December 5, 2012 7:58 pm

Netflix targets the bigger picture

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Box office draw: Disney/Pixar family-centric movies, such as 'Brave', are a good fit for Netflix

Hollywood has long had a fruitful relationship with the pay-TV industry, with blockbuster movies produced by the biggest studios enjoying a lucrative afterlife on channels such as HBO, part of Time Warner, CBS’s Showtime and Starz, part of Liberty Media.

The relationship, which has endured for more than 20 years, meant pay-TV operators and the channels they carried could use exclusive film content to attract subscribers.

For the studios, deals with pay-TV became one of their most reliable revenue streams.

That relationship was upended this week when Netflix, an online subscription service, netted the industry’s biggest fish, signing an exclusive distribution deal with Walt Disney. The deal sent reverberations around Hollywood and beyond: for the first time a big studio had chosen to abandon premium TV in favour of an internet TV operator.

Netflix has already moved into territory occupied by pay TV channels by producing its own programming: its biggest bet, House of Cards, a $100m adaptation of the BBC series, airs next year.

However, the Disney deal raises the stakes yet higher: Ted Sarandos, Netflix’s chief content officer, told a conference in New York on Wednesday that the agreement was a “game-changer” for the company.

Disney had for several years been supplying its movies to Starz, which would air them in the pay TV “window” shortly after their release on DVD. Starz’s deal expires in 2016 and Disney opted to sign a new three-year deal with Netflix rather than renew the agreement with its TV partner.

Netflix is paying a high price for Disney content. Pay TV output deals are valued using a complex formula that links the licence fee per movie to its performance at the US boxoffice. That fee is usually about 10 per cent of the box office performance.

Netflix was willing to go higher than that ratio, according to people familiar with the situation, and could pay as much as $400m a year, depending on the performance of Disney’s movies.

This is considerably more than comparable studio-pay TV deal. 20th Century Fox has renewed its output deal with HBO in a deal worth around $200m.

While it is paying a premium, Disney’s family-centric movies are a good fit for Netflix, which is popular with parents looking for on-demand viewing that is suitable for their children.

“It’s a bold bet,” said Richard Greenfield, an analyst with BTIG Research. Netflix, he said, had “locked up the most important brands in the film industry”. Disney’s stable of brands includes Marvel, Pixar, and now Lucasfilm – which gives it the right to make a new series of Star Wars films. “It’s the highest quality content you can buy,” said Mr Greenfield.

The Disney tie-up “differentiates” Netflix from its competitors, such as Amazon, which has its own online video service, and Hulu Plus, wrote Barclays analyst Anthony DiClemente in a research note.

But as Netflix shares soared on Tuesday in the aftermath of the deal, he urged caution, saying the benefit would come over the “longer-term” with the tie-up not starting in earnest until 2016.

The irony is that Netflix used to have lots of Disney movies on its service thanks to an earlier deal it had with Starz.

The agreement allowed Netflix to screen whichever Disney movies Starz was screening – as well as other content carried by the channel, which included original TV shows, and films released by Sony Pictures.

In the summer of 2011, Starz and Netflix were negotiating a new deal worth an estimated $300m a year but Netflix walked away, triggering a sharp decline in its shares and the start of 18 months of turbulence marred by a price rise and a botched rebranding – which it later abandoned.

Netflix shares, which had touched $300, fell by two-thirds and recently attracted the attention of activist investor Carl Icahn, who has built a 10 per cent stake.

Netflix shares rose 10 per cent on Tuesday in the aftermath of the Disney deal announcement and were at $83 in afternoon trading on Wednesday.

Yet the company will pay more for Disney content with its new deal than it did in the previous Starz deal – which also provided it with access to Disney movies.

A Netflix spokesman said the new Disney deal was broader in scope and included Disney’s direct-to-DVD titles, such as a series based on Tinkerbell.

In dealing directly with Disney, Netflix had “cut out the middleman”, he said. “We have focused on Disney films and kids content that we believe will get extraordinarily high viewing hours.”

Despite its rocky share price, the company has added 10m subscribers in the past 22 months.

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