic solution is not as important as whether we have guidelines to work with. I think inaction is the worst because it will lead to chaotic situations and also to what I’m principally concerned about, which is getting/having AI out of control.”

Absent a more comprehensive government response (perhaps that was also part of Sarandos’ White House conversations today), what else can Netflix do?

Here’s an idea. The NFL is almost certain to reopen its $110 billion, 11-year TV contract as soon as this year. One sweet piece of revenge, swiping a bigger share of the most valuable programming on PSKY’s CBS and Paramount+. Without the WB deal, Netflix will certainly have the available resources to aggressively scoop up more NFL games.

And, as some analysts have suggested, Warner Bros, Discovery, and Paramount may all be back in the market again soon, at a bargain price. The combined company will have a crushing debt-to-EBITDA ratio of 7X, may have to cut $16 billion or more, and still may not be able to build a sustainable company.