The Future of Netflix: Will Netflix Become a Takeover Target? A Contrarian Opinion v. What CEO Reed Hastings Predicts

As I've written previously on this blog, Netflix is evolving - from a service that provided an online store where subscribers could rent DVDs through the mail, to a hybrid service that rented DVDs and streamed other people's content to subscribers, to a hybrid company that produced original content for streaming as well as licensing other producer's content for streaming...

Now comes the essay (above) in which Reed Hastings predicts that Netflix will evolve yet again - into a content creator and online content delivery system via apps.

Will this latest pivot work?

As Kosha Gada has written in the April 24th, 2013 issue of Forbes:

"Netflix spent roughly $100 million to produce “House of Cards” plus additional marketing investments, including advertising buys for primetime TV spots and high-profile billboards. If “House of Cards” brings in half a million new Netflix subscribers, with the same average life span as current subscribers (an estimated 25 months), the show will just about break even in two years. The real test is the lifetime value of these new customers. What if many or most turn out to be opportunistic viewers who end up canceling their subscriptions a few months after watching “House of Cards?” Then the breakeven opportunity looks vastly different. For example, if the average customer life span is closer to four months, then Netflix will need more than three million new subscribers for the project to breakeven—essentially, a 43 percent increase over its current average acquisition rate."

House of Cards is apparently a hit. And Netflix is about to offer new episodes of Arrested Development. Won't that also lead to additional new subscribers and goose revenues yet again?


But is this cycle, of creating expensive new content and adding new subscribers, sustainable?

Here's a thought (courtesy of Kosha Gada): "The end game may well lie in [Netflix] pivoting away from subscriptions and distribution altogether and moving into the world of content licensing. This would fundamentally change the company’s equation."

In other words, Netflix could pivot yet again - earning significant revenue by competing with the studios - making Netflix-branded original content that is distributed via third parties (e.g., in theaters?).

But is Netflix - a company that has always been about home video despite all the pivots - really ready to compete with the studios making content that is monetized in theaters?

Are the latest moves by Netflix really about strengthening the Netflix brand - or are they overtures to a takeover?

Is Netflix ready to compete with the majors (which still supply a great deal of Netflix's content) or is Netflix about to become the New World face of a Chinese or Old World content provider?

What if (as Kosha Gada also asks) "the move into content may be dressing Netflix up for a sale?"

Now that they've proven their ability to produce content (making choices about genre, stars etc. based in part on data from subscribers - and delivering that content profitably to a subscription audience via the web) will Netflix become an attractive takeover target?

As Kosha Gada sees it, "Netflix’s model presents a value proposition to a range of potential companies, from the cash-rich new-media giants looking to expand into new markets, to the traditional studios and networks hoping to reinvigorate their old business models, or even a major telco or cable company eager for a piece of the growing over-the-top content distribution pie."

Will Reed Hastings and his board let this happen?

In November of 2012 Netflix's board adopted a provision - commonly known as a "poison pill" - that would prevent an unwanted takeover (e.g., one that undervalues the company). The Netflix "poison pill" was adopted when it became known that corporate raider Carl Icahn had acquired a large stake in the company (just under 10%).

But the Netflix "poison pill" isn't an absolute barrier to a takeover or merger: Netflix's board could approve a takeover on terms that they thought were favorable.

And why talk about a takeover at a time when Netflix is making headway into profitability and the stock price is way up?

Despite recent profits and rosy predictions from some analysts, it's still unclear to me whether Netflix will be able to achieve long-term profitability. The cost of licensing content produced by the studios keeps going up. And the risks of producing original content have yet to really kick in for Netflix (the studios know a lot about producing mass entertainment too - and they still have their John Carter's).

The pivots have kept Netflix going - and House of Cards and Arrested Development are keeping the shine on Netflix - but the content production business requires huge amounts of capital, big risks, etc.

And the competition from companies that have revenue models based on advertising and other platforms may inevitably force Netflix into yet more pivots (e.g., licensing their original content) to maintain profitability and growth.

Then again, Netflix CEO Reed Hastings has successfully navigated prior pivots. Looking back, Netflix has been nimble enough to recover from prior false steps.

It would be a mistake to say that Netflix can't adapt (or regain it's footing) as the world of digital circulation of content grows up.

Consequently, when Reed Hastings releases an 11 page report on where he sees the business of TV circa April 2013 (above) - it's worth a read.

Here are a couple of excerpts:

“Existing networks, such as ESPN and HBO, that offer amazing apps will get more viewing than in the past, and be more valuable. Existing networks that fail to develop first-class apps will lose viewing and revenue.”

While Netflix is "passing HBO in domestic members in 2013, it will be several years before we are peers with them in terms of Original programming, Emmy awards, and international members. It wouldn’t be surprising to us if HBO does their best work and achieves their highest growth over the next decade, spurred on by the Netflix competition and the Internet TV opportunity."

To sum up... There's no denying that Netflix has added subscribers with House of Cards - and they're likely to do it again when new episodes of Arrested Development hit at the end of May 2013. But is this pattern sustainable? If not - and the market matures with no new subscribers to be had - or if Netflix stumbles and overspends on a few flops - all the current talk about Netflix being "the future of TV" may seem a bit hyperbolic. The history of some of the best content creators in recent history (e.g., Miramax and HBO) suggests that huge sources of capital and multiple channels of distribution are required when you start spending tens of millions of dollars on content. If the economics of high-end content remains true and Netflix continues on this path away from their original rationale (distributing content that was licensed for next to nothing making a small margin on the Long Tail) - then the future of TV may look a lot like the recent past - and Netflix may become a shingle in a corporate empire of a well-heeled partner.

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