Amazon To Rival Netflix And Hulu With Original Programming

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For those that use streaming or on-demand video services, the race to be the biggest and best has been dominated by Netflix (NASDAQ:NFLX). Between Netflix's domestic and international streaming business, the company had nearly 30 million subscribers at the end of Q3. Netflix has the biggest selection of content and at $8 per month, seems like the best value out there.

The race to compete with Netflix has been fast and furious, and is getting more intense by the day. There may not be one huge competitor out there that will destroy Netflix next year, but there are a number of smaller rivals that will attempt to chip away at the streaming giant. Netflix hopes that its large content library as well as a shift to more original programming can keep it way ahead of the pack for quite some time.

That brings me to Amazon (NASDAQ:AMZN). When you think of who might be second in this space, Amazon's Prime gets a lot of votes. With Prime, subscribers pay a flat yearly rate, $79, but get tons of benefits. They get access to Prime Instant Video, which has over 25,000 movies and TV shows to choose from. Users also get free two day shipping on millions of items with no minimum purchase. Additionally, they get a Kindle book to borrow for free each month from the Kindle Owners' Lending Library.

Amazon's Prime Instant Video selection may not be as large as that of Netflix, but Amazon is a large company that is willing to compete. Amazon is currently working on developing its own original programming, which it believes could revolutionize not only the streaming wars but the TV industry as well. Amazon is looking to challenge not only Netflix, but Hulu, which according to the article above, has a budget of $500 million per year for original programming.

Amazon isn't making a small run at this either. Here's the list of who they've targeted for original content.

Just one show, a sitcom, was written by unknowns. The others include TV veterans from shows like 30 Rock, The Daily Show, and Big Bang Theory, as well Gary Trudeau, author of the Doonesbury comic strip, and the people at the satirical newspaper The Onion.

For full descriptions of the shows Amazon will offer, click here. Amazon will try an interesting method to determine what makes the cut and what doesn't. They will let people view these shows for free, with the viewing public getting a chance to chime in on the shows. Amazon will then determine what shows to keep, and what to dump. Those that make the cut will then be available on Prime Instant Video. It's not exactly the way that Netflix does it, although you could argue that the free month trial that Netflix offers is similar in some respects.

One blogger recently stated that he is "worried and excited" for Amazon's launch of these new shows. Eric Mack says that original programming has had mixed reviews in the past. Netflix's Lilhyhammer was "bleh", but he wanted more of Hulu's Battleground. Like the other article, Mack believes that Amazon is seriously upping the ante here with the lineup they've brought in. Should these shows stick, it could create a serious original programming battle between the powerhouses that could change how we watch our shows. Netflix stated in its Q3 investor letter than it plans to debut four new original series in 2013.

But as I stated in my recent Amazon article, how is Amazon really paying for this content? Content is expensive, and Netflix CEO Reed Hastings believes Amazon is losing up to $1 billion dollars on Prime. Amazon just raised $3 billion in debt, so they could feasibly use some of that cash to pay for content. Amazon will need to continue spending on content just to stay in the race. How expensive can this original content be? Here are some excerpts from Netflix's Q3 investor letter on the subject.

Embarking on original series has implications from a cash flow standpoint. Our cash expense for originals is quite front loaded, compared to the P&L expense on these deals. We'll often pay for the entire 5-10 year license all in the first few years. Q4 of this year will be the first quarter in which our originals start to become a material use of cash relative to the P&L. More on this topic below in the FCF section.

As we've highlighted, our movement into original programming will require more up-front cash payments than our typical content licensing agreements, beginning in Q4 and increasing in 2013. So, due to initial cash payments for originals, in addition to other cash payments for content in excess of P&L expense, we anticipate negative FCF for several quarters. We have enough cash on hand to fund our planned originals in addition to our ongoing expenses, maintain an adequate reserve, and then return to positive FCF. We believe the investment in originals is wise, and we will evaluate the performance of the slate next year to determine at what level we should fund additional originals.

To be fair, Netflix isn't the most profitable company right now anyway, so they weren't producing a lot of free cash flow to being with. But Amazon isn't really very profitable either, in fact, they've had some big losses recently. Content is expensive, and it requires more up front payments according to Netflix. Netflix believes they have the cash on hand to fund all of this, but maybe Amazon didn't, and that's why they raised money. We know that Amazon needed to pay for its headquarters too, but they raised $3 billion and the headquarters was projected to cost $1.2 billion.

I agree with the blogger from above. I am both excited and worried about Amazon's push to original content here. On one hand, it provides more content to TV junkies and it heats up the streaming video wars, which are really fun to watch and discuss. On the other hand, I'm worried that Amazon could find this venture to be a bit costly. Analysts currently believe that Amazon will lose money in 2012 (full year), and 2013 estimates have continued to go lower over time. As I stated in my last article, Amazon is a great short candidate, but shorting Amazon has not been a winning strategy. Maybe the move to more original content will push them to enough losses that shorting Amazon could eventually work.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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