The HBO/Netflix Rivalry Is Heating Up

Includes: NFLX, TWX
by: Dan Strack


Netflix surpassed HBO in subscriber revenue during the second quarter for the first time ever.

Netflix is currently valued approximately $11 billion more than HBO.

International expansion is the key for both companies to grow revenue going forward.

The rivalry between Time Warner's (NYSE:TWX) HBO and Netflix (NASDAQ:NFLX) is heating up. Shortly after Time Warner released their quarterly earnings, Netflix CEO, Reed Hastings, couldn't help but point out that Netflix surpassed HBO in subscriber revenue.

"Minor milestone: last quarter we passed HBO is subscriber revenue ($1.146B vs. $1.141B). They still kick our ass in profits and Emmy's, but we are making progress. HBO rocks, and we are honored to be in the same league. (yes, I loved Silicon Valley and yes it hit a little close to home.)"



($ millions)

3 months ended 6/30/14

Y/Y % change

3 months ended 6/30/14

Y/Y % change


$ 1,417


$ 1,340


Operating Income

$ 548


$ 129


Operating Margin





While Reed Hastings correctly point out Netflix overtook HBO in subscriber revenue, HBO still maintains a narrow margin in total revenue over Netflix. However, over the next couple quarters Netflix is likely to overtake HBO. Where HBO has set itself apart is profitability. HBO has an operating income over 4 times larger than Netflix. While Time Warner management continues to downplay the rivalry with Netflix, Reed Hastings is quick to embrace it, by placing it front and center in the company's long-term view posted online.

"The network that we think is likely to be our biggest long-term competitor-for-content is HBO. In the USA for example, HBO recently won long-term exclusive domestic movie output deals with Universal and Fox. HBO bids against us on many original content projects though is not currently a bidder against us for prior-season television from other networks. HBO has global reach and a strengthening technology capacity."

Original Content

Both companies view original content as a major contributor to gaining and retaining customers. HBO has been producing award winning original content for years, where as Netflix just started their own original programming with the successful releases of House of Cards and Orange Is The New Black. Some of HBO's original content includes Game of Thrones, The Sopranos, The Wire, Sex and the City, Boardwalk Empire, Band of Brothers, Oz, Entourage and True Blood, just to name a few. HBO once again led the industry with 99 primetime Emmy nominations, more than double its nearest competitor, and the most nominations for 14 years in a row. Netflix, on the other hand, received 31 Emmy nominations this year, more than double the 14 received last year.

Netflix has heavily invested in original content that it should begin to really capitalize on later this year and into 2015. Currently, Marvel's Daredevil, Netflix's first original series from Marvel Television, is shooting in New York and Sense8, a series from the creators of The Matrix trilogy, began production in June. In August, comedy Gracie and Frankie as well as Narcos will begin shooting. Netflix also recently announced an agreement with Chelsea Handler to launch the company's first ever talk show in early 2016.

HBO currently has one of its strongest line-ups ever with Game of Thrones, True Detective, Silicon Valley and VEEP. The fourth season of Game of Thrones averaged a gross audience of 19 million viewers, making it the most watched season of an original series in HBO's history, surpassing even The Sopranos. HBO is continuing all these series, as well as adding John Oliver's Last Week Tonight and new drama The Leftovers. The Leftovers is the first show Warner Bros. has produced for HBO, and is averaging 8 million viewers per episode.

HBO has a tremendously long history of successful original series and maintains a solid advantage over Netflix, but Netflix is closing the gap quicker than most predicted. It's hard to overstate the importance of Netflix's success with House of Cards and Orange is the New Black. Had these series flopped, many would question whether Netflix was prepared to launch its own original programming.

