On Tuesday, Netflix (NFLX 0.09%) and Walt Disney (DIS 0.64%) announced a deal to make new feature films from Disney's studios available on Netflix's streaming content system. Starting in 2016, films released by Disney, Walt Disney Animation, Pixar, and Marvel will be available to Netflix subscribers on multiple platforms, including television and tablets, about seven months after their release. Netflix will be the only American pay TV service to offer these films. Disney will also make films from its back catalog available on Netflix immediately, as well as release new direct-to-video features on Netflix starting in 2013. Shares of the video streaming service rose as much as 15% on the news.
This is a substantial coup for the young video distribution company, and it marks the first time a major studio has passed over traditional premium pay TV services like Starz and HBO in favor of a streaming-based service like Netflix. Netflix had previously made Disney content available through a partnership with the Starz premium service, owned by Liberty Media Company (LMCA +0.00%), which had held the streaming distribution rights to Disney content.
However, after negotiations to renew that deal failed, Netflix lost all Starz content early in 2012. Today's news is a measure of vindication: Disney's deal with Starz expires in 2016, and the media giant chose to license directly to Netflix instead of Starz. Shares of Liberty Media Company sank 6% on Tuesday.
This is certainly the biggest win for Netflix in acquiring exclusive content, but not the first. Late in 2011, Netflix bought up the exclusive rights to stream content from DreamWorks Animation (DWA +0.00%), the animation studio behind films such as Shrek and Madagascar. Netflix will be able to begin streaming DreamWorks content in 2013. However, DreamWorks' library of only 25 feature films and pipeline of two to three films per year pales in comparison with a giant like Walt Disney, with a library spanning hundreds of films and a pipeline capable of producing more than a dozen films annually.
Netflix lured DreamWorks away from Time Warner (TWX +0.00%) subsidiary premium TV channel HBO, but HBO seemed perfectly willing to drop DreamWorks, even letting the studio out of its agreement with Time Warner early. HBO's access to Time Warner's impressive content portfolio, which is the largest in the industry, as well as its own award-winning original series, makes that platform less reliant on securing outside content. The video-on-demand HBO GO service, which allows subscribers to access HBO content on many different devices, could eventually shape up to be serious competition for Netflix.
While HBO remains tied to traditional cable providers, however, Netflix's biggest competition is the entry of tech giants such as Amazon.com (AMZN +1.96%) into the content streaming business. A subscription to Amazon Prime provides access to Amazon Instant Video at no additional cost. The two services are available on many of the same platforms, including computers, gaming consoles, and tablets, so the primary differentiator between the services is the content library that each offers.
While Amazon Instant Video has made progress in acquiring valuable content -- for instance, securing an exclusive licensing agreement with premium channel Epix in September that Netflix had held previously -- Netflix's exclusive deal with Disney should provide a decisive edge in superior content. For now.
The missing piece
What was left out of Tuesday's announcement was the sum Netflix paid Disney for the distribution rights. As more distribution channels for content emerge, particularly competing streaming services such as Amazon Prime, Hulu, and even Google's (GOOG +1.11%) YouTube, studios and content owners can demand ever-higher premiums for their features. In recent years, content acquisition costs have risen faster than subscription prices.
In fact, when Netflix first lost access to Disney content as a result of the failure to reach a deal with Starz, the problem was that the two companies couldn't agree on a price. The original contract between Netflix and Starz was for a five year, $30 million licensing agreement. Netflix CEO Reed Hastings had claimed his company would pay as much as $200 million for a new contract, but apparently a deal worth almost seven times more than the original agreement wasn't good enough for Starz.
Netflix has so far been silent on what it cost to grab the rights to Disney content out from underneath Starz, but the Los Angeles Times cited an internal source to claim that Netflix may be paying more than $300 million annually. That's about 10% of Netflix's 2011 sales, and significantly more than the company's $226 million in 2011 net income. To continue to afford this kind of content, Netflix will have to grow its subscriber base rapidly.
Many of its rivals don't face this kind of cash crunch. Companies such as Amazon, Time Warner, and Google generate revenue and earnings orders of magnitude greater than Netflix and could afford deals for premium content much more easily than their small competitor. If securing access to quality content becomes the single most important factor in the success or failure of different video streaming services, Netflix will be at a distinct disadvantage.
