How To Know If Netflix 2.0 Is A Success

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Research Notes

3Q 2013

Actionable Research on the Broadband, Media & Entertainment Industries

Leichtman Research Group, Inc.

Netflix 2.0 (Years Later)

hen last we wrote a column about Netflix in these Research Notes, the Company had just gone through a series of self-inflicted wounds that left it weakened, and its future cloudy. Fast- forward two years, and we see that

Netflix has more than rebounded, both in terms of its valuation,

and its overall impact on the industry. In a relatively

short time, Netflix has transformed itself from

its legacy as a DVD- delivery company, into

a leader in the streaming media business. The

problems of two years ago (on the surface) appear to be largely in the rear-view mirror.

It now seems like a long time ago, but it was in July 2011 when Netflix separated its DVD business from its streaming business. This essentially raised the price of subscribing to Netflix by 60%;

briefly created a separate DVD- by-mail service named Qwikster; and in the course of just over three months brought the Market Cap of the Company from $14 billion down to $6 billion.

While the Company struggled to regain

its footing through the next year, 2013 has been an accelerated uphill climb for the Company’s stock, starting the year below 100, and reaching an all-time high price above 300 in Mid-September.

Netflix began October with a Market Cap of more than $19 billion.

The evolution of Netflix into a streaming company can be seen in its quarterly results over the past two years.

• In Q2 2013, Netflix reported having 29.8 million domestic streaming subscribers (with about 4% not paying for the service) – an increase from 21.4 million at the end of Q3 2011

• In Q2 2013, Netflix reported having 7.5 million domestic DVD

subscribers – a decrease from 13.9 million at the end of Q3 2011 But these figures only show a part of the change. An LRG study from earlier this year found that:

• 73% of Netflix subscribers stream video from Netflix at least on a weekly basis – up from 55% in 2011, and 27% in 2010

• With the growth in Netflix’s subscriber base, this extrapolates to 22% of all adults in the US streaming Netflix video weekly – up from 12% in 2011, and 4% in 2010

When people talk about over-the-top (OTT) content, the list should start with

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In this issue:

– Netflix 2.0 (Years Later)

– Over Three- Quarters of U.S.

Households Get Broadband at Home – Major Multi-Channel Video Providers Lost About 345,000 Subscribers in 2Q 2013

– 86% of TV Households

Subscribe to a Multi- Channel Video Service

– About 295,000 Add Broadband in the Second Quarter of 2013

– Industry by the Numbers

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Page 2 Netflix and YouTube, with all others

trailing as if they were the Houston Astros competing for an AL

championship. In terms of long-form video content, a recent LRG survey found that Netflix subscribers are three times more likely to watch a full-length TV show online each week than are non- Netflix subscribers.

Now, more than ever before, Netflix has become a prime component for those who do not subscribe to a multi- channel video service. LRG’s surveys found that:

• 40% of non-subscribers to a multi- channel video service get Netflix – up from 25% in 2011

• 30% of Netflix subscribers with a multi-channel video service stream Netflix daily – compared to 58% of Netflix subscribers who do not get a multi-channel video service

While Netflix may be an important source of content for those who do not subscribe to a multi-channel video service, it is not necessarily the prime motivator for people not to subscribe to a multi-channel service (just 5% of all non-subscribers cite Netflix as the reason for not-subscribing). In addition, the percentage of Netflix subscribers getting a multi-channel video service is similar to two years ago. Netflix

subscribers also remain more likely than other multi-channel video subscribers to get a premium service, and Netflix subscribers getting a premium service have actually increased in recent years.

Netflix has clearly made significant gains over the past two years. The Company’s subscriber base has increased both domestically and

internationally; usage of the streaming service has increased; the reputation of the brand has largely been restored; and it even had an original show (House of Cards) that won Emmys awards – even if it didn’t win any of the major ones.

But there are some aspects of the Company that may not be readily apparent, and/or some choose to ignore.

Netflix has changed some ways that it reports results from two years ago. The Company no longer reports subscriber acquisition cost, churn, total domestic revenue, or revenue per subscriber. Yet total domestic revenue (the combination of streaming and DVD revenue), and ARPU are fairly easy to calculate. We see that:

• Total domestic revenue was $903 million in Q2 2013 – compared to

$824 million in Q2 2012, and $770 million in Q2 2011

• Based on an estimate of total subscribers, ARPU per domestic paying subscriber (not including free subscribers) was about $9.95 per month in 2Q 2013 – compared to $11.01 in 2Q 2012, and $11.49 in 2Q 2011

Did you know?