HBO GO & International expansion

HBO GO is HBO's version of Netflix. It allows HBO subscribers to access the HBO library from anywhere and stream video on-demand. HBO GO active users grew 35% year-over-year in June and is available in 24 territories around the world. Until this point, Time Warner has had a difficult time monetizing the increasingly popular streaming HBO GO. Due to agreements with cable providers, who bundle HBO in television packages, Time Warner has yet to offer HBO GO as a stand-alone subscription service. However, a recent Wall Street Journal article outlined how Time Warner may be expanding its web-TV internationally. Since 2012, HBO has offer Nordic countries access to its web-TV service without being pay-television subscribers. Now it is believed Time Warner is looking to expand HBO GO to Japan and Turkey, where HBO doesn't generate much revenue from licensing and the broad-band infrastructure is very good. HBO international business accounts for roughly 25% of HBO's $4.9 billion in annual revenue and is growing quickly. International subscribers have grown by 15% over the past 12 months and the company believes it can greatly expand upon that. HBO is investing heavily in HBO GO with plans to double the number of engineers in its Seattle office to 100 by the end of the year.

Likewise, Netflix sees international growth as its biggest market going forward. With over 50 million domestic subscribers, the market is nearing saturation. Netflix is also investing heavily in international expansion and plans to launch its video streaming services in 6 European markets (France, Germany, Austria, Switzerland, Belgium, Luxembourg) in September. If Netflix wants to keep its rapid revenue growth, successful launches in these international markets is essential.

Who wins?

Speaking strictly from a revenue standpoint, it's difficult to see Netflix not overtaking HBO in total revenue. Netflix is developing strong original content faster than many expected and still has room to grow internationally. HBO future revenue growth will depend on how the company can monetize HBO GO internationally and then domestically, without harming relationships with cable providers. Time Warner has received a bump in revenue growth from selling old HBO content to Amazon Instant Video, which the company plans to reinvest the proceeds to building out an expanded HBO GO.

In terms of profitability, Netflix will have a difficult time reaching HBO. HBO's operating income is more than 4 times larger than Netflix and thin margin will likely continue for a long period of time. Netflix must bid against HBO and Amazon Instant Video to buy the vast majority of their content. HBO owns its own programs from the start and has the luxury of Warner Brothers under the same Time Warner umbrella. This means HBO has potential access to the Warner Brothers studio and immediate access to all Warner Brother's movies. If Netflix were to want any Warner Brother's movies, they would have to pay an arm and a leg to acquire such rights. While Netflix is seeing success in original content, it is only a drop in the bucket compared to their entire on-demand library that they must acquire the rights too. In addition, Netflix has been in a very public battle with broadband providers over net neutrality. The company has reportedly paid fees to telecom giants, such as AT&T, Verizon and Comcast to ensure quality video stream downloads. Such hurdles will be difficult to overcome and will continue to eat into profits and result in thin margins.

Better Investment Option

First off, I consider myself mainly a value investor, so I'm admittedly biased. Back in February 2014, I wrote an article comparing Netflix's valuation to HBO. With HBO representing roughly 20% of Time Warner's revenue and 25% of profit, it's fair to assume HBO's value is around $15 billion of Time Warner's $62 billion market cap. Netflix currently has a market cap of $26.8 billion, making its market value around $11 billion more than HBO. Netflix has the potential to keep growing revenue at 15-20%, but a slight hiccup in any quarterly earnings report would result is a sharp sell-off in the stock. However, investors buying into a stock with a P/E value of 134 should already understand this risk. Netflix has also struggled to produce healthy margin and currently has an operating margin of around 9% compared to HBO's impressive 39% operating margin. I believe Netflix will struggle to get to the kind of margins HBO operates at for the foreseeable future due to customer price sensitivity and the high cost of buying the vast majority of content. Once the company has established a solid library of original content that customers demand, then the company may be able to increase fees and reduce expenses.

I believe the failed take-over attempt by 21st Century Fox recognized the value in Time Warner's assets, such as HBO, and were willing to pay a premium for them. If the company can successfully monetize HBO GO internationally, it will be a huge step forward in adding value. In time, the company may be able to roll-out a similar platform domestically. The investments Time Warner is making in HBO GO now will have a huge return on investment down the road. Netflix will surpass HBO in total revenue this year, but that shouldn't mean Netflix is worth $11 billion more than HBO. Time Warner has many positive catalysts working in its favor right now and has the kind of value I look for in a company.

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

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