TEXT-S&P discusses potential credit effects of Disney/Netflix deal
Dec 7 - On Dec. 4, 2012, Netflix Inc. (rated 'BB-' with a stable rating outlook) and The Walt Disney Co. (A/Stable/A-1) announced a licensing agreement that will make Netflix the exclusive U.S. subscription television service for first-run live-action and animated feature films from The Walt Disney Studios, starting with films released in 2016. We believe this is a groundbreaking agreement, as it is the first such arrangement between an online subscription video-on-demand (SVOD) operator (Netflix) and one of the major U.S. studios. (Netflix already has first-run distribution agreements with a number of independent studios, including DreamWorks Animation SKG.) It is also a significant loss to Liberty Media, owner of the Starz LLC (BB/Stable/--) premium movie service and the current U.S. pay TV distributor of Disney films through 2015, because of the high profile of Disney (including Pixar and Marvel) films. The Netflix/Disney deal has no immediate impact on the credit quality of the participants, .given the three-year lead time before this agreement starts and the contractual delay between theatrical release and pay television availability (nine-plus months after theatrical release). Over the long term, however, our credit ratings on certain of the participants, as well as other entertainment companies, could be affected. THE WALT DISNEY CO. We believe that the Netflix transaction could be a minor credit positive for Disney, but is unlikely to move the rating. Based on press reports, Netflix will be paying Disney significantly more than what Starz is currently paying--and more than what Starz was offering to renew the contract. In addition, there could be some minor upside to our 2013 revenue estimates for Disney, as some of the company's direct-to-home videos will be made available on Netflix beginning in 2013. Lastly, in a separate agreement, Disney is also making available immediately selected titles from its library. Despite these positives, it is highly unlikely that we'll raise our rating on Disney, as we expect the company to use the incremental cash flow for acquisitions, share repurchases, or dividend increases. NETFLIX INC. In our view, the cost of the licensing agreement with Disney could cause some intermediate-term earnings pressure for Netflix, though we think it is a longer-term business positive for the company. The Disney deal will give Netflix access to very attractive family-oriented content, especially animated Disney and Pixar films. This will likely aid Netflix's efforts to acquire new subscribers (especially as we get closer to the launch of the Disney contract in 2016), and could lay the groundwork for Netflix expanding its service offerings beyond its traditional streaming service.. We think this will be increasingly important as 2016 approaches, because the majority of the Disney agreement cost will begin to accrue and become payable in 2016. In the shortr term, the agreement places added pressure on Netflix to accelerate subscriber acquisition or possibly increase prices in order to preserve its EBITDA margin and cash flow. Netflix will need to significantly expand its subscriber base over the next three to four years in order to afford this and other potential content contract renewals. STARZ LLC The Disney/Netflix deal is a credit negative for Starz over the longer term, in our opinion. The agreement will deprive Starz of a significant portion of its live action and family movie content beginning in 2016, and could reduce its negotiation leverage in carriage agreement renewals with cable operators. Several cable operators have aggressively communicated their focus on reducing subscriber fees to cable networks. We believe that the agreement between Disney and Netflix also could push Starz to further increase its investment in original programming. The success or failure of its original programming efforts will take on greater importance in the absence of Disney content being available in 2016. OTHER PREMIUM TV NETWORKS We believe the agreement could have a long term negative impact on the three other premium television channels (HBO, owned by Time Warner Inc. (BBB/Stable/A-2); Showtime, owned by CBS Corp. (BBB/Stable/A-2); and Epix, a joint venture between Viacom Inc. (BBB+/Stable/A-2), Metro-Goldwyn-Mayer Inc. (B/Stable/--) and Lions Gate Entertainment Corp. (B/Positive/--)), as it could lead to more aggressive competition from a stronger Netflix, a weakened Starz, and additional SVOD players, such as Amazon and Apple, which would want to keep up with Netflix. In our opinion, the deal with Disney elevates Netflix to the same competitive position as the premium television channels. Historically, Netflix focused on television shows and older film libraries, but this contract, along with its recent contract with DreamWorks, will give Netflix access to a film slate that rivals those of the other channels. The upside potential is that Netflix may be able to increase subscriber fees, eventually putting the company on stronger financial footing and enabling it to use its improved financial flexibility to pursue other studio distribution deals as they come up for renewal. The downside scenario could be one of insufficient subscriber growth amid increased competition, leading to pressure on credit measures. Starz, on the other hand, would be left with only its existing Sony distribution agreement and would need to aggressively pursue other studio deals and possibly increase its original programming efforts to remain competitive. Even if neither Netflix nor Starz were to land those contracts, they could certainly push up pricing for the eventual winners. In addition to Sony's agreement with Starz (which expires in 2016), the other significant agreements are 20th Century Fox with HBO (recently renewed through 2022), Warner Brothers with HBO (expires in 2014), Paramount with Epix, and NBC Universal with HBO (expires at the end of 2015). Both HBO and Showtime have increased their strategic emphasis on original programming content, with significant success, which could provide downside protection against the loss of a studio distribution agreement. OTHER FILM STUDIOS We believe the Netflix/Disney agreement could be a positive for all the film studios if competitive bidding does materialize from SVOD competitors, leading to higher pricing for the studios. Standard & Poor's, a part of The McGraw-Hill Companies (NYSE:MHP), is the world's foremost provider of credit ratings. 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