The Real Reason Behind Netflix's Cable Push

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Netflix (Nasdaq: NFLX  ) seems bent on showing up on your cable bill, and now it's starting to become painfully obvious why the dot-com flick-streamer is talking to cable providers about offering Netflix as a premium add-on service.

In a note to clients yesterday, Barclays Capital analyst Anthony DiClemente praises the move by pointing out how it should increase Netflix's subscriber base, lower its subscriber acquisition costs, and deliver long-term profit growth.

Obviously, it remains to be seen what the ultimate product will look like, but Netflix won't be able to charge more than the $7.99 a month it charges existing streaming subscribers. With cable companies historically taking roughly half of the revenue, how can Netflix, making $4 or so a month off each cable customer, be better off than it would be by reaching out directly?

Well, let's drag out the churn card.

As the world churns
Netflix is no longer reporting its monthly defection rate, and there's a good reason for that. Streaming customers are a fickle lot. Netflix's churn for members taking out DVDs was never all that impressive, but at least they have unwatched Netflix DVDs around the house. They also have steady and predictable queues -- unlike with the streaming product, where a good chunk of a member's queues can be wiped clean by the end of a licensing deal.

In the last quarter that Netflix reported domestic churn -- last year's second quarter -- churn clocked in at a stubborn 4.2%. That's a monthly rate, implying that Netflix loses roughly half of its subscribers over the course of a year.

Now let's compare Netflix to DIRECTV (NYSE: DTV  ) . The country's largest satellite television provider reported its latest quarterly financials on Monday. The service provider with 19.4 million stateside subscribers -- and growing -- doesn't have any reason to hide its churn. Just 1.5% of its accounts are canceling every month. Maybe it's the gear. Maybe it's complacency. However, it would also follow that premium movie channels that cable and satellite television customers tack on would also have healthy loyalty rates.

If Netflix is just a small line item on your cable bill, you're less likely to nix the service than you would be if it was a stand-alone offering. And -- to Netflix's credit -- it's just too darn easy to terminate the service.

Apple leads the way
One of the interesting developments surrounding yesterday's Apple TV announcement -- yes, it wasn't all iPad for Apple (Nasdaq: AAPL  ) yesterday -- was a partnership with Netflix. Apple TV owners can now sign up for Netflix directly through Apple's small set-top home theater gadget.

The new Apple TV will allow couch potatoes to stream Netflix in high-def 1080p, backed by rich Dolby Digital 5.1 audio. However, the interesting twist is that the subscriptions are managed through Apple iTunes.

Why would Netflix be willing to give up Apple's piece of the action -- likely nearly a third of the revenue -- for something that it can otherwise control directly?

You already know the answer. This is the kind of move that will likely result in lower churn. Oh, and the additional members may truly be incremental. There's a reason why they would sign through Apple TV -- or eventually through a cable provider -- instead of cutting out the middleman, and it's because they likely wouldn't be wooed by Netflix on its own.

All roads lead to HBO
DiClemente points out how Time Warner's (NYSE: TWX  ) HBO is feasting on EBITDA margins of 35%, well above what Netflix has been up to lately. Clearly, there's money to be made by teaming up with a cable provider.

However, DiClemente also points out that the move may force Netflix into landing more proprietary programming to stand out. Netflix has already taken inroads into original programming. There was Lilyhammer last month, and House of Cards is shuffling the deck this summer.

Then again, if Netflix is pricing its offering at roughly half of HBO's monthly ransom, can't it score enough subscribers with its quantity over quality?

I was initially skeptical of Netflix's rumored push through cable providers, but now that it's growing closer to becoming a reality, it does make sense. Once again, Hastings is one step ahead of the market.

Good luck getting away with all of the hooks that Netflix is throwing into the water.

Stream on
Motley Fool Co-founder David Gardner has been a fan of Netflix as a disruptor for nearly a decade, but there's a new rule-breaking mutlibagger that's getting him excited these days. Learn more in a free report that you can check out right now.

The Motley Fool owns shares of Apple. Motley Fool newsletter services have recommended buying shares of Netflix and Apple, as well as creating a bull call spread position in Apple. 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. The Motley Fool has a disclosure policy.

Longtime Fool contributor Rick Munarriz has been a Netflix subscriber and shareholder since 2002. He does not own shares in any of the other stocks in this story. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early.

Read/Post Comments (4) | Recommend This Article (7)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 08, 2012, at 10:02 AM, MINNION wrote:

    You can stream NFLX form your XBox, Playstation etc, Apple Tv is just another device.

    The reality is that NFLX is LOSING its customer base. Xfinity is $4.99 a month. For NFLX to stay relevant it has to charge no higher than that.

    Thereby cutting its current lost to a Demise. HBO Go is Free. Good luck to all that is buying the stock at this price, because its going lower.

  • Report this Comment On March 08, 2012, at 12:17 PM, Tidalcloud wrote:

    HBO Go isn't free. You have to be subscribing to HBO via your television service. HBO Go simply provides additional points of access.

  • Report this Comment On March 09, 2012, at 1:00 PM, JoePhx wrote:

    The only reason I don't have Netflix is because it requires a device that I would have to buy, hook-up, etc... If it was available through my cable company, I'd sign up today. Also, I find it absolutely ridiculous that people complain about Netflix's pricing. They should get double for what they offer.

  • Report this Comment On March 10, 2012, at 3:33 PM, funspirit wrote:

    ou can hook up your PC to your TV and send netflix to it via that, or roku. Not that hard.

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