On Tuesday, Amazon.com (NASDAQ:AMZN) announced that it had signed a new licensing agreement with Viacom (NASDAQ:VIAB) covering thousands of TV episodes. Amazon Prime members will now have free access to a variety of shows from channels like Nickelodeon, MTV, and Comedy Central. Amazon will also receive exclusive streaming rights to future episodes of popular kids shows like Dora the Explorer and SpongeBob SquarePants.
The new streaming deal between Amazon and Viacom is another blow to Netflix's (NASDAQ:NFLX) quest for streaming dominance. While Netflix began with a big lead in terms of content, Amazon has been catching up quickly. Amazon's apparent ability and willingness to shell out big bucks for content -- combined with Netflix's focus on keeping content costs in check -- bodes ill for Netflix's growth prospects over the next several years. When the market catches on to this fact, Netflix stock is likely to suffer severe multiple compression.
Netflix tightens its belt
Whereas Netflix had acquired a reputation for spending freely on streaming content prior to its 2011 meltdown, the company has recently become very choosy about content. In a "long-term view" memo posted to the company's investor relations site, Netflix management states, "Competitive pressures in bidding for content would tend to make us have slightly less content than we would otherwise, rather than overspending."
Investors observed this new focus in Netflix's Q1 investor letter. Netflix noted that going forward, it was planning to focus on exclusive "curated" content, rather than broad licensing deals. As a result, it would be allowing a broad licensing agreement with Viacom to expire at the end of May, resulting in the removal of a variety of shows from Nickelodeon, MTV, and BET .
However, CEO Reed Hastings and CFO David Wells stated that they were interested in gaining exclusive access to a few of the Viacom shows that were covered by the prior license arrangement. Nevertheless, talks between Netflix and Viacom dragged on through May with no resolution. Netflix eventually agreed to a deal with Disney (NYSE:DIS) for several kids shows , as a potential replacement for the Viacom content it was about to lose .
Amazon steps in
Amazon's new licensing agreement with Viacom more or less nixes the possibility that some of the recently departed Viacom shows would return to Netflix. Kids who want those shows will now have to convince their parents to get a Prime subscription. While few people would sign up for an Internet video service like Netflix or Amazon Prime to watch a single show, Amazon has been growing its streaming content library rapidly, and could soon catch up to Netflix in terms of breadth of content.
Clearly, Amazon saw the Viacom kids shows as an important point of differentiation vis-a-vis Netflix. The company reportedly paid more than $200 million for the license ! Amazon's deep pockets enable it to add content faster than it wins new Prime subscribers, which will allow Amazon Prime to rival Netflix in video content even with a smaller base of members. Long-term, this represents a serious threat to Netflix, because while some people might choose to subscribe to both services, others could drop Netflix if Amazon Prime became more appealing.
Watch out, Netflix!
For now, Amazon's rapidly growing content library has not put a visible dent in Netflix's domestic streaming growth. Netflix has added a total of 5.8 million domestic streaming members in the past four quarters, amounting to 25% year-over-year growth in the subscriber base .
Longer-term, though, Netflix needs to watch out. As the Netflix domestic subscriber base passes 30 million, growth may be harder to come by, due to the magnified effect of subscriber churn and the beginning of market saturation. Facing a competitor that is willing to pay top dollar for high-quality content could cause Netflix to return to its high-spending ways in order to drive continued subscriber growth.
Alternatively, if Netflix maintains its spending discipline, it will risk a drop-off in subscriber growth as some consumers choose Amazon Prime instead. Either way, Netflix will be hard pressed to keep growing fast enough to justify its current sky-high valuation.
Adam Levine-Weinberg is short shares of Netflix and Amazon.com. The Motley Fool recommends and owns shares of Amazon.com, Netflix, and Walt Disney. 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.