(Bloomberg ) Netflix Inc. (NFLX) will test whether Machiavelli and math are a winning formula as the world's largest subscription-video service debuts "House of Cards," its most ambitious step yet into original online-TV programs.
Netflix will make the political thriller, starring Kevin Spacey, available today to its 33 million streaming subscribers worldwide. Chief Executive Officer Reed Hastings, looking to extend the company's lead in online TV, likens the show to "West Wing," the NBC series that ended in 2006, if it were done by Machiavelli.
"We're on the cusp of something that will change television forever," Hastings said in an interview at Bloomberg's New York headquarters. "Our view is that over the next couple of years as Internet TV really grows, people will look back and say that this was the turning point."
Hastings, 52, is placing big financial bets to secure Netflix's future as the dominant player as more viewers move online. He says efforts like "House of Cards" and the revived "Arrested Development" cement relationships in Hollywood and help fend off competitors like Amazon.com Inc. Netflix's Silicon Valley roots analyzing viewer habits also give it an edge as cable channels like HBO move online, he said.
"Relative to HBO, we're much deeper on the tech side, and relative to Amazon, we're much deeper on the creative side," Hastings said. "We're able to do more and more calculations and big-data statistics so that what we do is represent Netflix more and more as a place where you come for relaxation, escape."
90 Million
Hastings, whose company has 27.2 million U.S. subscribers, says Netflix can grow to as many as 90 million over the next two decades -- a challenge made harder as online competitors like Amazon, Hulu LLC and Redbox Instant by Verizon pile in, and traditional channels expand with digital offerings like HBO Go from the Time Warner Inc.-owned channel.
"If you look at the content gap over the last two years, it has closed to some degree," said Michael Olson, an analyst with Piper Jaffray Cos. in Minneapolis, pointing out that movies from the Epix channel, which Los Gatos, California-based Netflix had exclusively online, are now with Seattle-based Amazon as well. "The game over the next couple of years is going to be about Amazon and maintaining a content gap."
To stay ahead, Hastings is sacrificing short-term profit to spend more on original content. The company said this week it would borrow $500 million to refinance about $225 million in debt and spend more on original programming. The company has committed more than $5 billion to streaming content, including movies from DreamWorks Animation SKG Inc. (DWA), Epix and Walt Disney Co. (DIS)
Debt Hazard
There are risks. Standard & Poor's changed its outlook on Netflix's speculative BB-minus level debt to negative, citing cash flow levels this year and next, increasing debt leverage and "risks associated with original programming."
The company's content costs are rising faster than profit, said Michael Pachter, an analyst at Wedbush Securities in Los Angeles who has an underperform rating on the shares.
"Netflix will continue to generate negative cash flow going forward, driven by the company's ever-increasing streaming commitments," said Pachter.
This year, Netflix also will offer a new series by "Weeds" creator Jenji Kohan called "Orange Is the New Black," the thriller "Hemlock Grove" and comedic actor Ricky Gervais's "Derek," slated for summer. "Arrested Development" brings back the canceled Fox show.
Subscriber Retention
"Lilyhammer," about a gangster who goes into hiding in Norway, will return for a second season in the fall after a "warm-up run" last year that Netflix used to learn about financing and marketing original content, Hastings said.
The shows may help Netflix keep subscribers, Olson said.
"I don't know whether it will drive new additions right out of the gate but it could over the longer term," he said.
As it did with "Lilyhammer," Netflix will offer immediate access to all 13 episodes of "House of Cards." By contrast, networks like HBO roll out dramas such as "Game of Thrones" one episode a week to keep the viewer hooked.
While Hastings expects customers to find more that they like to keep them on the site, there's a risk that they may take advantage of Netflix's policies, which offer a free first month and make it easy to quit. A user could sign up, watch all of "House of Cards" or "Lilyhammer" and then quit.
"We just have amazingly broad content," Hastings said.
Viewer Feedback
Hastings gains confidence from the number-crunching that went into choosing new shows. The company financed "House of Cards" after seeing many subscribers watched Oscar-nominated director David Fincher's movies and that others are fans of its protagonist, Spacey. It resurrected the canceled series "Arrested Development" after similar analysis.
Netflix paid about $100 million for two seasons of "House of Cards," Deadline.com reported. Netflix hasn't discussed the cost publicly, said Jonathan Friedland, a spokesman.
The company will measure this and its other originals a success if a large percentage of subscribers watch entire seasons, Hastings said. Research also will reveal whether non- members hear about the original programming and are more likely to subscribe, he said.
"What they're really doing is going, 'What are the genetics of the shows, the types of shows that people want to use our platform to watch,'" said Richard Greenfield, co-head of fundamental equity with BTIG LLC in New York.
HBO Threat
Investors including Carl Icahn, who holds a 10 percent stake of Netflix stock and options, are showing confidence in the company's strategy. The shares, which Icahn purchased for about $58 each in September and October, have almost tripled. They closed at $165.24 yesterday in New York, down 1.5 percent.
Should its exclusive programming succeed, Netflix might in the future use its content clout to force Internet carriers to share a portion of their broadband-access revenue, Greenfield said. For now, HBO, which had about 39.5 million U.S. subscribers including its Cinemax channel at the end of 2011, doesn't have to break itself off from the cable system.
"If it gets to 40 million or 50 million subscribers you wonder if HBO starts to reconsider," Greenfield said.
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