Why "House of Cards" Doesn't Need to Be a Hit

Netflix's (NASDAQ: NFLX  ) new original series House of Cards has pulled in piles of critical praise since debuting on the streaming service last month. And yet, the bears point out, it couldn't possibly attract enough new subscribers to justify what Netflix had to pay for it.

That's probably true, but I think it's a too-narrow way to look at Netflix's investment. The show doesn't need to be a marketing hit to generate a good return for the company.

Sure, at a quick glance the math looks rough. We know that the company paid $100 million for two seasons. As the argument goes, it would need to sign up over 1 million new subscribers at the current rate of $7.99 per month -- and keep them on the service for a full year -- to get that investment back in new revenue. Considering that Netflix only managed to add about 5 million streaming subscribers in the U.S. for all of last year, expecting 1 million new subs based on this single title would be unrealistic.

But Netflix isn't just interested in getting new subscribers. Even more important is keeping the masses of current customers happy. Netflix has made a point of allowing streamers to easily break out of the service. As CEO Reed Hastings said in last quarter's conference call, "[W]e really want to make it easy to quit." That's a smart long-term strategy, as long as you have great content to convince users to stay, or to entice them back after taking a break. Otherwise, customers can take their business to rivals like Amazon.com. The e-tailer's Prime video service has been shelling out for exclusive content too, most recently in an agreement to stream CBS' new show Under the Dome this summer.

When viewed as more of a tool to keep subscribers from jumping ship to competitors, it's clear that Netflix has a good shot at getting its money's worth from the House of Cards investment. The company started this year with 25.5 million domestic streaming subs. To make $100 million more in revenue, it would need those members to stick around just half a month longer than they otherwise would have.

Could compelling exclusive content be enough to move the needle on subscriber churn? You bet. One early survey of Netflix users by the investment firm Cowen found that 86% of subscribers said House of Cards made them less likely to cancel their subscription.

There are two ways that Netflix can raise its membership rolls: adding a new subscriber or keeping a current one from canceling. It's with this second group that the company's original content investments could really pay off.

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  • Report this Comment On February 26, 2013, at 11:21 AM, DigitalMediaView wrote:

    The premise of this article is deeply flawed. NFLX has to significantly grow their subscriber base to pay for the cost of streaming content, like the very expensive new Disney deal they recently signed. They cannot simply retain their existing base, and they certainly cannot afford a $100M expenditure that merely functions as sub retention, because their margins are currently razor thin. They have made huge multibillion dollar content commitments in the future predicated on growing their subscriber base.

    While people surveyed did tell Cowen they were more likely to stay subscribed to watch House of Cards, for how long? Long enough to watch the show, which was released all at once, and then churn. Two recent assessments based on data analysis shows this binge release publicity stunt may backfire on retention and long term value of the investment, gauged by declining social media buzz (http://nyti.ms/12NaEgT) and search volume (http://bit.ly/13gwQvf).

  • Report this Comment On February 26, 2013, at 11:26 AM, TheGrowingValue wrote:

    This article is so foolish. Amazon can afford to provide streaming for free, but Netflix cannot. Netflix does not have anywhere nearly as big a pocket as Amazon. Competing with Amazon on free offering is going to bankrupt Netflix.

    This article is full of wishful thinking that is clouding the judgment of proper investing.

    Investors need to separate facts from wishful thinking. The CEO yesterday already clearly trying to downplay the effect of House of Cards. Investors should get the hint and understand House of Cards added not much to Netflix offerings. It is a very expensive experiment for Netflix, but it failed to provide the needed impact. That is the reality. And investors should understand new experiment fails all the time. What the investors should worry is knowing this avenue does not work, but Netflix still has a lot more money it has to spend in this dead end road due to contracts. How is Netflix going to survive?

    It is really foolish that to analyze a stock there is no mention of how absurdly high the PE is. There is no way Netflix investor can justify the high PE. Especially when it is so hard to make money in this industry with so thin of profit margin and fierce competitions.

  • Report this Comment On February 26, 2013, at 12:17 PM, AceInMySleeve wrote:

    Water cooler talk gets replaced with:

    A) [on Friday] Hey A, have you seen House of Cards?

    B) No

    A) Check it out.

    B) [After weekend]: Holy crap that was amazing.

    A) How far did you get?

    B) [blushes] All of it. Couldn't stop.

    A) Word up, B.

    CHAT CHAT CHAT CHAT

  • Report this Comment On February 26, 2013, at 6:15 PM, TMFSigma wrote:

    @digitalmedia - I wouldn't call Netflix's margins razor thin. Contribution margin from U.S. streaming was 18.5% last quarter, almost double the 10% the company saw a year ago. And management expects that to keep expanding. With over 100 million in profits from that division in just the fourth quarter, of course the company can afford to make content investments like this.

    @thegrowing value - I don't think comparing PE ratios and recommending Amazon is the way to go here. Sure, Netflix has a high ratio, but Amazon has *no* ratio, given that it hasn't logged per-share profits over the last 12 months (maybe Amazon can't afford to give streaming away). But I agree that HoC is an expensive experiment. It's definitely too early to say that it failed, though.

    @AceinMySleeve - I heard a lot of the same chatting with my friends, B.

    Thanks,

    -Demitrios

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