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Netflix Content Spending Not Slowing Down

26 Jun, 2013 By: Erik Gruenwedel

The SVOD pioneer’s largest-ever streaming deal with DreamWorks Animation and related pacts with Cinedigm and ZDF underscore willingness to spend on specific content

On the heels of its biggest-ever content license agreement with DreamWorks Animation, Netflix is not putting away the wallet, acquiring rights to select exclusive programming it feels will retain and lure subscribers — despite analyst concerns to the contrary.

Los Gatos, Calif.-based Netflix through March 31 had $5.7 billion in content license liabilities on the books — $700 million more than it did at the end of 2012. This amount was before the recent DreamWorks announcement as well as subsequent deals with Cinedigm and ZDF — the former touted as an “eight-figure” deal by Cinedigm management.

But Netflix is justifying the spending in part by the fact that it added 2 million domestic subscribers in the first quarter, and it trails Hulu Plus in available TV programming. Indeed, Netflix had episodes from 33% of the top 75 TV shows available for streaming through 2012, according to Piper Jaffray. That percentage was actually 11% less than what Hulu Plus offered. The SVOD service, which reportedly is for sale, is co-owned by The Walt Disney Co., News Corp. and Comcast. Amazon Prime Instant Video trailed with 7%.

“Netflix is actually thinking [whether] it actually wants all the shows that everyone else has,” Tom Gara, reporter with The Wall Street Journal Corporate Intelligence blog, said in an online interview.

He believes Netflix will bypass offering every TV show and focus on specific programming, including originals.

“Netflix is trying to be more like HBO, exclusive content. If you want to see it, you’ve got to pay for it,” Gara said.

Eric Wold, analyst with B. Riley & Co. in Los Angeles, said the recent “eight-figure” deal with Cinedigm is for both library content as well as indie films as they are released. Wold said Netflix’s typical content licensing agreements include payments timed to when the content is made available to subscribers. Therefore, the “eight-figure” is not paid upfront, but rather throughout the life the agreement.

“Given the amount of money that Netflix has already committed to external licensing agreements as well as in developing original programming, this would seem like a drop in the bucket for Netflix even though it is relatively meaningful for Cinedigm,” Wold wrote in an email.

While Netflix appears to have become increasingly knowledgeable as to what content resonates with their subscriber base and is worth paying for — i.e., the decision to exit the Viacom deal (and Nickelodeon content) a few months ago — some analysts aren't so sure.

Sanford C. Bernstein June 25 issued a note downgrading its rating on Netflix to “underperform” from “market perform,” based in part on what it characterized as Netflix’s “unrealistic expectations” on subscriber growth and margins.

Michael Pachter, analyst with Wedbush Securities in Los Angeles and long-time critic of Netflix’s content spending, said costs associated with original content are stealing from future subscriber growth. Pachter believes Netflix will be challenged to grow its subscriber based in the second half of the year if its original programming is less compelling.

In an April note, Pachter said Netflix’s content costs in Q1 only increased by about a third of revenue increases on domestic streaming. He said that is not sustainable as content holders ultimately will not be satisfied getting only 33% of Netflix’s domestic streaming revenue. It’s a POV the analyst has not wavered from.

“You know what I think,” Pachter quipped in a June 25 email.

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