It's no coincidence Disney (NYSE:DIS) selected Netflix (NASDAQ:NFLX) as its strategic partner for online streaming video delivery. While Netflix is making the case to consumers for one of its subscriptions over the addition of another pay-TV station through a cable provider, Disney is positioning itself for success regardless of what the future holds for its new partner.
The deal is rumored to have netted Disney $300 million per year in revenue and aligns it with Netflix for the future (just in case Netflix is not able to pull out of the nosedive that began over a year ago). Ultimately, while Netflix shareholders are feeling flush -- the stock popped 14% higher on the announcement -- Disney is the better play on the deal.
Under terms of the transaction, Netflix will immediately gain access to many Disney classics, including Dumbo, Pocahontas, and Alice in Wonderland. In 2013, Netflix will gain access to a variety of "high-profile Disney direct-to-video new releases." These titles will allow Netflix to position itself more like a pay-TV channel at a far more attractive price.
Ted Sarandos, chief content officer at Netflix, spoke highly of the deal: "Disney and Netflix have shared a long and mutually beneficial relationship and this deal will bring to our subscribers, in the first pay TV window, some of the highest-quality, most imaginative family films being made today." The belief in the appeal of the content is evident from the reported price tag, which will require significant subscriber growth in order to offset the additional cost.
The final piece of the deal does not come into play until 2016. At that time, all major theatrical releases through Pixar, Disney, Marvel, Walt Disney Animation and Disneynature will all be available to watch on Netflix. No mention was made of Lucasfilm, leaving many to wonder if the expected new chapters of the Star Wars saga will be included. If the financial projections are correct, Netflix will have paid Disney nearly $1 billion in fees before it becomes eligible for any of the new releases.
Netflix was able to secure rights to the Disney content by beating out Starz, which is owned by Liberty Media (NASDAQ:STRZA). While Netflix spiked on the announcement, Liberty shed nearly 5% on the news that it had been outbid for the content. Earlier this year, Starz and Netflix were unable to reach a new agreement that would have kept the bulk of Starz content, including many Disney favorites, streaming through the Netflix system.
The Disney position
If the alliance is sufficient to affect a turnaround at Netflix, which has languished since a series of poor management decisions took the company from market darling to pariah, Disney will have backed an online streaming partner with a huge subscriber base. As of September, Netflix was able to boast a subscriber base of 25.1 million customers. If Netflix is able to afford the rising costs of its operation, it will be by adding to that base significantly. The company has added roughly 360,000 subscribers over the last year, but will need to accelerate this growth rate to remain viable.
Perhaps the more interesting case for Disney is if Netflix falters and becomes unable to manage its ballooning costs. Should that occur, Disney will be holding a fairly significant bargaining chip with which to negotiate with the company. Even if Netflix cannot grow fast enough to pays its bills, it is likely to grow and become an important distribution network for Disney. In a weakened state, Netflix would make a natural an easy acquisition target for the Mouse House.
Disney, which already has significant programming and online presences through its ABC and ESPN ownership, would benefit from a streaming division that would allow it to exercise greater control over content delivery. This possibility makes both Amazon (NASDAQ:AMZN) and Coinstar's (NASDAQ:OUTR) Redbox unlikely partners. Amazon's reach into other areas is simply too vast and the company's retailing would significantly compete with Disney's retail efforts. The partnership between Redbox and Verizon make the former an unlikely partner, as their new service -- Redbox Instant -- is both untested and yet still backed by Verizon's financial strength. The partnership with Netflix is something of a win/ win for Disney.
A win for Disney
While the initial reaction to the announced deal between Netflix and Disney appears to be a boon for Netflix, the real advantage goes to Disney. If the alliance is successful in reinvigorating Netflix, Disney will be well paid for access to a huge audience. If the online video provider falters, Disney will be well positioned to quietly absorb its failing partner. Based on these considerations, Disney looks like an attractive long-term play on the news.
Fool contributor Doug Ehrman has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com, Walt Disney, and Netflix. Motley Fool newsletter services recommend Amazon.com, Walt Disney, and Netflix. 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. The Motley Fool has a disclosure policy.