In its previous quarterly results announced less than two months ago, Netflix (NASDAQ:NFLX) reported a 10% increase in revenues to $905 million while its profits dropped by 87.7% to $7.67 million. Throughout 2012 the company has fallen far short of its growth projections - adding only 1.2 million subscribers in Q3 - and finally had to downgrade them from 7 million new users to just 5.4 million. Netflix's stock dropping on bad news has been nothing short of de rigeur for the past 18 months and it seemed as if every bit of news was an implied negative for it even when it necessarily wasn't - Amazon's (NASDAQ:AMZN) Epix deal comes to mind. However, in the first week of December, Disney (NYSE:DIS) and Netflix announced a deal that reinforces a meme I've been discussing for months now. Disney is looking for new distribution avenues for its content as it remakes its revenue streams to emphasize content creation rather than distribution and broadcast, ie. ESPN and Disney cable stations.
Disney's shows and movies are currently aired on Starz network but starting in 2016, only Netflix's subscribers can watch Disney's titles from Walt Disney Animation, Marvel, Pixar and Disneynature on their TV's, computers, phones and tablets. Netflix will also have Pay-TV rights over new Dreamworks releases from 2013 onward. No matter how much Netflix may have tarnished their brand last year with the Quikster debacle, the fact remains that they are a dominant player in content distribution with a superior interface and technology alongside their data gathering on viewer habits that content producers are desperate for.
This is a major setback for Starz which currently has the rights to air movies by Disney and its subsidiaries just eight months after their theatrical release. Liberty Media Corp (NASDAQ:LMCA), the parent of Starz, relies heavily on Disney as the latter constitutes about half of Starz content. Its own original content, which includes the Spartacus series, simply cannot sustain the network at this point. This deal will certainly spoil Liberty Media's plans to spin-off Starz into a separate company through an IPO. Its shares fell by almost 5% on 4th December when Disney announced its departure. However, Starz still has first-run rights to titles released by Sony Pictures Entertainment, owner of Columbia and Tri-Star and a subsidiary of Sony Corp. (NYSE:SNE).
As soon as the news was revealed, Netflix's stock jumped by 15%. This gives them the ammunition to compete with whatever streaming versions of their service HBO and Showtime put together. This deal, in a sense, is almost a triple win for Netflix as Disney has recently acquired Lucasfilm and the Star Wars franchise. Even though the first Star Wars film under Disney's banner will be released before 2016, you can bet that having exclusive right to air Episode 7 weighed heavily in this deal. Its immediate impact is that Netflix subscribers can start watching other non-exclusive Disney titles - "Alice in the Wonderland" for example - instantly. This is a huge win for NetFlix's children's lineup.
Netflix has not disclosed the financial details of the deal, most probably because it doesn't want them to overshadow the good will it generates. But at a guess, this deal will include a considerable premium over the $250 million Liberty Media previously paid annually. Everyone was wondering what Netflix was going to do with the money saved from no longer having exclusivity to show Epix content - previously costing them $200 million per year - and now we know. Netflix also had an agreement with Starz to air Disney and Sony movies, so between the savings on that and the Epix premium the cost from this deal should be mostly mitigated. It'll put pressure on their bottom line but it should drive subscriptions up.
What separates Netflix from other services is that by its on-demand nature, viewer habit information that they are acquiring is of higher quality than the time-based broadcast model. This creates a more streamlined conduit between the broadcasters and the producers, taking the advertisers out of the loop in terms of dictating the kind of content they want produced to push products. It will cause a subtle shift in how advertising manifests itself. If Netflix is successful in effecting this industry transformation advertisers will have to work harder at the creation stage of the content to insert themselves into the process as opposed to latching onto the finished product afterwards. In other words, you should expect to see more product placement and possibly direct investment by corporations in content production.
Amazon is trying to create something similar with its prime video service as are others. But, the user experience on Amazon is atrocious and why would companies like Google want the headache of dealing directly with the media companies. Where's the value-add for them? Apple (NASDAQ:AAPL) through iTunes is the major threat to Netflix at this point and one could speculate that fear of Apple being able to dictate terms to the studios and media companies is part of the reason they keep cutting lesser deals with cash-strapped players, i.e. Netflix and Amazon. Be that as it may, Netflix is ahead of the curve in terms of content distribution, now they just have to figure out how to properly monetize it.