If Verizon Buys Netflix, Juicy FiOS Revenues are at Risk
After rumors that Verizon (NYSE:VZ) was looking to partner with RedBox in order to provide stand-alone online streaming services next year, a recent report emerged that Verizon is now looking at potentially placing a bid for Netflix (NASDAQ:NFLX) instead. [1] This came as a welcome respite to Netflix’s shares that rose over 6% after the news broke on Monday. A Verizon-Netflix combination would be a major force to reckon with for cable operators such as Comcast (NASDAQ:CMCSA) and Time Warner (NYSE:TWC) who are already concerned about cord-cutters dropping their pay TV subscriptions in favor of cheaper web-based alternatives. However several questions remain on how Verizon would roll out Netflix without directly cannibalizing its own FiOS service which have much higher average revenues per user than a Netflix subscriber would.
Our price estimate for Verizon’s stock is $43.50, which is about 15% above market price.
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Netflix’s rocky year
Sustained pressure on Netflix’s stock ever since it announced a price hike has seen its market capitalization fall to one-fourth of its mid-year highs. The recent fall has made Netflix’s stock look cheap and so Verizon could see a bid as an opportunistic way to tap the streaming trend.
However, Netflix’s slide has not been totally unsubstantiated. With a growing subscriber base, Netflix needed to add more content and in a bid to address that need, overpaid for the content. Netflix’s current streaming content obligations stand at $3.5 billion, up more than three times since the start of 2011. [2] Subsequently, it had to announce a price hike to protect its bottom line that led to a mass exodus of subscribers and Netflix posted a net decline in quarterly subscriber adds in Q3 2011 for the first time since 2009. If Netflix has hit a peak in its subscriber growth rate, Verizon may not be so interested.
Expensive content deals go against Netflix
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.
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 more familiar with in the online streaming business. However, as with Redbox, a few questions remain.
Not wanting this new offering to cannibalize on its existing FiOS service, Verizon will wants 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 has 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 or chooses to go it alone, this much is clear. Verizon is entering the video-streaming business and the clear 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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Notes:- Verizon ‘Very Serious’ About Making Bid for Netflix, Banker Says, Bloomberg, December 12th, 2011 [↩]
- Netflix Q3 2011 10-Q filing [↩]