TiVo has 981,000 stand- alone DVR subscribers – compared to a peak of 1,745,000 in 4Q 2007 (the company has reported net losses for stand-alone DVRs in every quarter since then).

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Page 3 The shift from DVDs to streaming has

increased the subscriber base, but it has also resulted in a gradual decline in the revenue per subscriber.

And while Netflix no longer reports churn, this remains a major component of subscription businesses (and one that tends to increase with lower prices). A look back finds that, including free subscribers, Netflix’s annual domestic churn was about 50% in 2010, and about 70% in 2011. While it is likely that churn has calmed down from two years ago, it is probably still similar to 2010 levels.

Despite revamping of the Company into Netflix 2.0, and an impressive stock market performance over the past year, this combination of lower ARPU, and ongoing high churn rates, along with increasing expenses present challenges for Netflix’s business model going forward. As noted two years ago, the final part of the Netflix case study is still yet to be written.

Over Three-Quarters of U.S. Households Get Broadband at Home

eichtman Research Group, Inc.

found that about 78% of US households get a broadband Internet service at home. Broadband now

accounts for 94% of all households with Internet service at home – an increase from 92% last year, 75% in 2008, and 33% in 2004.

Overall, 83% of households get an Internet service at home, and 55% of adults access the Internet on a

Smartphone. While the percentage of

households getting Internet service at home is similar to last year, those accessing the Internet on a Smartphone increased from 44% last year.

These findings are based on a telephone survey of 1,304 households from

throughout the United States and are part of a new LRG study, Broadband Access

& Services in the Home 2013. This is LRG's eleventh annual study on this topic.

Other related findings include:

• 9% of all households get broadband, but do not subscribe to a multi- channel video service – compared to 8% the past two years

• 64% of broadband subscribers also access the Internet on a Smartphone – compared to 52% last year

• 19% of all not online at home access the Internet on a Smartphone – compared to 12% last year

• 1% of households paid to subscribe to Internet service at home in the past year, do not currently subscribe,

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According to a recent

Leichtman Research Group (LRG) study on U.S.

broadband , there are 82.4 million subscribers

among the 17 largest cable and telephone providers in the country.

- TMCnet

October 2, 2013

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Page 4 and do not plan to subscribe again in

the next six months

• Less than 1% of all online

households say that broadband is not available in their area – compared to 6% in 2008

• 42% of households with annual incomes <$30,000 do not use a laptop or desktop computer at home – compared to 8% with incomes

>$30,000

• 1% of all households have an iPad or tablet, but do not use a desktop or laptop computer

While overall online penetration at home has flattened, broadband has grown by attracting previous narrowband

customers, late-adopters of online at home, and movers into new households.

Despite an increasingly limited base of

potential new subscribers, and some consumers opting to solely access the Internet on a Smartphone, broadband will continue to grow at a modest pace for the next few years.

Major Multi-channel Video Providers Lost About 345,000

Subscribers in 2Q 2013

found that the thirteen largest multi- channel video providers in the US – representing about 94% of the market – lost about 345,000 net additional video subscribers in 2Q 2013. In 2Q 2012 and in 2Q 2011, the multi-channel video industry lost about 325,000 subscribers.

The top multi-channel video providers account for nearly 94.6 million

subscribers – with the top nine cable companies having about 50.5 million video subscribers, satellite TV companies having over 34 million subscribers, and top telephone companies having over 10 million subscribers.

Other key findings include:

• The top nine cable companies lost about 555,000 video subscribers in 2Q 2013 – compared to a loss of about 540,000 subscribers in 2Q 2012

• The top telephone providers added 373,000 video subscribers in 2Q 2013 – compared to 275,000 net additions in 2Q 2012

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U.S. cable and satellite TV

operators took it on the chin again in the historically weak second

quarter, while the telcos pulled in some solid subscriber gains,

Leichtman Research Group found in its latest analysis of the pay-TV industry.

