How Cable Companies Are Gearing Up To Take On Netflix

  • Time Warner plans to buy a 25% stake in Hulu, one of Netflix's biggest competitors.
  • Hulu will now be backed by 4 out of 6 of the largest media conglomerates.
  • Growing content competition for content from the likes of Hulu could lead to even higher content costs for Netflix, whose content costs remain alarmingly high.
  • Netflix's impressive international expansion, however, could turn out to be the company's saving grace.

News has emerged that Time Warner (NYSE:TWX) will now buy a stake in Hulu, one of Netflix (NASDAQ:NFLX) key competitors in video streaming, and in the process become an equal partner with existing cable owners Walt Disney (NYSE:DIS), NBC Universal, and Twenty-First Century Fox (NASDAQ:FOX) for a 25% stake each. The new deal values Hulu at $5 billion-$6 billion, more than double the $2 billion valuation the company was given three years ago.

Netflix shares had lost as much as 5% after news of the Hulu deal emerged, but later recovered after the Australian Communications and Media Authority revealed that Netflix Australia had managed to garner 2.5 million subscribers just 6 months after Netflix started streaming in the country. Australia has a total of 3.2 million video subscribers, which implies Netflix has already managed to grab close to 80% of the Australian market.

Implications for Netflix

The move by Time Warner would definitely be a strategic play against Netflix. Hulu is currently the third-largest streaming subscribers, with a reported 9 million subscribers as of April this year compared with 69.2 million by Netflix and an estimated 50 million-60 million by Amazon (NASDAQ:AMZN) Prime Video.

The main reason why the Hulu news rattled investors is because it confirmed earlier reports that cable TV companies, which have traditionally been Netflix’s major content providers, have begun souring on the video streaming company in favor of Hulu. Once Time Warner becomes one of Hulu’s owners, it will effectively mean that four of the six largest media conglomerates now back Hulu, the other two being CBS (NYSE:CBS) and Viacom (NASDAQ:VIA).

A better-financed Hulu is of course bad news for Netflix. Hulu has reportedly jacked up its content spending to $1.5 billion this year from $600 million last year. What’s even more worrying is that the company’s heavy investments in original content seem to be paying off handsomely as the platform continues to gain new subscribers at a rapid clip. Hulu has even managed to outbid Netflix for some original content.

The worst part of it all is that cable TV companies have increasingly been preferring to license content to Hulu due to Hulu’s better rates, and of course because Netflix is mainly to blame for the rampant cord-cutting going on. Fox chief executive James Murdoch did not mince words when he recently openly admitted that content rules had changed and that cable companies preferred licensing to Hulu because it offers better compensation.

When Netflix’s original content deal with Epix ended in September, Epix signed a new deal with Hulu instead. It’s not very hard to see some subscribers signing up with Hulu now that Netflix is going through a rough patch with no original content until Disney steps in in 2016.

Hulu’s better content rates is certainly not a good thing for Netflix, whose content costs have actually been growing faster than revenue and putting a lot of pressure on the company’s bottom line. Netflix spent 79.6% of revenue on content costs in 2012; 86.8% of revenue in 2013, and 89% in 2014. Economies of scale dictate that the opposite should be happening, with content costs as a percentage of Netflix’s revenue falling as the company continues to scale up its operations. But the fact that this has not started happening tells you that Netflix has been facing plenty of competition when competing for content. A stronger Hulu certainly won’t improve things a bit.

Hulu not a threat in international markets

Despite Hulu’s growing threat to Netflix, there is one key area where the Netflix stands head and shoulders above the company: international growth. Whereas Hulu recently said that it’s more interested in garnering a respectable customer base back home before thinking of expanding into international markets, Netflix is already expanding into these markets at full gear--and it is bearing fruit for the company.

During the last quarter, Netflix managed to add just 0.88 million domestic subscribers, but 2.74 million subscribers in international markets. Most of Netflix’s growth now comes from international markets, where Hulu and Amazon Prime Video are not nearly as dominant. Netflix spends minimally on infrastructure and capital expenditure ($69 million during the last fiscal year, or just 1% of revenue). So while the company’s content costs remain alarmingly high, its rapid expansion into international markets will help it stem these costs and eventually become profitable.

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Comments on this article and NFLX stock

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I pay for both netflix (many years now) and hulu ad-free (three months). Finally cut the cord this summer.

I wouldn't worry too much about netflix. Their model relies on being able to show you things you are interested in, not a specific tv show. Their interface and recommendations are much better than hulu (who seem primarily interested in pushing their own shows rather than considering what I might want).

Hulu has all kinds of "current tv" deals, which seem nice/powerful, but don't you dare fall more than 5 episodes behind, or you'll be waiting for the whole season to show up somewhere else before you can catch up. And they don't even have those 5 episodes for all of the current shows I might be interested in. They also let themselves be bullied into not including some of the content in the ad-free plan, which will probably let other content providers do the same in the future and reduce the value of the plan.

At the end of the day I feel like Netflix is interested in what I want, and Hulu is interested in what the content providers want. I'm perfectly content to pay for both for a while, however, until GOT season when I'll probably swap hulu for hbo for a few months.

The worst interface of all is of course amazon, but they balance that with the fact that you really can buy anything that isn't part of the free streaming library, plus the free shipping.
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