Netflix: The Real House of Cards


First of two articles

Happy Valentine’s Day, honey. Instead of going out to an overpriced dinner in a restaurant crowded with a few dozen other tired, tense couples, how about we stay in and binge?

On “House of Cards,” season 2.

Netflix today posted all 13 episodes of the much-anticipated second season of the Kevin Spacey/Robin Wright political soap opera, replete with sexual romps, homoerotic undertones and the real star of the show: the naked abuse of power and manipulation in our nation’s capital.

Which is the perfect backdrop for the fight that will break out over the $45 billion takeover bid that #1 cable operator Comcast just made for #2 Time Warner Cable. More cable clout could lead to higher traffic-tolls that Netflix must pay to send huge volumes of video over cable wires and into 30 million homes nationwide.

And Netflix can ill afford any increase given its gossamer finances. In the fourth quarter it raked in over $1 billion in subscriber fees, yet was able to set aside “free cash” of only $5 million.

That’s five dollars on $1,000 in sales: This is the business behind the best stock of 2013?

As “House of Cards” unfolds, expect tune-in from a couple million of Netflix’s 30 million homes in the U.S., some portion of which will watch the entire series in just a weekend. (I’ll be among them.)

But for all the buzz it will bring, “House of Cards” itself won’t generate a dollar of extra revenue for Netflix. While fans love it, the show hasn’t sparked any boost in subscriber growth.

In Q1 2013 when “House of Cards” premiered, Netflix added 2.03 million new subs—fewer than the 2.05M it added the quarter before. And a quarter later, Netflix added only 630,000 new members. So “House of Cards” had no halo effect at all.

It’s hard to get non-Netflix homes to sign up just to see a show they’ve never sampled before, and easier to pitch them a panoply of content. Yet original shows are the central plank of Netflix’s strategy to be the HBO of the Internet age (though HBO is doing a good job itself). They’re much more expensive than renting reruns of a series already on TV.

And the more original shows Netflix produces—the company now figures it has this elusive art down pat—the more flops it will have to endure. Simple Hollywood math.

Netflix spent over $100 million on the first two seasons (26 eps) of “House of Cards.” The series will end after season 3, leaving a 39-episode package when 100 is standard in the syndie-biz. And Sony reaped any upside from DVD sales of the first season, even though NFLX had bankrolled it.

Over all, Netflix has committed more than $6 billion in payments to Hollywood for programming, yet it hasn’t begun to deduct the bulk of those costs from earnings because the shows have a long shelf-life, the company argues. So it deducts those costs from earnings only gradually.

This sets up Netflix as a kind of Ponzi scheme: It plows cash from current members into new programming purchases, to stoke membership growth, which brings in more cash to buy more content, aimed at adding still more subs.

At some point Netflix will hit saturation, subscriber growth will slow markedly in the U.S., and the programming costs will start hurting earnings. And the Ponzi scheme will have to move overseas.

So which is the real “House of Cards”? The TV show, or the company itself? My bet would be the latter, though this is a momentum stock you can’t dare bet against right now.

Binge-viewing is what made Netflix great, and legions of fans will be binging this weekend. But even that bodes ill for NFLX. It recently disclosed that because of the binge-trend, it must start writing off costs sooner, reducing earnings.

That’s because viewers binge so much, especially on new series such as “House of Cards” and now the lesbians-behind-bars melodrama, “Orange is the New Black,” that the shows have a shorter shelf-life. So they now must be written-off faster. That will hurt earnings, but for now Wall Street focuses more on subscriber growth. When that slows, disillusionment at waning and wobbly earnings could rise.

We binge-viewers need not worry about all of that as the stream starts for season 2 of “H.o.C.” But investors certainly should.

Next up: The political implications for Netflix et al in the Comcast-Time Warner Cable merger.

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