The Facebook Post Worth $779 Million

Netflix shares jumped 20.6 per cent this past week after a July 3rd Facebook post by company founder and CEO Reed Hastings congratulating chief content officer Ted Sarandos and his team with helping Netflix exceed 1 billion hours for the first time ever in June.

The stock had closed at $67.85 on July 2nd and ended at $81.89 on July 6th. With 55.52 million shares outstanding, that worked out to a bounce of $779 million in Netflix’ market capitalisation after everyone from the New York Post to The Los Angeles Times to Ad Age responded with significant coverage of the implications of 1 billion hours streamed in a month and how the factoid should be interpreted. Some early headlines, later revised, suggested the volume “beat cable”.

The AdAge analysis quoted Janney Capital Markets analyst Tony Wible warning “the message to advertisers is there is a continued risk to ratings, and as a result, to advertising revenue. Networks will become more desperate to sell digital rights to make up for this advertising shortfall.”

Netflix competes with all other video sources — ranging from HBO to YouTube to Hulu to cable VoD to basic networks and broadcasters — for viewing time but like HBO and other premium services it doesn’t compete for ad dollars. And at least historically, advertisers have been largely willing to compensate for viewer erosion to non-ad-supported sources by increasing advertising CPMs (the cost-per-thousand rates charged for commercial units). This is particularly true for the broadcast networks in prime time. Television Bureau of Advertising data shows that the average broadcast network prime time show has seen viewing households in the last ten years drop from 6.472 million in 2003 to 4.630 million in 2012 (a 28.5 per cent decline) while the average 30-second unit spot cost has risen from $89,100 to $111,500 over the same time frame. That works out to a CPM increase of over 57 per cent, from $15.51 per 1,000 homes to $24.08 per 1,000 homes.

So what does 1 billion viewing hours in a month really equate to? Since Netflix only sells one subscription per household, the most relevant comparison metric is household viewing. Most broadcast and cable networks today report Nielsen numbers in terms of the number of individual viewers and even then the focus is mostly in the 18-35 and 18-49 demographic. As the industry adage goes, advertisers buy demographics, not households. But some 2010 data on basic network viewing by households does allow for some comparison.

 

TOP TEN BASIC NETWORKS 2010

24-Hour

Viewing

Network

TVHH

Hours/Month

(000)*

(000)

Nick

1,575.6

1,134,432

Disney

1,252.0

901,440

USA

1,116.0

803,520

TNT

1,018.0

732,960

Fox News

899.0

647,280

Cartoon

861.5

620,280

ESPN

801.0

576,720

TBS

676.0

486,720

A&E

607.0

437,040

History

599.0

431,280

*Source: Nielsen Media Research

 

In 2010, Nickelodeon averaged 1.5756 million viewers per hour across its entire 24-hour schedule. Multiplying by 24 hours and then by 30 days works out to 1.134 billion viewing hours per month.

The bottom line: all of Netflix’ TV viewing is equivalent to that of the largest ad-supported basic networks such as Nickelodeon, Disney and USA. What makes that impressive is that each of those networks is available to more than 99 million TV households, while the latest reports put Netflix in 26.5 million subscribing households. However, unless Netflix begins competing with broadcasters and cable networks for advertising dollars, these viewing level comparisons are largely academic. National advertisers are focused on reaching national audiences and the reality is that Netflix, even if it were to sell advertising, is in less than a quarter of all US television households. There is even a good historical precedent: when HBO had twin monster hits with The Sopranos and Sex And The City, there was little industry talk about ratings or advertising erosion.
So who does Netflix really compete with? For discretionary monthly subscription dollars, it is the premium services (HBO, Showtime, Starz and Epix), especially HBO and Showtime which have placed major programming resources against original episodic programming… and that is precisely where Netflix has pegged its hopes for future growth. Unless there is a major change in movie studio output deals with the premium services, with the exception of its deals with the parents of the Epix premium service (Paramount, Lionsgate and MGM), the movie component of Netflix’ streaming service is going to continue to be largely composed of older library titles (HBO, Showtime and Starz control the electronic subscription rights to studio output movies through their first two pay cycles, which keep them off Netflix for seven to nine years).

An argument could be made that from a pure user experience standpoint, the closest comparison is between Netflix and the VoD offerings of the various wired cable operators, such as Comcast, Time Warner and Cox. Here again, however, since cable operators don’t charge for their free VoD offerings, there is no economic impact from Netflix. In fact, cable operators do have something Netflix does not: the rights to rent individual new movie titles on an on-demand basis in a window that is just 6-8 weeks after their DVD debut.

Ultimately, the biggest competition is for creative talent. To the extent that Netflix (and the other premium services) shift more programming dollars into acquiring original scripted dramas and sitcoms, it could drive up the above-the-line costs for producers, writers, directors and actors. In the end, broadcast and basic network television could wind up predominantly the source for live news and sports, reality fare, game shows and competition series such as Dancing With The Stars, Amazing Race, American Idol, The Voice and X-Factor. Scripted dramas and sitcoms could increasingly shift to subscription–based services.

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Larry Gerbrandt (larry@mediavaluation.com) has been a media analyst for more than 25 years with companies such as Kagan and Nielsen. He is a principal at Media Valuation Partners, which provides strategic consulting, research, valuation and expert witness services and is a managing director of Janas Consulting, which provides management consulting, valuation and investment banking services.

 

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