Netflix's Strategy Plays Out: If You Build It, They Will Come

Netflix (Nasdaq: NFLX) is enjoying a content bonanza right now. Will it make a difference to the bottom line? Read on for the answer.

Is Netflix the next HBO?
Let's start with the obvious: Netflix just announced yet another original series. Hemlock Grove puts an award-winning horror novel in the hands of director Eli Roth, who specializes in horror movies that make a small fortune on shoestring budgets. The first season of 13 episodes will debut in 2013, starring X-Men alumna Famke Janssen and Swedish actor Bill Skarsgard, son of international superstar Stellan Skarsgard.

This is Netflix's fourth original series, following Mafioso-in-Norway dramedy Lilyhammer as well as upcoming political drama House of Cards and comedy Orange Is the New Black. The company is also producing new episodes of beloved but canceled comedy Arrested Development, slated for streaming next year. This lineup may not quite measure up to the Emmy-winning power of Time Warner's HBO, but it beats any basic-cable channel you'd care to mention.

Like Lilyhammer, Hemlock Grove is produced by an independent studio and Netflix simply pays for exclusive rights to the pay-TV first-run window. That's a low-risk strategy that reduces Netflix's financial exposure in case these projects turn out to be total turkeys.


On the other hand, the company also gets left out of the profits if other online movie outlets or -- shock, horror -- cable channels and the Big Four networks pay up for later distribution rights. Syndication is an important part of the strategy for HBO and other premium cable networks. But Netflix isn't going for content-production paychecks: All that matters today is sucking new subscribers into the streaming experience by the millions. The company may become an outright producer one day, but that's simply not important right now. Check again in five years.

Dead can dance
Hemlock Grove is one of several gambles on unproven shows that may or may not bring in new subscribers. That's not the case with The Walking Dead, which has been available to Netflix customers since last October. That zombie drama's second-season finale set basic-cable records this week, with 9 million viewers. That's nearly enough to land on Nielsen's list of the 10 most watched on-air network shows.

Now, Netflix has to wait until AMC releases that season on DVD before airing that record-breaking season. But if AMC sticks to the three-month delay pattern from season one, that means raising the curtains in June or July. Meanwhile, Amazon.com (Nasdaq: AMZN) will let you watch the entire season online today.

That'll cost you $1.99 per episode, though, or $20.99 for the entire season. That's something like three months' worth of Netflix streaming service. You're trading cash for convenience. We're talking about two very different business models here.

Either way, both Amazon and Netflix should enjoy the record-breaking interest in The Walking Dead. Expect Netflix to build entire marketing campaigns around zombies when the second season draws closer to becoming available.

Stay hungry, feel the fire
And that's not all. Through its content agreement with Epix, Netflix has early dibs on Lions Gate Entertainment (NYSE: LGF) productions such as The Hunger Games. That adaptation of another best-selling novel hits theaters at midnight Thursday, and even the studio is shocked at how quickly tickets are pre-selling. Lions Gate's shares have jumped 16% in the past five days and nearly 90% year to date, largely thanks to expectations on this particular film.

"Exactly how much the studio can gross for the first weekend depends on how many screenings each theater can pack into 72 hours by finding enough staff willing to work the extra hours and keep the pic running continuously," says famed Hollywood watcher Nikki Finke. That includes 270 large-format IMAX (Nasdaq: IMAX) screens, where ticket prices also come supersized. Even in these cash-conscious times, IMAX can sell out midnight screenings at premium prices for this title.

Even Microsoft (Nasdaq: MSFT) wants to cash in on this guaranteed blockbuster's popularity by making an immersive online 3-D tour of the Hunger Games Capitol. And you know that there are big bucks on the line when Redmond gets personally involved.

In other words, here's another eyeball magnet that will be worthy of special promotion when it hits the Netflix streaming library. Hunger Games is another Twilight-class hit, except with fewer vampires and better storytelling. And if that's not enough, consider that The Hunger Games is a trilogy. It's the gift that keeps on giving.

If Huger Games and The Walking Dead don't motivate a significant influx of new Netflix subscribers in the second half of 2012, I'll buy a hat just so I can eat it. Many prospective Netflix investors have been scared away by the large off-balance-sheet content costs, but that's what it takes to build a library that's worthy of attention and subscriptions. I'm as comfortable owning Netflix shares as ever, and this week's movie magic just underscores how healthy this business really is.

Netflix has its fair share of critics these days, but you always get better buys when everyone else is selling. Buying when there's blood in the streets is a winning strategy.

At the time this article was published

Fool contributor Anders Bylund owns shares of Netflix but holds no other position in any of the companies mentioned. The Motley Fool owns shares of Microsoft and Amazon.com. Motley Fool newsletter services have recommended buying shares of IMAX, Microsoft, Amazon.com, and Netflix and creating a bull call spread position in Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinion, but we all believe that considering a diverse range of insights makes us better investors. Check out Anders' holdings and bio, or follow him on Twitter and Google+. We have a disclosure policy.

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