Blurring Boundaries Between Pay-TV And Online Video To Benefit Netflix

Not surprisingly, Hulu is in discussion with several pay-TV service providers to bundle its service, or make it available on their set-top boxes. ^[1] Netflix (NASDAQ:NFLX) has been making a similar effort of partnering with Comcast (read Will Comcast Really Partner With Netflix?), indicating a possible union between pay-TV companies and the alternative video service providers which were once being hailed as a competitive threat. The U.S. pay-TV industry has been losing customers as Netflix and other streaming services continue to gain popularity. This phenomenon is called “cord cutting.” Data suggests that cord cutting has gained some momentum in recent years, and it makes sense for the pay-TV service providers to partner with Netflix and others alike, in order to stall this decline. In turn, Netflix will get much wider distribution and visibility. While Hulu’s intention can be seen as a competitive move, it also indicates the blurring of boundaries between the traditional and modern video consumption models.

Our price estimate for Netflix stands at $232, implying a discount of about 35% to the market price.

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How Real Is “Cord Cutting?”

The cord cutting phenomenon appears to be gaining momentum as consumers turn to cheaper alternatives. According to Sanford C. Bernstein, the U.S. pay-TV companies lost 400,000 net subscribers in Q2 2012, and the loss stood at 113,000 for the third quarter of 2013. ^{[2] [3]} Although the satellite and phone companies are gaining customers, they aren’t able to offset the losses suffered by the cable operators. The market is saturated and may decline going forward. Even in the quarters when the industry grew, the growth was lower than that for the number of households, an indication that cord cutting is still going on. ^[1]

Cord cutting can be attributed to the growing popularity of alternative video services such as Netflix, Hulu, Amazon Prime and others, and the emergence of Internet as a preferred platform for content consumption. The pay-TV companies are making efforts to stall this decline by being more competitive on pricing, offering their own streaming services and bundling pay-TV with broadband. The growth has still remained dismal, and these companies are now looking at the possibility of partnering with the very firms that are responsible for cord cutting. This union could be mutually beneficial, and help Netflix drive long term growth in the U.S.

How Will Netflix Gains From The Of Pay-TV And Online Video Union

Netflix currently has close to 33 million streaming subscribers in the U.S. Although the growth is still strong, it has come down slightly over the past few years. Additionally, the company has covered a lot of ground domestically, as many users have tried the service and discontinued it. This suggests that the growth may continue to slow down in the coming quarters despite the improvement in content quality. Partnering with pay-TV service providers will help Netflix in better marketing and distribution since more than 85% of the household in the U.S. subscribe to pay-TV. Such partnerships could also help in content deal negotiations as cable and satellite companies have long standing relationships with content owners. We currently project Netflix’s U.S. subscriber base to reach 54 million by the end of our forecast period. However, if the partnerships with pay-TV companies push this figure up to 62 million, there could be 10% upside to our current price estimate.

Our price estimate for Netflix stands at $232, implying a discount of about 35% to the market price.

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1. Hulu Wants to Be Offered With Pay-TV Bundles, The Wall Street Journal, Nov 12 2013 [↩] [↩]
2. Evidence Grows on TV Cord-Cutting, The Wall Street Journal, Aug 7 2012 [↩]
3. Cord-cutting: Pay-TV companies lose 113,000 customers in quarter, Los Angeles Times, Nov 12 2013 [↩]