Studios lick their lips over new-look Netflix

$1 billion Epix deal gives them another film buyer

Perhaps it's fitting that while the stock market was tanking last week, shares of Netflix were touching all-time highs. What else to expect from a company that is remaking Hollywood's home-distribution model?

That seems to be the popular consensus, anyway, since it was revealed last week that Netflix will pay almost $1 billion to Epix over five years for online-streaming rights for movies from Paramount, Lionsgate and MGM.

Before that, online streaming might have been considered more a necessary annoyance than an actual business with revenue and profit. But with the stroke of a pen, Netflix has upped the ante so significantly that movie studios have no doubt begun to ratchet up expectations for licensing fees they can charge going forward.

"It certainly proves that on-demand streaming rights have value," said Jim Packer, co-president of MGM Worldwide Television.

"We're the only ones that have put real money in play," Netflix chief content officer Ted Sarandos said.

In fact, Netflix probably paid more money for digital rights than traditional pay TV has been willing to pay for television rights in recent years. That's a sea change.

"For studios, the fear was the Internet was going to turn dollars into pennies," Sarandos said. "But there's a real economic model online. We didn't get any big discount because we're on the Internet. We're showing that everything that happens online is not going to be stolen or given away."

Richard Greenfield, an analyst with BTIG Research, figures that when Paramount, Lionsgate and MGM ditched Showtime to create Epix, Showtime was offering $175 million a year for their combined content, whereas Netflix values that same content, delivered over the Internet, at $200 million a year.

Netflix had already signaled a willingness to outbid more traditional outlets in July when it agreed to pay Relativity Media about $100 million a year for rights to movies that otherwise might have gone to HBO or Showtime.

"We're definitely another buyer in this market," Sarandos said.

That's great for studios, especially at a time when DVD revenue is dwindling, but it's bad for the likes of Showtime and HBO. Aristotle Munarriz of the Motley Fool went so far as to predict HBO is "toast" because of the Epix-Netflix deal.

After all, through video game consoles, Blu-ray players, TiVo and other boxes, millions of Netflix users are streaming movies onto their TV screens where they would otherwise be watching HBO. And it's costing Netflix users only $8.99 a month for unlimited access to thousands of titles, whereas cablers charge up to $15 a month for a premium movie channel.

Sarandos notes that the movies for which Netflix has streaming rights have accounted for 46% of the year's boxoffice so far this year, one percentage point more than HBO, which has films from Universal, Fox, Warners and DreamWorks.

Nevertheless, Sarandos bristles at the suggestion Netflix is a competitor to Showtime and HBO and, in fact, said he wouldn't mind striking Epix-style licensing deals with them.

He noted Netflix has no plans to follow HBO and Showtime into original programming and that Netflix won't stream movies until 90 days after Epix first shows them on television, so they have created a window separate from that of pay TV.

Munarriz predicts Netflix will eventually reserve streaming for its higher-tiered subscribers. Though Sarandos says there's no plans for that now, it makes sense that Netflix would want to pass along the cost of big licensing deals to its customers.





And expect Netflix to spend a lot more beyond Epix. It also has a Starz deal ending in the next two years, for example, that it pays only about $30 million for annually, according to Greenfield.

Judging from what it just paid Epix, if Netflix re-ups, it will do so at a hefty cost, and Starz has already agreed to pay Disney and Sony a portion of whatever extra it can extract from Netflix in streaming rights.

"We knew going into this that we'd be having to write bigger and bigger checks," Sarandos said.

Partially offsetting those big checks is money saved when Netflix subscribers stream a movie rather than have a DVD mailed to them, which costs the company 78 cents round trip. This year, it will cost Netflix $600 million and next year $700 million to mail DVDs.

"Netflix is under pressure to share postage savings plus incremental margins from its subscriber growth with the studios," Wedbush analyst Michael Pachter said.

Netflix only began streaming movies online in 2007, but the service has experienced phenomenal growth. In the most recent quarter, 61% of Netflix's 15 million subscribers used the streaming feature, up from 37% in the same quarter a year ago.

Success breeds competition, and Redbox is reportedly readying its streaming service. That's more good news for studios, as another bidder in the streaming marketplace will drive licensing fees higher still.

"A healthy industry is always good," Epix CEO Mark Greenberg said. "We pay a substantial license fee for our content, and that helps create more content.

"Here's a new entrant into the business -- us -- and we're generating, from a new platform, a lot of money. It's a game-changer. It puts us profitable. There's not many channels that, within 10 months on the air, can say that."
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