Everything seems to be humming along smoothly at Netflix (Nasdaq: NFLX).
Shares of the digitally proficient movie-rental service hit an all-time high yesterday, and it's easy to see why. The company's subscriber base is growing quickly, topping 15 million couch potatoes and counting in its latest quarter.
Cynics who figured that Netflix would be toast as postage rates inched higher and the optical disc approached extinction find that the flick-flinger is laughing last. Its decision to aggressively expand its digital library over the past three years -- and work with video-game console, DVR, and Blu-ray player manufacturers to make home-theater streaming seamless -- has left Netflix at the forefront of the digital celluloid revolution.
After striking deals with Relativity Media and Liberty Starz's (Nasdaq: LSTZA) Starz to gain access to fresher streaming content, Netflix turned heads this month by inking a multiyear deal with Epix -- the premium digital television service owned by Lionsgate (NYSE: LGF), MGM, and Viacom's (NYSE: VIA) Paramount, which has digital rights to the films put out by the three studios.
Everything seemed to be going swimmingly, but there's a holdout in Netflix's plans to one day replace disc-based rentals with cheaper and inventory-free digital streaming. Time Warner's (NYSE: TWX) HBO isn't about to be wooed by a sweetheart deal.
This is huge. We're not just talking about HBO hits including Entourage and Curb Your Enthusiasm. According to Bloomberg, HBO also holds the cable and online streaming rights to films cranked out by Warner Bros., 20th Century Fox, and General Electric's (NYSE: GE) majority-owned Universal Pictures.
"There is value in exclusivity," HBO Co-President Eric Kessler tells Bloomberg, indicating that it would rather beef up its own digital offering than fortify a competitor.
HBO would be leaving a lot of money on the table by ignoring Netflix. The deal with Epix will reportedly find Netflix paying more than $900 million over the next five years -- and that's is simply for streaming access to Epix's library, three months after films become available on cable.
Smarter than a Soprano
HBO isn't stupid. For starters, it knows that being the only landowner not to cave to the mighty developer may smoke out a better deal.
However, even if this isn't a ploy to squeeze Netflix, it makes perfect sense for HBO to protect its own space. Time Warner is beefing up HBO Go, a streaming service that it's making available to existing HBO premium subscribers at no additional cost.
Maintaining exclusivity is an easy way to drum up more HBO subscriptions. The moment Curb Your Enthusiasm calls it quits, I'm cancelling HBO. I would likely do the same if first-run episodes of the show were available through Netflix.
The entire cable industry -- including Time Warner spinoff Time Warner Cable (NYSE: TWC) -- is probably cheering HBO on here. Can you imagine the incredible sucking sound of cable and satellite television cancellations if Netflix offered on-demand access to hit television shows and movies?
HBO is actually doing the industry a favor by playing keep-away with Netflix. It's also, oddly enough, helping to keep the DVD alive.
Life without an entourage
As long as Netflix can't get all of the movies its subscribers crave digitally, it will continue to man distribution centers and shuffle DVD and Blu-ray discs around the country. Its entry into Canada later this year -- strictly as a streaming service -- will never be complete.
HBO has that kind of power for now. It may not last.
After all, two can play that game. If HBO wants to save the premium cable industry, Netflix simply needs to find a partner that can fill in the gaps. Why can't Netflix's on-demand library -- uncontested in terms of sheer volume -- become the next HBO? Why can't Netflix work to stack its service on top of either basic cable or work with the next generation of web-based television providers? HBO may be the lone holdout, but Netflix has all of the land around it. If it wants to Daniel Plainview the cable channel -- and drink HBO's milkshake -- Netflix can do exactly that.
It would be a shock if, five years from now, folks aren't paying a lot less for a greater selection of video. It would also be a surprise if Netflix isn't in the middle of it all.
HBO Go isn't a service. It's a mandate. If the two come to blows, don't be surprised if consumers side with Netflix.
Can Netflix ever compete with premium cable? Share your thoughts in the comment box below.
