The Real Reason Behind Netflix's Cable Push

Netflix (NAS: NFLX) seems bent on showing up on your cable bill, and now it's starting to become painfully obvious why the dot-com flick-streamer is talking to cable providers about offering Netflix as a premium add-on service.

In a note to clients yesterday, Barclays Capital analyst Anthony DiClemente praises the move by pointing out how it should increase Netflix's subscriber base, lower its subscriber acquisition costs, and deliver long-term profit growth.

Obviously, it remains to be seen what the ultimate product will look like, but Netflix won't be able to charge more than the $7.99 a month it charges existing streaming subscribers. With cable companies historically taking roughly half of the revenue, how can Netflix, making $4 or so a month off each cable customer, be better off than it would be by reaching out directly?

Well, let's drag out the churn card.

As the world churns
Netflix is no longer reporting its monthly defection rate, and there's a good reason for that. Streaming customers are a fickle lot. Netflix's churn for members taking out DVDs was never all that impressive, but at least they have unwatched Netflix DVDs around the house. They also have steady and predictable queues -- unlike with the streaming product, where a good chunk of a member's queues can be wiped clean by the end of a licensing deal.

In the last quarter that Netflix reported domestic churn -- last year's second quarter -- churn clocked in at a stubborn 4.2%. That's a monthly rate, implying that Netflix loses roughly half of its subscribers over the course of a year.

Now let's compare Netflix to DIRECTV (NYS: DTV) . The country's largest satellite television provider reported its latest quarterly financials on Monday. The service provider with 19.4 million stateside subscribers -- and growing -- doesn't have any reason to hide its churn. Just 1.5% of its accounts are canceling every month. Maybe it's the gear. Maybe it's complacency. However, it would also follow that premium movie channels that cable and satellite television customers tack on would also have healthy loyalty rates.

If Netflix is just a small line item on your cable bill, you're less likely to nix the service than you would be if it was a stand-alone offering. And -- to Netflix's credit -- it's just too darn easy to terminate the service.

Apple leads the way
One of the interesting developments surrounding yesterday's Apple TV announcement -- yes, it wasn't all iPad for Apple (NAS: AAPL) yesterday -- was a partnership with Netflix. Apple TV owners can now sign up for Netflix directly through Apple's small set-top home theater gadget.

The new Apple TV will allow couch potatoes to stream Netflix in high-def 1080p, backed by rich Dolby Digital 5.1 audio. However, the interesting twist is that the subscriptions are managed through Apple iTunes.

Why would Netflix be willing to give up Apple's piece of the action -- likely nearly a third of the revenue -- for something that it can otherwise control directly?

You already know the answer. This is the kind of move that will likely result in lower churn. Oh, and the additional members may truly be incremental. There's a reason why they would sign through Apple TV -- or eventually through a cable provider -- instead of cutting out the middleman, and it's because they likely wouldn't be wooed by Netflix on its own.

All roads lead to HBO
DiClemente points out how Time Warner's (NYS: TWX) HBO is feasting on EBITDA margins of 35%, well above what Netflix has been up to lately. Clearly, there's money to be made by teaming up with a cable provider.

However, DiClemente also points out that the move may force Netflix into landing more proprietary programming to stand out. Netflix has already taken inroads into original programming. There was Lilyhammer last month, and House of Cards is shuffling the deck this summer.

Then again, if Netflix is pricing its offering at roughly half of HBO's monthly ransom, can't it score enough subscribers with its quantity over quality?

I was initially skeptical of Netflix's rumored push through cable providers, but now that it's growing closer to becoming a reality, it does make sense. Once again, Hastings is one step ahead of the market.

Good luck getting away with all of the hooks that Netflix is throwing into the water.

Stream on
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At the time thisarticle was published The Motley Fool owns shares of Apple.Motley Fool newsletter serviceshave recommended buying shares of Netflix and Apple, as well as creating a bull call spread position in Apple. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.Longtime Fool contributor Rick Munarriz has been a Netflix subscriber and shareholder since 2002. He does not own shares in any of the other stocks in this story. Rick is also part of theRule Breakersnewsletter research team, seeking out tomorrow's ultimate growth stocks a day early.

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