Verizon itching to enter video-streaming business

Netflix doesn't make for a very good acquisition target, with more than $3.5 billion in future content obligations.

By Trefis Dec 16, 2011 5:46PM
A report this week saying that Verizon (VZ) was mulling a bid for Netflix (NFLX) caused Netflix shares to briefly stop their downward march.

Why? Because a Verizon-Netflix combination would be a major force to reckon with for cable operators, such as Comcast (CMCSA) and Time Warner Cable (TWC), who are already concerned about cord-cutters dropping subscriptions in favor of cheaper Web-based alternatives. However, questions remain about how Verizon would roll out Netflix without directly cannibalizing its own FiOS service, which brings higher user revenue.

Our price estimate for Verizon's stock is $43.50, which is about 15% above market price.

See our complete analysis for Verizon

Netflix's rocky year

Since its price hike, Netflix's market value has fallen to a quarter of its mid-year highs. Suddenly, the stock looked cheap, and so Verizon could see a bid as an opportunistic way to tap the streaming trend.

However, Netflix's hike has not been totally unsubstantiated. In its zeal to provide more content for a growing subscriber base, Netflix overpaid for what it received. Netflix's current streaming content obligations stand at $3.5 billion, up more than three times since the start of 2011. So it announced a price hike to protect its bottom line, and that led to a mass exodus of subscribers and the first net decline in quarterly subscriber adds since 2009. If Netflix's subscriber growth rate has peaked, Verizon may not be so interested.

Netflix US Subscribers

Expensive content deals hurt

With a market cap of $3.8 billion and over $3.5 billion in future content obligations (which will only continue to grow as the company signs more content deals), Netflix doesn't make for a very good acquisition target. Moreover, if a big player like Verizon buys Netflix, the content owners will only ask for more.

One of the reasons we liked Redbox as a partner was that it would help Verizon leverage its existing relationship with content providers to win favorable deals. (see Verizon's potential Redbox partnership looks smart but questions remain) However, with Netflix having already overpaid for content, Verizon will not have that advantage if it chooses to go with Netflix.

Netflix Content Acquisition Cost as percent of Revenues

Where Verizon can see value in Netflix though is its huge, albeit declining, subscriber base of almost 23 million and a brand name that customers are familiar with. However, as with Redbox, a few questions remain.

Not wanting this new offering to cannibalize on its existing FiOS service, Verizon will want to launch the joint offering in outside markets at first. But will a national player like Netflix allow Verizon to cherry-pick its markets? If it doesn't, and Verizon has to launch the service in existing FiOS markets as well, will customers drop their FiOS TV connections in favor of the streaming service?

In either case, will Verizon be able to market its service in outside markets to customers who haven't hitherto used a Verizon offering for their TV connection? Netflix's brand should mitigate the last concern to some extent though.

Apart from Netflix and Redbox, Verizon also considered Hulu when it was up for sale last summer before ultimately passing. Whichever way Verizon tilts in its final assessment of possible partners, this much is clear: Verizon is entering the video-streaming business and the losers here are the cable operators who recently signed deals with the carrier to give away their wireless spectrum and with that, their chance to return the favor and challenge Verizon in its core business. The timing behind Verizon's revelation of its online streaming plans couldn't have been more impressive.



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