The thirteen-largest multi-channel video providers in the U.S., representing 94%

of the market, lost a combined 345,000 net video subs in the second quarter, which is typically plagued by

“seasonality” as college students and snowbirds churn out. That compares to the 325,000 subs those providers lost in the second quarter of 2012 and 2011, LRG said.

- Multichannel News August 19, 2013

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• Satellite TV providers lost 162,000 subscribers in 2Q 2013 – compared to a loss of 62,000 in 2Q 2012 o Although just the third time DBS

providers reported net quarterly losses, total DBS net losses in 2Q 2013 were the highest in any quarter since LRG began tracking the industry over a decade ago

• Over the past year, multi-channel video providers lost about 100,000 subscribers, compared to a gain of about 380,000 over the prior year o DirecTV added 107,000

subscribers over the past year – compared to 481,000 over the prior year

The traditionally weak second quarter proved to be a down quarter for the multi-channel industry, but industry- wide losses were similar to recent second quarters. The multi-channel video industry has leveled-off, with major providers losing about 0.1% of all subscribers over the past year.

86% of TV Households Subscribe to a Multi- Channel Video Service

finds that 86% of households nationwide subscribe to some form of multi-channel video service. While major multi-channel video providers reported a cumulative increase of less than 1% of subscribers over the past three years, penetration has slightly declined over that time due to a larger

increase in the number of rental housing units. Multi-channel video penetration essentially peaked at 88% in 2010 following the digital transition, having increased from 82% in 2005.

Among TV households that do not currently subscribe to a multi-channel video service, 40% subscribe to Netflix, 11% to Amazon Prime, and 7% to Hulu Plus – in total, 42% of non-subscribers get at least one of these three over-the- top (OTT) services, and 58% of non- subscribers do not get any. Overall, this results in 8% of all TV households watching over-the-air (OTA) broadcast TV only (down from 10% in 2010), and 6% watching a combination of OTA and OTT programming. This group includes about 1% of all household that do not subscribe to a multi-channel video service primarily because they can watch all that they want via the Internet or Netflix.

These findings are based on a telephone survey of 1,319 households from throughout the United States, and are part of a new LRG study, Cable, DBS &

Telcos: Competing for Customers 2013.

This is LRG's eleventh annual study of this topic.

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Did you know?

Four of the top six

multi-channel video

providers are not

traditional cable

companies.

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Page 6 Other related findings include:

• Nationwide, 20% of TV households with annual incomes <$50,000 are non-subscribers, compared to 9%

with incomes >$50,000 – a division that has been fairly consistent for years

• Mean reported monthly spending on multi-channel video service is

$83.25 – an increase of 5.9% from last year

• Multi-channel video subscribers with household incomes >$50,000 spend 18% more per month than those with incomes <$50,000

• 10% of non-subscribers had

subscribed to a multi-channel video service in the past year, and 7% plan to subscribe to a service in the next six months

• Overall, about 1.4% of all TV households paid to subscribe to a service in the past year, but currently do not – a similar rate to the past five years

• 5% of current multi-channel video subscribers did not subscribe at some time in the past two years and just watched programs from the Internet instead

The number of households subscribing to a multi-channel video service is slightly higher than it was three years ago, yet the penetration of households subscribing to a service is now below its peak. While some consumers continue to go in and out of the category,

economic factors appear to be as a strong force in shaping this market as the emergence of over-the-top alternatives alone.

About 295,000 Add

Broadband in the Second Quarter of 2013

found that the seventeen largest cable and telephone providers in the US – representing about 93% of the market – acquired about 295,000 net additional high-speed Internet subscribers in the second quarter of 2013. These top broadband providers now account for over 82.7 million subscribers – with top cable companies having over 47.8 million broadband subscribers, and top telephone companies having nearly 34.9 million subscribers.

Bruce Leichtman, president and principal analyst for LRG said, “While some

consumers continue to go in and out of the category, economic factors appear to be as strong a force in

shaping this market as the emergence of over- the-top alternatives alone.”

