Netflix’s Achilles Heel: Content Costs? AUGUST 10, 2010, By Michael Corkery
The biggest deal of the week has nothing to do with M&A. It is Netflix’s content-sharing agreement with Epix, a joint venture of Lions Gate, Paramount and MGM.
The deal, which will reportedly cost Netflix $1 billion over five years, will give the DVD renter access to 1,500 movie titles, including such flix as the “Indiana Jones,” “Star Trek” and “Godfather” series.
For Netflix, it is a big step toward expanding its streaming-video offerings, upon which the company is staking its future. Netflix is seeking to move away from the mail-order DVD business, which is bloated with shipping and warehouse costs, and build its digital, “Watch Instantly” business.
But this deal comes at a cost for the high-flying company (whose shares have doubled in the past year). In order to pay for the deal, Stifel Nicolaus estimates Netflix must attract 500,000 new subscribers a quarter more than the firm’s current estimated subscription growth. Any fewer subscribers and the company would erode its 35% gross profit margins that investors have come to love.
Another problem is that these content-sharing deals are getting progressively more expensive for Netflix. In 2008, it negotiated a content-sharing deal with Starz, giving it access to Disney and Sony titles, for a mere $30 million a year, for several thousand movie titles. (The Epix deal averages $200 million a year). Of course, the Starz deal came in different times for Netflix, which had yet to break into streaming services for television set boxes and was largely confined to PC viewing.
“We do not believe Starz will make the same mistake twice,’’ writes Bank of America analyst Nat Schindler.
In negotiating its next deal (which could happen by the end of the year), Schindler estimates Starz could extract $180 million a year in Earnings Before Income Taxes Depreciation and Appreciation from Netflix, “with no change in the user experience.”
So the race is on. As content gets more expensive, Netflix will have to find ways to either phase out its old line DVD business, significantly cut costs or keep rapidly building out its subscriber base.
The upside of increasing its moving offerings is that it may enable Netflix to raise prices on its streaming services (currently $8.99 a month, compared with Hulu’s $9.99 a month)
[The following paragraph has been updated to reflect Netflix's current subscriber base]
But Netflix should tread carefully in tinkering with its more than 15 million subscribers. As the Epix deal reminds us, the company doesn’t generate its own content. Its streaming technology isn’t proprietary (Hulu and YouTube have it).
At the end of the day, subscribers are Netflix’s greatest asset
NOW IF STAR Z DEMAND $180M FOR STREAMING DEAL, WHAT HAPPENS TO: MARGINS? CASH FLOW?
Hastings already wiped out all cash and used DEBT for this Bubble scam for quick loot with massive zero cost stock options enrich scheme. $200m Debt and current earnings not enough for EPIX and what about StarZ by End of 2010?
THE BOMB: But Netflix should tread carefully in tinkering with its more than 15 million subscribers. As the Epix deal reminds us, the company doesn’t generate its own content. Its streaming technology isn’t proprietary (Hulu and YouTube have it).