Why Amazon's Movie Service Won't Hurt

Amazon.com (Nasdaq: AMZN  ) made a bold move into the digital media world last week. A brand-new movie subscription service is now attached to the Amazon Prime free-shipping program for no additional charge. It's an unexpected add-on for an unrelated service, but the move also carries loud echoes of Netflix (Nasdaq: NFLX  ) adding its own streams as -- surprise! -- a free add-on for a mail-based service.

The business case
It's a brash and unexpected expansion of Prime that follows through on promises made by CFO Tom Szkutak in Amazon's latest earnings call:

Many of our digital initiatives are around how do we make sure we get customers, not only creating great price and great selection but they get to have their content immediately. We start with the customer first. That's where our focus is. We found that by aligning with the customer, it's been great for customers as well as great for shareholders over time.

The idea is to draw customers into the Amazon fold for the long haul. Amazon isn't talking about this, but I would assume that a Prime subscriber ends up placing more and larger orders with Amazon. We all want to get some value for that annual subscription fee, you know. Higher sales means bigger profit and more cash for Amazon, so it's in the company's best interest to grow Prime membership as quickly as economically feasible.

To that end, this is a brilliant move that will pay dividends for years to come, even if Amazon keeps Prime's movie add-in small and cheap and never truly becomes a big-time movie distributor. The publicity gained from the whole affair is a good start, and many consumers will sign up for anything if given the right incentives.

Bears come out of hibernation
But Wall Street doesn't necessarily see it that way.

Analysts at UBS downgraded Amazon on this news, because they think movie streams will be too expensive. Citing "increased content costs and new distribution deals with hardware providers (game consoles, TV's, etc)," the firm cut its price target on the stock by 8% and lowered it from "buy" to "hold."

This is the exact same argument that keeps getting invoked around Netflix. Licenses are too expensive, the business will never be profitable, it's just going to get worse over time as every studio raises its license prices. Cry me a river.

The real deal
Amazon's movie subscription service really goes down in the plus column for the company and the stock.

Nobody is expecting this 5,000-title library to measure up to the much larger (and still growing) Netflix catalog, and it's a free service to begin with. The list of Prime-eligible flicks is decidedly long in the tooth as the top rentals currently include classics like Jerry Maguire and Amadeus. By contrast, Netflix's deals with Liberty Starz (Nasdaq: LSTZA  ) , Epix, and other middlemen brings out plenty of reasonably fresh content. So Netflix has a stronger immediate customer pull, but Amazon will get some nice growth out of the deal.

We don't know exactly how the company has structured this first round of license deals, but I think it's reasonable to assume that it's a low-cost handful of flat-rate licenses rather than a sliding scale that would require payments per view. And we know that the actual cost of storing and sending digital content is borderline negligible.

Potential pain
In the absolute worst-case scenario, Amazon would see Walt Disney (NYSE: DIS  ) , Time Warner (NYSE: TWX  ) , and the other Hollywood bigwigs playing hardball with their licenses. Movie streams could become a potential drag on earnings, just as UBS predicted.

The experiment would be a failure, Amazon would drop it like a hot potato, and that's the end of that. The harm to Amazon's financial statements would be very small, if not zero. Netflix would remain the only serious subscription-rental game in town unless Coinstar (Nasdaq: CSTR  ) gets its long-rumored online service up to speed. That's a big "if."

That's hardly cause for a significant Amazon downgrade, and again, that's the worst that could happen.

Amazon will probably see more upside than that, encouraging the bookseller to stay in the rental-subscription game and invest in the business. One day, you might be able to buy an Amazon movie subscription without the Prime package, much like Netflix offering a stand-alone digital service nowadays.

Have you gone bonkers?
So if I'm so happy about Amazon's movie service, shouldn't I then be shaking in my boots as a Netflix shareholder?

No, and I'll tell you why: This market is plenty big enough for several competitors. It's kind of like asking if there's room for more than one brand of soap, or several types of cars and trucks, or perhaps we should give the Yankees a monopoly on baseball?

Healthy competition will only serve to grow the digital media market faster, which sounds like a net positive for Netflix, too. Seal it with a kiss, Bezos.

Amazon is one of the real cash kings that are changing the face of retail right now. Find out who's the other one by downloading this free report from Tom and David Gardner.

Fool contributor Anders Bylund owns shares of Netflix, but holds no other position in any of the companies discussed here. Amazon.com, Walt Disney, and Netflix are Motley Fool Stock Advisor picks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. You can check out Anders' holdings and a concise bio if you like, and The Motley Fool is investors writing for investors.


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