- CED Magazine September 16, 2013

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Page 7 Other broadband findings for the quarter

include:

• Overall, broadband additions in 2Q 2013 amounted to 116% of those in 2Q 2012

• The top cable companies added about 296,000 subscribers,

representing 91% as many additions as in 2Q 2012

• The top telephone companies lost about 2,000 subscribers – compared to a loss of about 73,000 in 2Q 2012

• AT&T and Verizon added 802,000 fiber subscribers in the quarter (via U-verse and FiOS), while having a net loss of 818,000 DSL subscribers

• AT&T has reported net broadband losses in six of the past nine quarters

• The top cable broadband providers have a 58% share of the overall market, with about 13 million more subscribers than the top telephone companies – compared to 11.2 million more a year ago

The second quarter of the year is traditionally the slowest quarter of the year for broadband additions, and this year was no exception. For the third time in the past four years, Telcos cumulatively reported small net

broadband losses in the second quarter.

Over the past year, cable companies have accounted for 85% of the 2,600,000 net broadband additions.

About 78% of U.S. households are equipped with a broadband Internet service, but the overall proportion of households with an Internet

connection at home has

leveled off to about 83%

, about the same as last year, according to a new survey from the Leichtman Research Group (LRG).

- Multichannel News September 26, 2013

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Sources: The Companies and Leichtman Research Group, Inc.

* Includes leased equipment and unreturned box costs

** Includes revenue from commercial accounts and other non-consumer spending

Net Adds Gross Adds Subscriber Average Revenue Subscribers in 2Q 2013 in 2Q 2013 Acquisition Cost* Per Sub/Month**

20,021,000 (84,000) 839,000 $888 $98.73 14,014,000 (78,000) 624,000 $882 $80.90

34,035,000 (162,000) 1,463,000

DBS

DIRECTV Dish Network

Total DBS

Data includes LRG estimates of pro forma results from system sales

Net Adds Net Adds Subscribers in 2Q 2013 in 2Q 2012

5,035,000 140,000 120,000 5,001,000 233,000 155,000

10,036,000 373,000 275,000

Telco Video

Verizon FiOS AT&T U-verse

Total

Totals include LRG estimates and pro forma results from system sales and acquisitions.

* Internet data does not include RCN

** Telephone data does not include Bright House Networks

Net Adds Net Adds Passings Subscribers Penetration in 2Q 2013 in 2Q 2012

121,700,000 50,490,000 41.5% (555,000) (540,000) 121,200,000 47,535,000 39.2% 295,000 325,000 115,600,000 24,550,000 21.2% 190,000 280,000

Top Cable MSOs in the U.S.

Basic Cable Broadband Internet*

Telephone**

Industry by the Numbers – (as of the end of 2Q 2013)

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* Retail residential phone lines include both primary and additional lines, but do not include wholesale lines Includes LRG estimates and some results adjusted from prior reports

2Q 2012 3Q 2012 4Q 2012 1Q 2012 2Q 2013

(1,011,000) (986,000) (886,000) (894,000) (883,000) 280,000 220,000 250,000 300,000 190,000

U.S. Residential Telephone Lines – Gains and Losses

Telco Net Adds*

Cable Net Adds

Top Broadband Internet Providers in the U.S.

* Cablevision includes estimate for former Bresnan properties sold to Charter on 7/1/2013

** Includes LRG estimates for Cox, Bright House Networks and RCN Cable totals do not include WOW with 709,000 subscribers

^ CenturyLink slightly adjusted totals from previous quarters

^^ LRG estimate, does not include wireless subscribers Totals reflect pro forma results from system sales and acquisitions

Top cable and telephone companies represent approximately 93% of all subscribers Company subscriber counts may not represent solely residential households

Broadband Internet Provider

Subscribers at the end of 2Q 2013

Net Adds in 2Q 2013

Cable Companies

Comcast 19,986,000 187,000

Time Warner 11,559,000 21,000

Charter 4,138,000 52,000

Cablevision 3,087,000 1,000

Suddenlink 1,017,200 (9,000)

Mediacom 949,000 9,000

Cable ONE 464,292 566

Other Major Private

Companies** 6,664,000 35,000

Total Top Cable 47,864,492 296,566

Telephone Companies

AT&T 16,453,000 (61,000)

Verizon 8,939,000 45,000

CenturyLink^ 5,909,000 (8,400)

Frontier^^ 1,781,500 29,500

Windstream 1,194,500 (11,400)

FairPoint 332,620 2,538

Cincinnati Bell 261,700 1,500

Total Top Phone 34,871,320 (2,262)

Total Broadband 82,735,812 294,304

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Leichtman Research Group, Inc.

www.LeichtmanResearch.com (603) 397-5400