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Original Content: The New Weapon in Video Streaming

Adam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Maybe it’s just me, but it seems like Netflix’s (NASDAQ: NFLX) new original series, House of Cards, is all over the internet lately. It’s in the entertainment news, the financial news, the tech news – everybody wants to talk about this show. Whether you love it, hate it, or could care less, it’s a big shot by Netflix in the war for the living room.

Content is king

Netflix boasts by far the best streaming library available for television and movie watchers. With “hundreds of thousands” of titles available according to the company, it knocks competitors out in that regard. However, the moat for most of those titles isn’t very large. Any competitor with deep pockets can come in and snatch up the exclusive rights to quite a few of those titles.

In fact, that’s exactly what Amazon (NASDAQ: AMZN) did earlier this month when it struck a deal with PBS to gain exclusive rights to future seasons of the popular Downton Abbey. Netflix viewers that want to binge on seasons 3, 4, and 5, will have to switch to Amazon Prime or buy the DVDs when they’re released (likely through Amazon). Both companies understand that exclusive rights to the shows and movies people love to watch again and again will be the weapon that wins this battle.

That’s why both companies as well as Hulu Plus have started investing in original programming. The advantage of original programming is that it doesn’t matter how fat your wallet is, the content cannot be bought. It’s what’s driven Time-Warner’s (NYSE: TWX) HBO to more than 30 million subscribers willing to pay about $15 per month extra to their local cable company. Subscribers want Girls, they want True Blood, Game of Thrones, The Wire, Sopranos, Entourage, and everything else HBO has to offer. They love it, and it’s what helps them justify paying an extra $15 a month.

With HBO Go, HBO’s online streaming platform, available on Smart TVs, Microsoft’s Xbox 360, and soon AppleTV, poses a serious threat to Netflix as well. I believe it’s just a matter of time before HBO frees itself from cable subscription packages and becomes available as a stand-alone product - a real Home Box Office. That’s why Netflix chief content officer, Ted Sarandos said, “The goal is to become HBO faster than HBO can become us” in a recent article for GQ.

Is original content profitable?

$100 million. That’s the price tag for two seasons of House of Cards. That amount will get Netflix 26 episodes released 13 episodes at a time. The first 13 were released all at once one Feb. 1 to the delight of weekend TV bingers everywhere. In order to be a profitable investment, Netflix is betting that more than 1 million subscribers will join for at least a year just to watch House of Cards.

That’s really not that many viewers. Consider that HBO’s True Blood consistently draws about 5 million viewers on the day each episode airs. It’s easy to imagine 20% of viewers were convinced to buy HBO based on the exclusivity of True Blood. However, it also implies that Netflix’s programs are on the same level as HBO, which is definitely debatable.

This is the first full year of an exciting experiment, led by CEO Reed Hastings, to invest in original streaming content. Netflix is investing $300 million in original content over the next three years including the $100 million for House of Cards. Upcoming releases include the much-anticipated season 4 of Arrested Development, the return of Netflix original Lilyhammer, as well as new entrant Orange is the New Black. We’ll have to wait and see how these affect subscriber growth rates, but the break-even point is about 1 million additional subscribers over the next three years. I definitely think that’s doable.

More profitable than licensing

At the very least, I suspect original content from Netflix will be more profitable than its expensive licensing deals. Netflix has over $5.6 billion in content obligations, $2.3 billion due within the year according to the company’s most recent annual report. Compared to just two years ago, content costs have ballooned out of proportion from the $1.2 billion in obligations the company once had.

The problem is the only revenue Netflix makes is from subscriptions. With only about 33 million subscribers at the end of 2012, it’s no wonder the company is struggling to make a profit in recent quarters as content costs go up. The company is looking to finance its expansion through debt, not cash, as Reed outlines in his most recent letter to shareholders.

With cash rich companies such as Amazon, Apple, and Google all looking to compete for living room supremacy, Netflix has quite the battle on its hands. If any of those companies make a serious grab at video streaming content, Netflix won’t be able to do much to stop them without a significant cash pile of its own. We’re already starting to see it happen. Perhaps the real winners here are the content creators and distributors. But that’s the topic of another article.

For now, Netflix is still the king of online video streaming. But the moat to its castle is narrowing, and the competition smells blood in the water. The battle is on. It’s now a matter of who crafts the better weapon – original programming – and can draw in the subscribers.   

adamlevy owns shares of Amazon.com. The Motley Fool recommends Amazon.com and Netflix. The Motley Fool owns shares of Amazon.com and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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