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A report from Convergence Consulting Group made the rounds last week, showing that 2.65 million Americans cut the cord on cable TV in the last three years. I'll buy that for a dollar, judging by the anemic subscriber trends at all of the major cable service providers.
But then the analyst group broke out a crystal ball to predict the future of cord-cutting. I'm afraid their palantir could use a good cleaning.
Convergence sees the trend reversing in 2012 and 2013. OK, I'll bite: Have Comcast (Nasdaq: CMCSA ) and DISH Network (Nasdaq: DISH ) figured out how to win back their lost customers? Will the cable guys impose strict bandwidth caps on their high-speed Internet products in order to discourage heavy use of Hulu and Netflix (Nasdaq: NFLX ) ? Did the firm find some new, legitimate threat to the rise of digital video?
Any of these explanations would at least make some sense. But what Convergence actually came up with borders on the ridiculous. The main driver of the expected trend reversal is the rising cost of content licenses. To me, this shows that the firm doesn't understand how Netflix works.
It's all in the timing
Speaking to the Hollywood watchers at TheWrap.com, Convergence analyst Brahm Eiley explained his position: "Unless Netflix achieves sufficient revenue growth it will not be able to sustain its high programming costs."
This is true in the long run. Movie studios and TV networks will inevitably charge more for their streaming licenses as Netflix and other digital services prove that there's real money to be made there. It's already happening, which is why Netflix walked away from its distribution contract with Liberty Starz a month ago. And as Convergence correctly notes, content costs are "skyrocketing" in 2012 and 2013. Piles of big-dollar content contracts are about to move onto the balance sheet as the actual films in these contracts become available to Netflix subscribers.
Based on that nugget, Convergence might be able to predict a slowdown in cord-cutting by 2014 or 2015 at the earliest. But a sudden increase in license costs does not lead to an immediate drop in consumer interest. If there is an implosion lurking in these numbers, it would come when the batch of signed, sealed, and soon-to-be delivered license deals expire and come up for outrageously expensive renewals.
In the meantime, the influx of costly but high-quality content deals should result in accelerating customer counts for Netflix and even more defections from the cable and satellite services. Netflix CEO Reed Hastings isn't stupid. He wouldn't pay top dollar for new content agreements unless they made his service better and more attractive. And good content is the honey with which consumer services like Netflix lure in new subscribers.
The writing on the wall
The takeaway from these facts is clear: If cord-cutting in general and Netflix in particular are about to peak, that sea change is still several years away.
The digital movie market today is comparable to the music industry when Apple (Nasdaq: AAPL ) iTunes was young. Studios must adapt to the new reality of digital consumption, which will eventually squeeze out DVD and Blu-ray discs to become the main distribution method. The old guard never expected Apple to change the music industry, but the big-box retailers aren't laughing anymore. The story is about to repeat in Hollywood. Convergence Consulting isn't reading the writing on the wall.
So I wouldn't sell Netflix or buy cable stocks based on reading this report. It's a fundamentally flawed study, at least in the forward-looking section.
Netflix already accounts for one-third of all Internet bandwidth at peak hours in America. Plastic discs simply can't compete with the low costs of digital distribution, just as the low overhead of online retailing is killing the traditional big-box stores right now.