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Apple’s Move Into Content Creation Could Devastate Netflix And Amazon

 Summary
  • Apple is reported to be recruiting executives to head up a content creation effort.
  • Apple will probably fund outside production companies to create Apple exclusive content as Netflix does.
  • This original content is expected to appear in a streaming video service for iTunes and Apple’s various devices.

Yesterday, the venerable Hollywood business paper Variety reported that Apple (NASDAQ:AAPL) is exploring getting into original video content production. This effort is being led by SVP for Internet Software and Services Eddy Cue, who also has been in negotiations with TV programmers for content to support a live streaming service for the new Apple TV. Given that these negotiations have reportedly stalled, and that Apple has over $200 billion in cash, a move into content creation was probably inevitable. Apple funding content creation could remove the advantage Netflix (NASDAQ:NFLX) and Amazon (NASDAQ:AMZN) have enjoyed, as well as the leverage of traditional TV and motion picture studios.

Going Hollywood

Content creation as its done by the traditional movie and TV production companies is an expensive business, and revenues tend to be uneven. One year, a studio might have several blockbusters, and another year a string of flops. As such the production companies have been drawn to deep pockets, and vice versa.

Howard Hughes, whose family fortune was founded on oil well drilling equipment, ventured into film making, and his Hughes Tool Company eventually gained control of a Hollywood studio, RKO Pictures in the 1940s.

In the 1980s Sony (NYSE:SNE) was the Apple of its day in consumer electronics and branched out to content creation through the purchase of Columbia Pictures. At the time, it was asserted that there would be “synergies” between content creation and distribution, especially into the home.

Whether those synergies have ever manifested is open to question. The Variety article wondered,

Given the often fractious relationship between the media and technology sectors, there’s often been curiosity as to why Apple doesn’t just build its own content capabilities, if not acquire a studio outright.

The financial performance of Sony Pictures is probably more than adequate illustration of why Apple wouldn’t acquire a studio. In the June quarter, Sony Pictures suffered a 12% y/y revenue decline to $1.414 billion. Sony Pictures posted an operating loss of $96.4 million in the quarter compared to the previous year’s $76 million profit. Just the ups and downs of the movie business.

Netflix Model

Apple is most likely to structure its content operations as Netflix has done, hiring outside production companies to produce exclusive content. Anyone with the cash to spend can do this. Some have pointed to the original content of Netflix as an important discriminator against its competition.

Netflix has produced some wonderful original content, including House of Cards and Marco Polo. Just because a company has the money to fund original content doesn’t mean that the company will fund high quality or popular content.

Therefore, Apple’s success in content creation is not absolutely assured. The Variety report indicates that Apple is addressing this issue by recruiting executives from the major studios to head its content creation efforts. This follows a well worn path by companies looking to get into the content business. When Sony acquired Columbia, it hired movie business insiders Peter Guber and Jon Peters to head the studio.

Assuming that Apple can hire the requisite talent, Apple will probably have a very good chance of bettering the content quality of Netflix. Apple will be able to attract the best talent and field the best offerings because of its huge resources. If Apple only spends a quarter of its cash, say $50 billion, that can buy a huge amount of content. This content will almost certainly go into a streaming video service for the current and next generation Apple TV systems.

Apple distributing its own exclusive content also offers a couple of other advantages. The first is that production can take place overseas, so that it can be funded by the offshore component of Apple’s cash, about 90% of the total,according to Bloomberg. The other advantage is that marketing costs can be very effectively limited. Currently it’s estimated that big budget Hollywood movies cost about $200 million just for marketing.

Competitive Impacts

When I wrote Can Apple Burst The Netflix Bubble? one of the comments I received pointed out that Netflix has an advantage through its original content creation. My view of this is that content creation really isn’t an important discriminator for either Netflix or Amazon because it’s too easily duplicated by anyone with deep enough pockets. Apple has the deepest pockets around.

But it will take time to develop the capability at Apple and to churn out content through the production process. Netflix and Amazon have probably a year’s breathing space. Depending on how secretive Apple is about their content efforts, Netflix and Amazon investors may go on blithely assuming that their companies’ positions will go unchallenged. Once Apple’s content efforts are revealed, I expect the Netflix stock bubble (and to a lesser extent Amazon’s as well) to burst.

Apple’s entry into content is just part of a broader disruption of traditional big media. The traditional distribution channels of movies and TV are being disrupted by the Internet. Those companies that have been successful with Internet content distribution are commandeering the media remnants that are of value, the movie and TV production companies.

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