In recent days, repeated reports have emerged of an extension nearing completion between Netflix (NASDAQ:NFLX) and the CW Channel for exclusive access to all of CW's shows in a syndication window. At least one other bidder, Hulu, appears to have fallen short. While not yet officially announced, the concurrence of the reports on several important details, if born out by the official deal, sends an important signal about Netflix's ability to continue competing in an increasingly competitive field.
Again, the deal is not yet official. But here is what everyone thinks is happening:
Netflix and the CW will extend their existing relationship another five years, in exchange for another $1 billion payment from Netflix over that same period, identical in amount to the one negotiated back in 2011. The waiting period for CW shows will be shortened from three months to "a few weeks," giving Netflix a complete season of new episodes only a few weeks after the season finale bows. Hulu, another CW partner that is currently allowed to broadcast the most recent five episodes of the current season, has been cut out completely of the new deal, with "rolling five" rights shifting to CW itself, which will show the same five episodes on its own website.
Content Continues To Command Top Dollar
Anyone looking at just the headline figures might think that Netflix had actually negotiated a reduction in content costs, since the same $1 billion is apparently buying five years worth of shows instead of four and cutting the waiting times to boot. But actually not.
Remember, when Netflix negotiated with CW for the first time, it had no existing relationship with the station. So when Netflix bought 'all' the shows on the channel, it was actually buying several years worth of shows at once. If CW has twelve shows in total and they roll over three shows a year, for example, then Netflix's first deal would have bought 21 shows. All 12 shows that were on air when the deal was signed, plus three years worth of new shows as they came on. That haul reportedly came to more than 700 hours of programming.
This time, there is a pre-existing relationship. So when Netflix buys the syndication rights to 'all' CW shows for the next five years, it is only buying the new shows that come in every year. The others are already covered under the old deal.
So Netflix is buying five years worth of new shows only, for about the price it paid for four years worth of new shows and existing shows back in 2011. Unless CW rolls over 75% of its lineup a year - it doesn't - it still commanded a hefty raise for its content compared to four years ago.
How Did It Happen?
Despite the fact that Netflix is not exactly getting a discount bargain, however, the deal is still a very positive sign for them. In recent months, the calls have been growing louder that Netflix is doomed to drown in spiraling content costs as major content studios, many of them vertically integrated with the very incumbent distributors that Netflix competes with, hike rates on content to encourage people to retain their existing cable/satellite subscriptions. Aside from Netflix's production of its own original content, the CW deal is as close as Netflix will probably come to encapsulating all of its answers to that challenge in a single deal.
First, the deal appears to represent no more than an increase of about 40% in content costs, or about 9% per year. It's a little approximate in a deal with so many moving parts, of course. But this year, CW is debuting four new shows in a schedule with about a dozen scripted shows a year. Even adjusting for the fact that not all new shows stick beyond the first season, and the pre-existing shows discussed earlier, the deal is 25% longer for the same dollar amount, and carries other benefits like shortened window delays. The denominator probably hasn't shrunk very much and the numerator didn't get any bigger.
That 9% is right in line with the industry norm in recent years, which has seen even giants like Comcast (NASDAQ:CMCSA) pay 8% more per year and smaller operators paying over 10% per year. At this rate, it will be quite a while before Netflix has to worry about being priced out of business against the $100 cable bundle.
Second, the deal was, apparently, completed despite the entanglements of vertical integration. CW is co-owned by two major studios, CBS (NYSE:CBS) and Time Warner (NYSE:TWX). Either they both signed off on the deal, which would augur well for their willingness to complete deals for further content in their own vaults, or CW was able to complete the agreement despite pushback from corporate parents, which would augur well for the ability of other content producers to complete deals with Netflix notwithstanding parent company objections. That second one would be especially positive for negotiations with NBCUniversal, which is now owned by Comcast.
Not Hard To Imagine
Nor is that second option out of the realm of possibility. No, it's not very likely NBCUniversal's management stormed into Comcast CEO Brian Roberts's office one day and demanded he keep his nose out of their business for the sake of artistic purity. But what has become the standard narrative of greedy cable companies killing any Netflix deal they don't like has long overlooked one crucial interest group that can issue ultimatums to Roberts and his compatriots: the actors, writers, and directors who make these shows.
In modern Hollywood, creators and artists are never completely separated from their work, spiritually or, more importantly, financially. They are paid regular percentage royalties for each subsequent syndication deal, and any effort by Comcast and others to steer content away from the best offer simply because it happens to come from Netflix or Amazon (NASDAQ:AMZN) could seriously harm their relationship with the people who really make television go. If word of that got out, it would almost certainly affect where those top talents chose to offer their next project.
But that, of course, is speculation, and I know a lot of people won't risk their money on speculation. That's fine. Let's stick to what we know.
We know that CW is owned by CBS and Time Warner, two companies that have both launched direct streaming competitors to Netflix as well as having a big stake in the existing ecosystem. We know that at least one other bidder, Hulu, which is co-owned by the other three major content providers, was competing with Netflix for the rights.
If there was ever a deal that the incumbent operators should have been able to kill, it was this one.
And for whatever reason, the deal happened anyway.
We think. Again, there hasn't been an official announcement yet. But it certainly appears that Netflix can still get quality content at a reasonable price, or at least at prices no more unreasonable than its competitors. And if the incumbents didn't kill this deal, they probably won't kill any deal where Netflix is the high bidder. That is a very positive signal for Netflix's ability to operate in this new environment.
Disclosure: I/we 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.