Netflix Has an Ace Up Its Sleeve

If studios are going to keep content out of Netflix's (Nasdaq: NFLX  ) digital vault, it might just have to make its own.

Deadline Hollywood is reporting that the leading movie rental company has outbid AMC and Time Warner's (NYSE: TWX  ) HBO for House of Cards, a drama series directed by David Fincher and starring Kevin Spacey.

If it's true, this is pretty substantial. AMC is available in more than 96 million homes. HBO has 28.2 million premium subscribers in this country alone, according to media research firm SNL Kagan. Netflix just started selling $7.99 monthly streaming plans this year, but it's largely seen as a DVD service to its more than 20 million subscribers, with its digital catalog also available at no additional cost.

Netflix is reportedly making a full commitment for 26 episodes across two seasons, a move that Deadline Hollywood estimates will set Netflix back about $100 million.

Is paying $5 per subscriber worth it? Yes. Will Netflix really go it alone here? We'll see.

Full house
Some reporters speculate that Netflix will team up with a friendly cable network or broadcaster to offset the costly production expenses. Every episode would then air first on the channel, before moving on to Netflix as its exclusive online provider.

That's a sound strategy, but does Netflix really have to go that far? The company would get the most value from House of Cards by making its subscription service the only way to see Fincher's first television series.

After all, this would be the ultimate bargaining chip in acquiring non-exclusive content. Liberty Starz (Nasdaq: LSTRZ  ) is the first major digital deal that Netflix has coming up for renewal. Netflix has made it clear that there is no single content deal it absolutely can't live without. That's an easier argument to believe once Netflix begins stocking up on proprietary content.

HBO can set a couch potato back by as much as $24 a month, on top of a cable or satellite television provider's standard programming charges. HBO has been shedding subscribers lately, but if it can get away with a $10-$24 charge a month with a handful of movies and original shows, why can't Netflix be the next major premium content hub?

There's no other all-you-can-watch digital service even close to Netflix in reach. It's the New York Yankees of streaming video, with a blank check that no one else can match. Can you picture Amazon.com (Nasdaq: AMZN  ) or Redbox parent Coinstar (Nasdaq: CSTR  ) ever going this route?

Me neither.

Royal flush
Shelling out $5 per subscriber for two years of a single show may seem like lunacy for a company that already has tens of thousands of streaming options.

Instead, I think it's brilliant. Netflix's most troubling metric is its 3.8% churn rate. That may seem like a small number, but keep in mind that this is a monthly cancellation rate. Every month, Netflix sheds 3.8% of its subscribers (while attracting new ones, of course). Add that up over the course of an entire year, and one begins to realize how Teflon-coated Netflix's model really is. A series that plays out over two years, exclusively to subscribers, could help more of those wayward customers stick around.

Churn won't be the death of Netflix. The company can make up those transient losses in volume. Subscriber acquisition costs are low, down to a freakishly cheap $11.13 in its latest quarter. But on the flipside, a cancellation is never more than a couple of clicks away. This isn't a hardware-driven premium entertainment service like DirecTV (NYSE: DTV  ) or Sirius XM Radio (Nasdaq: SIRI  ) , where initial investments and subscriber acquisition costs are high, but churn is low.

There is little incentive to join Netflix right now. Its digital catalog relies largely on television shows and older movie titles. Even the new releases that are hitting your local Blockbuster or pay-per-view source aren't likely to be on Netflix, even via DVD. Netflix, and to a lesser extent Redbox, have struck deals with studios for 28 day delays in retail availability.

A hot show, though -- available only on Netflix and served up in installments over a two-year span -- should work wonders for improving the movie service's churn rate.

Netflix won't be seen as a house of cards if it nabs House of Cards -- all for itself.

What do you think of Netflix possibly getting into original programming? Share your thoughts in the comment box below.

Amazon.com and Netflix are Motley Fool Stock Advisor selections. 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.

Longtime Fool contributor Rick Munarriz has been a Netflix shareholder -- and subscriber -- since 2002. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.


Read/Post Comments (2) | Recommend This Article (11)

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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 16, 2011, at 5:32 PM, adamhu wrote:

    While the rosiest of scenerios could see Netflix returning 10% per year to shareholders, it's far more likely that new deals, combined with adjustments for their current amortization method, plus the realization of how little cash is being generated in relation to earnings will ultimately pull the stock back more in line to the fundamentals (which are fairly strong...)

    So maybe a 50-70% correction would see a good price for a decent company.

  • Report this Comment On March 17, 2011, at 11:19 AM, racchole wrote:

    I seriously hope Netflix isn't depending on Fincher's upcoming House of Cards to bring in subscribers.

    House of Cards is a re-make of the original BBC production of the same name. The original was 4 episodes, each 1 hour. Yet again, the United States is going to attempt to adapt a BBC broadcast for the American audience, and it will be mediocre at best. This adapation will be akin to Life on Mars, another show stolen by ABC from the BBC network, which lasted less than a year on television in the United States.

    I love Netflix and have been a proponent of their company for several years, but if they are going to start taking risks on un-finished television broadcast rights, then I fear they won't reach the subscriber numbers that they anticipate.

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