A fix for Netflix

Its subscriber base is unrivalled, but without its own hit shows, can the video-streaming service survive?
Jaime J. Weinman
LONDON, ENGLAND - JANUARY 09: An Apple Ipad is used to view Netflix during the Netflix UK launch in London, England on January 9, 2012. Netflix the leading global internet subscription service for films and TV programmes, launches today in the United Kingdom and Ireland, offering instant and unlimited access to a broad range of entertainment for the low monthly price of ?5.99 in the UK and ?6.99 in Ireland. (Photo by Gareth Cattermole/Getty Images for Netflix)
Gareth Cattermole/GETTY IMAGES

Is Netflix in trouble? Carl Icahn doesn’t think so, or if it is, he thinks it can be sold for a lot of money before the trouble comes. Icahn, a veteran investor with a reputation as a corporate raider, picked Halloween as an appropriate time to announce he had purchased up to 10 per cent of the shares in the video rental and streaming company, and that he had big plans for it. Netflix, he explained, has “significant strategic value for a variety of significantly larger companies.” Its share price rose on the announcement and the implication that Icahn might engineer the company’s sale. Observers theorized about potential buyers—Amazon, Microsoft, Google—but it’s by no means a sure thing that such a sale will happen—or even that Netflix has enough that’s worth buying.

Netflix’s problems have been subjected to much publicity since last year, when the company announced and then withdrew a plan to phase out the DVD mail-order rental service it began with. Since then, its stock has dropped precipitously (from a high of $295 to $78) and its business model has been questioned. But there’s one thing Netflix still has that few other video companies can match—a huge, engaged subscriber base that practically dominates not only the streaming business, but the entire Internet. According to a report last week by the Canadian Internet company Sandvine, Netflix accounts for 33 per cent of traffic during peak hours in the U.S., and reports have shown it doing even better in Canada. Other streaming services simply can’t compete. Amazon, which is building up a streaming service that hopes to rival Netflix, currently has less than two per cent of the business.

What Netflix doesn’t have yet is something to sell beyond that subscriber base. Deadline Hollywood executive editor David Lieberman wrote that “analysts see few likely buyers” for Netflix, because among major companies like Apple and Google, “none has a burning need to own a subscription video-streaming service.” And as for big studios, they make money by licensing movies and shows to Netflix. Analysts have noted that studios are happy to take money from Netflix, but don’t see anything all that attractive in its low-margin business model.

That could help explain why Netflix has been trying to expand into content and away from its total dependence on pre-existing material. In recent months, the company has been ramping up its attempts to create original shows, particularly TV episodes, an increasingly popular part of the service. In 2013, Netflix will unveil a new season of the cancelled cult favourite Arrested Development, as well as the Kevin Spacey adaptation of the British TV series House of Cards. These series could provide what cable networks like HBO have—a library of films and shows that the studios can’t take away.

Even here, Netflix may be running headlong into studio resistance: with the exception of Arrested Development—which won’t even be able to reassemble the entire cast for every new episode—most shows being offered to it are ones the major studios and networks don’t particularly want. Its most recent acquisition was The Killing, an AMC murder-mystery show that had fans and critics hating it when it took two years to reveal the murderer. Netflix will co-finance a third season with AMC, but it has yet to demonstrate that it can get further access to shows with a genuine chance for popularity.

Still, AMC itself demonstrates how original content can turn things around for a company. The network was going nowhere until it diversified from movies into original series like The Walking Dead. If Netflix can develop its own Walking Dead-style hit to go with its existing distribution base, it might become more valuable to outside companies than it is now. Of course, that doesn’t mean Icahn will succeed in getting it sold: after he announced his investment, Netflix adopted a poison-pill amendment designed to keep him from taking over, which Icahn denounced as “poor corporate governance.” He then told CNBC’s Fast Money that he still wasn’t ruling out the possibility of a hostile takeover. “It certainly is one alternative,” he said, adding that “we haven’t made that decision at this point.”

By the time he decides whether to go through with the plan, Netflix could become a company with not only a lot of customers, but something of its own to sell. Even if that something is only another season of The Killing.