Analyst: This House of Cards Omission Will Cost Netflix

The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.  

On Thursday afternoon, AllThingsD reported that Netflix (NASDAQ:NFLX) only owns the first window streaming rights to the TV series House of Cards, and not the rights to sell the show in other venues. According to a PR Newswire report from October 2012, House of Cards originally debuted on Netflix on February 1, with all 13 episodes of the first season available to streaming subscribers in each of its territories. The second season is due to begin production in spring 2013.

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• Earlier this week, House of Cards became available for pre-order on the Amazon (NASDAQ:AMZN) website, with a DVD list price of $55.99 and Blu-ray list price of $65.99, with the studio listed as Sony Pictures Entertainment (NYSE:SNE), and not Netflix. According to the AllThingsD article, Media Rights Capital, the producer of the show has the rights to sell the series in other venues apart from the first window (which Netflix owns). Sony is handling distribution of the DVD in the U.S. and abroad on behalf of Media Rights Capital.

From the AllThingsD article: “The bigger (but smallish) point here is that even though this is a series commissioned for and funded by Netflix, it still isn’t Netflix’s series. Netflix’s money bought it an exclusive first “window” to stream the show. But Media Rights Capital, which actually produced the show, has the rights to sell it in other venues; Sony is handling distribution duties in the U.S. and abroad”…

Netflix confirmed its ownership of “first window” rights on its most recent earnings call. On the Q4:12 results conference call, CEO Reed Hastings disclosed: “The current originals mostly were a first window licenser. And for example, on House of Cards, Media Rights Capital owns the other rights and will be monetizing those downstream from us. So we’ll try different structures as we go forward, but primarily we’re focused on monetization on our platform.”

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Although Netflix’s ownership of only partial rights is not a new disclosure, we believe that in recent months, Netflix’s share price appreciation has been driven in part by the perceived potential upside for the company from House of Cards’ success. In our view, many investors believe that Netflix’s original series have the potential to place the company at competitive parity with HBO (NYSE:TWX), which has 39 original series currently listed on its website.

We believe that the difference between HBO’s and Netflix’s ownership of original content is meaningful, insofar as HBO can choose when other windows of distribution are exploited, and Netflix apparently cannot. In our view, Netflix’s ability to monetize House of Cards is limited to its own platform, negatively impacting the bull thesis that it may one day be able to compete with premium cable outlets such as HBO…

We estimate that Netflix spent roughly $2 million per episode on House of Cards, less than half of the estimated $4.5 million per episode production cost. We continue to question whether the company’s original content strategy is sound, particularly given the relatively high cost of production when compared to the relatively limited display rights the company receives in return.

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Netflix will report Q1:13 (March) results after the market close on Monday, April 22, and host a conference call at 3:00pm PT (Dial-in: 760-666-3613, webcast: http://ir.netflix.com). Our current bias is that the company is well-positioned to meet or exceed our Q1:13 EPS estimate of $0.22, compared to consensus of $0.18 and guidance of $0.00 – 0.23, due to the positive impacts of House of Cards and the recent domestic Facebook (NASDAQ:FB) integration on subscribers, as well as cost control. We will publish our Preview note closer to earnings.

Maintaining our UNDERPERFORM rating and 12-month price target of $55, which reflects a sum-of-the-parts that values domestic streaming ($28/share), domestic DVD ($20/share) and international streaming $7/share).

Risks to the attainment of our share price target include: a sudden increase in subscriber growth, declining competition from other movie rental competitors, lower than expected costs for content, technology development and deployment, and improving macroeconomic factors.

Michael Pachter is an analyst at Wedbush Securities. 

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