In part one of this article, I discussed the merits and prospects of Sirius XM (SIRI) making some sort of play for Pandora (P). The logic behind that speculation ties into an overarching theme I think will play out in 2012.
Expect consolidation in the audio, video and digital entertainment spaces. The continued proliferation of individual efforts to deliver audio content and stream digital programming makes little sense. I anticipate more meaningful partnerships - similar to the Clear Channel (OTCQB:CCMO)/Cumulus (CMLS) and reported Verizon (VZ)/Coinstar (CSTR) hook-ups - sprinkled alongside major M&A activity in 2012.
Or Disney acquires Time Warner outright. In any case, it's time for true empire building among television programmers/movie studios. In 2012, a hook-up of this magnitude catches the other big names asleep at the wheel and sets the stages for further, albeit lower-level consolidation in the space.
In 2011, both companies took groundbreaking digital strides. Disney made its various ESPN channels available via mobile app to customers of several cable companies. And, of course, Time Warner lets existing pay-HBO subscribers view the network's programming on any device through what Reed Hastings wants Netflix (NFLX) to be when it grows up - HBO GO.
These moves represent the tip of the iceberg that sees programmers and movie studios take control of their content and render middlemen such as Netflix "never was and never will bes." But, again, concerted efforts work better from so many standpoints, particularly from a consumer's perspective. If the old guard cannot rally around Hulu, companies with the most foresight will kick the trend setting into high gear.
Between the two companies, Disney and Time Warner control everything from ESPN, ABC, CNN, TNT, TBS, several other pay and premium cable networks to countless television shows and movies to brands such as Sports Illustrated and Time. A deal between the two allows them to bring the content together in one place and distribute it, using something that looks a lot like the cable model, through one massively-profitable digital platform.
A merger between Disney and Time Warner does not have to happen to drive home the larger point that consolidation in the space will occur in 2012. As much as it makes sense, I don't see Hulu becoming the one-stop shop for digital content that it should be or each cable and satellite operator offering apps that seamlessly mirror what they broadcast through traditional television. It will take two giants coming together to really get the ball rolling in the right direction.
DISH Network (DISH) Buys Netflix's DVD Division
For months, I've made the case that Netflix will have no choice but to sell its DVD unit to help keep the streaming side of its business alive. One of the most popular questions I receive from readers is who will make the purchase that buys Netflix more time?
The treatment Netflix CEO Reed Hastings gives his company's DVD division baffles me. While Hastings is probably right that streaming and smart TV is the future, he's shooting himself in the foot by turning his back on the one area of his business that turns and can turn a profit for at least another year or two, if not many more:
DVD will do whatever it's gonna do. We're gonna try to, ah, not hurt it, but we're not putting a lot of time and energy into doing anything particular around it.
Not only does this represent a 180 from what he said five months ago, but it's a potentially suicidal business strategy. With Hastings' "virtuous cycle" of subscriber growth funding digital content spending broken for, at the very least, the short-term, it makes zero sense to effectively squash a real source of profits. I cannot be the only person who realizes that Hastings makes a losing gamble banking on the return of subscriber growth to cover the costs associated with domestic and international streaming. Even if subscriber growth returns with a roar, that sole source of revenue never had a chance of meeting Netflix's lofty, if not impossible ambitions.
DISH Network probably does not think the DVD is quite as dead as Hastings does. Or, at a minimum, it's not as ready to push it and the profits it brings off a cliff.
In its most recent 10-Q, DISH says the following about the Blockbuster retail business it purchased for a cool $238 million out of bankruptcy court:
As of September 30, 2011, Blockbuster operated over 1,500 retail stores in the United States. We have negotiated flexible termination provisions in the leases of over 900 of these stores, should estimates of future revenue growth not meet our expectations.
Clearly and rightfully so, DISH wants flexibility at the retail level. It will need to shutter some stores. But, it likely makes sense to keep some of the top-performing outlets open and use them strategically as DISH, like Netflix, makes the transition from physical delivery of content to digital delivery.
Having a properly- and aggressively-run, profitable DVD-by-mail business provides DISH with a bridge toward that somewhat long-term end goal. In other words, Hastings is shedding the old way of doing things while it still has life left and before it's without worth. He's burning a bridge that I think DISH or some other suitor sees value in. If DISH was of mind to take on Blockbuster, I don't think it's crazy at all for it to take a chance on Netflix's DVD business. Plenty of obvious synergies exist between brick and mortar, DVD-by-mail, DISH's emerging streaming offering and its core satellite business.
Additional disclosure: I am long NFLX June 2012 $40 put options.