Can Viacom and Disney Deal a Painful Blow to Netflix?

NEW YORK ( TheStreet) -- Last week, Bernstein Research analyst Todd Juenger speculated that Disney ( DIS) and Viacom ( VIA.B) will pull the kids' programming they license to Netflix ( NFLX) from the video streaming service. In a nutshell, Juenger chalks up ratings declines on kids' television shows to Netflix's impact.

In this article, I assess Juenger's contention. Then I consider whether or not his scenario has any chance of unfolding. I close by discussing the larger ramifications for Netflix and the overall media space.

The Netflix Value Meal

When you stop and think about it, it's as unhealthy as McDonald's ( MCD) used to be and still can be. You pay Netflix $8 a month and plop your kid down in front of the computer so he or she can consume hours upon hours of iCarly and SpongeBob reruns. This approach to child rearing can bring on the munchies, pack on the pounds and save some families cash if they cut all or part of the cable cord. How many kids really know or care if they're watching the latest episode of SpongeBob or the reruns Viacom sells to Netflix?

If we believe Juenger's hypothesis, adults do know the difference. He contends that offering reruns of shows like Mad Men to Netflix has actually kept streamers in contact with cable because they seek out new episodes on AMC after watching old ones on Netflix. Obviously, the dynamic could have a lot to do with age as it relates to behavior; it's a double-edged sword. It might make sense to license an original program, serialized programming or old episodes of The Office, but not seemingly evergreen cartoons and kids' shows.

Does Netflix Have Any Control?

Because we do not know the ins and outs of the content deals Netflix signs we cannot come up with a definitive answer to this question. We can, however, cull from history to inform an educated guess.

Last year, Starz announced it would not renew its contract to stream movies via Netflix. This move came shortly after Sony ( SNE) pulled its movies, which were part of the Starz deal, from the service in what Netflix discounted as a "temporary contract issue." Clearly, it ended up being more than a fleeting dispute. Starz appears to have told the real story in the above-referenced September 2011 press release:
This decision is a result of our strategy to protect the premium nature of our brand by preserving the appropriate pricing and packaging of our exclusive and highly valuable content. With our current studio rights and growing original programming presence, the network is in an excellent position to evaluate new opportunities and expand its overall business.

Translation: At $8 a month, there comes a point where Netflix dilutes the quality of our content. We're no longer interested in giving it away.

While I consider this a profound point in the Netflix drama, I thought Bloomberg reporters jumped the gun last year when they said:
"Who knew this was a problem ... what Netflix never warned people was that Sony could pull out of its deal with Starz ..."

Netflix "has known all along."

It's flat out wrong to state that "Netflix never warned people" about Sony. Maybe not specifically, but if you read the risks section of Netflix's annual report, you'll find the possibility of content getting pulled clearly and openly discussed.

A little due diligence is all that it takes.

With relation to companies like Viacom and Disney pulling kids' shows then, we do not know what the deal is. I would imagine they're free to do it. As I have argued over the last year or so, competition is not necessarily what makes Netflix vulnerable to failure; the fact that content owners operate from a serious position of strength is. That said, without seeing the contracts or being privy to their terms, it's difficult for anybody to know exactly how this could shake out if it's even on the table to begin with.

Potential Impact

This whole episode, whether it plays out or not, only underscores the fragility of Netflix's model. The company aggressively pursues original programming because Reed Hastings is not an idiot. He can read the writing on the wall.

Presently, he scratches the content providers' backs by pumping up their revenue figures with millions in licensing fees. The content providers, in return, allow Netflix to live to fight another day.

First it was Sony. Then it was Starz. Next, it could be Disney and/or Viacom. As more and more of the companies who own the leverage in this relationship decide to dump Netflix as a buyer of their reruns, the closer Netflix comes to the edge. All Reed Hastings can hope is that miracles come and relatively unknown programs like Lilyhammer morph into original smash hits like The Sopranos. Otherwise it's time once again to call Wall Street or put a "For Sale" sign on the DVD division's door in an attempt to secure another bailout to keep the dream alive.
At the time of publication, the author was long VIAB and TWX.

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