Can Time Warner afford not to buy Netflix?

March 16, 2011

By Jeffrey Goldfarb
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Netflix is looking less like Web TV and more like HBO. The $11.5 billion DVD rental and online video service’s plans to branch out into original content encroaches on the territory staked out by the pioneering Time Warner cable network. Given this turn of events, wouldn’t Time Warner be better off acquiring its emerging rival?

That’s not the obvious takeaway from the high-profile trash-talk dished out by Time Warner Chief Executive Jeff Bewkes. He has been publicly and provocatively assaulting the Netflix business model. He may be right, up to a point. Bewkes wonders how Netflix can keep charging consumers so little when he and a few other media giants control most of the programming the service needs to acquire.

But Netflix, run by co-founder Reed Hastings, has an established track record of defying skeptics. It overcame those who said it wouldn’t survive rival Internet rental businesses from Blockbuster, and then Wal-Mart. Netflix powered through the recession, adding nearly 8 million new subscribers last year alone, taking it to 20 million. HBO meanwhile lost about 1.5 million customers, dropping its total to about 28 million.

Broadcasting exclusive programming is a natural next step. It is, after all, how HBO made its mark, with the likes of “Sex and the City” and “The Sopranos.” The dramatic series “House of Cards” which Netflix is trying to buy could be just the ticket to kick off the endeavor.

To Bewkes’ point, it won’t be cheap. The production from Oscar-winner Kevin Spacey and “The Social Network” director David Fincher may cost Netflix $100 million, or more than one quarter’s worth of operating profit. And committing to 26 episodes of an unproven series is a big risk, though it offers the potential upside of helping sustain the pace of subscriber growth.

It may be a necessary gamble as consumers rapidly change their viewing habits. HBO is trying to keep up by allowing paying customers to watch on any platform they choose. But if Netflix is the next HBO — and the distribution medium of the future — then Time Warner might be better off owning it too. It’s a tall order given the adversarial ground staked out by Bewkes and by Netflix’s pricey valuation of 50 times expected earnings. But it could just as easily be that Time Warner can’t afford not to buy Netflix.

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