Janney/NFLX: Sly Syndication Strategy - Tony Wible

Syndication has always played a big role in media and many TV networks have relied on this market to fill most of their programming hours. However, NFLX has changed the value proposition as consumers can now create their own network of rerun programming. One would think that this erodes the value of syndication, but in fact we have seen value increase significantly as more players jockey after hit shows around the globe. We believe NFLX is a driving force behind this change and is creating a competitive advantage by being an aggressive early buyer.

Rising Rates - Back in 1996 the most expensive syndication deal was for ER, which was sold to TBS/TNT for $800,000/episode. NFLX just paid $2 million/episode for The Blacklist – a 150% increase in pricing and the fifth most expensive deal on record. Although syndication pricing has generally trended up for years, the increases have ostensibly accelerated since NFLX got more aggressive in streaming in 2010. NFLX spent only $64 million on streaming content in 2009, which jumped to $406 million in 2010, and a staggering $2.3 billion in 2011. The price for the top syndicated shows has grown at a 7.5% CAGR since 2010 with the average top deal priced at $1.8 million vs. $1.2 million ($1 million excluding two mega deals) for the prior 15 years.

Incremental Value - We believe production companies are seeing NFLX as a way to reduce risk and generate incremental value, which NFLX will use to create a competitive advantage. TV ad revenue growth is slipping below the rising cost of production. Simply put, TV cannot rely on incremental advertising to cover incremental production costs. Many shows are produced with an initial deficit (i.e. they are not profitable until they are sold into international markets or go into off network syndication) with producers essentially taking a gamble that is getting riskier as ratings and ad revenue slip. NFLX is partly to blame for the ad revenue/ratings headwinds but ironically is helping (along with international payments) to eliminate/minimize initial US deficit accounting risk through its large payments.

Early Mover - NFLX's data is a competitive advantage it has leveraged to secure early syndication deals - in some cases before shows even debut. Most traditional players need to see how audiences respond to shows while NFLX can make predictions based on its audience viewing patterns. An early syndication payment is a substantial benefit for TV producers as they minimize the risk of taking a loss on shows that may prove to be unpopular or boost profit on promising new shows. We see NFLX being able to bid on shows one/two years in advance of others.

Top Dollar - NFLX has been the top bidder for the most popular TV series for the past two years. Although its rates are only marginally higher than Turner (a frequent top buyer), it still enjoys two benefits of being a top dollar payer for content. First, NFLX will naturally win rights to good programming as producers value NFLX's ability to quickly minimize deficit risk or bolster profit. Second, NFLX makes it more difficult for competitors to be profitable, as other digital/traditional networks have to pay more for content across a smaller sub/ratings base.

Tony Wible can be reached at twible@janney.com.

IMPORTANT DISCLOSURES
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I, Tony Wible, the Primarily Responsible Analyst for this research report, hereby certify that all of the views expressed in this research report accurately reflect my personal views about any and all of the subject securities or issuers. No part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views I expressed in this research report.
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