INSIGHT-Frugal Amazon opens checkbook for streaming video

* Amazon's Epix deal includes pay-for-performance provision

* Amazon pays more than Netflix on per-sub basis-execs

* Amazon spends $1 bln/yr on streaming video content-analyst

By Alistair Barr

SAN FRANCISCO, Oct 9 (Reuters) - Amazon.com Inc'sdeal to purchase streaming movies from cable network Epix couldtransform the way such deals are done, thanks to apay-for-performance sweetener that had not been previouslydisclosed.

According to an executive directly involved in the deal,Amazon agreed to an earn-out provision payable to Epix over timeif the number of subscribers to Amazon's Prime Instant Videoservice rises above a certain threshold. That comes in additionto a fixed upfront fee, the basis for most subscriptionvideo-on-demand deals up to this point.

The generous terms of the deal, announced in September,provide the strongest evidence yet that Amazon is willing to payup to be a player in this market as it faces a dwindling demandfor DVDs - once its core entertainment offering - and toughcompetition for its Kindle Fire tablets.

Film studios and TV network executives, meanwhile, now havea worthy foil to play against Netflix - once the only majorstreaming player - and possibly a template for future deals.

"This could be considered online video deals 2.0. Afterdoing 1.0 deals mostly with Netflix and a few with Amazon, itdawned on the media companies that they may want to get a pieceof any future growth too," said Goldman Sachs media analyst DrewBorst.

The deal with Epix - a partnership between Hollywood studiosParamount Pictures, Metro-Goldwyn-Mayer, and Lionsgate -was structured so studios could capture any rapid Prime InstantVideo growth, according to the executive involved in thetransaction.

Amazon did not respond to a request for comment on detailsof the deal. An Epix spokeswoman also declined to comment.

But Epix Chief Executive Mark Greenberg did say of Amazon:"Internet delivery of content is a way in which a new, emergingyounger audience wants to view content, and they know they canbe a significant player in the space, we are happy to help themget there."

Epix previously had a deal with Netflix , which hadbeen paying $200 million a year since 2010 for exclusive rightsto the network's movies. When that exclusivity period expired,Amazon swooped in and quickly struck a three-year partnership toadd about 3,000 movies from Epix to Prime Instant Video.

The deal sent a message that Amazon, which has not had areputation for paying richly for anything, was serious about itsdigital video ambitions and was willing to spend hundreds ofmillions of dollars to secure content.

"There are times when it's frugal to make big productiveinvestments," said Roy Price, head of Amazon Studios, Amazon'sHollywood studio. "When there are opportunities to do that wewill do that."


The studios are going to benefit.

"Hollywood loves it because they can say Amazon is paying usX and we want more from you," said Michael Pachter, an analystat Wedbush Securities in LA. "It's a club they can use to beatNetflix over the head."

A Netflix spokesman declined to comment on the structure ofits content deals.

"We never thought that we were going to operate withoutcompetition," Ted Sarandos, Netflix's chief content officer,said during an investor conference last month. "We weresurprised that it has taken this long for anyone to reallyemerge in a meaningful way."

Amazon's Prime Instant Video service has more than 25,000titles now, but that is still about half the number available onNetflix.

In addition to Netflix, Amazon also competes with Hulu, runby Jason Kilar, one of Amazon's former executives, which has asubscription video service called Hulu Plus. Earlier this year,Comcast Corp launched a rival called Streampix andVerizon and Coinstar's Redbox are expected tolaunch a competing service soon.

While Amazon's streaming deals cost less than Netflix's inraw dollar terms, it pays more on a per-subscriber basis,according to media executives and Wall Street analysts.

Amazon offers its streaming-video-on-demand service (SVOD)as a feature of its Prime program, which charges $79 a year inthe United States for free two-day shipping on most products thecompany sells.

The company does not disclose subscriber figures for itsPrime service. But some media companies that have done streamingvideo deals with Amazon have seen the data. One executive whohas seen the figures told Reuters Amazon has about 9 millionPrime subscribers. Prime Video subscribers - Prime members whohave used the streaming service - total between 3 million and 4million, this person said.

Netflix's larger customer base - it has about 25 millionstreaming video subscribers in the United States - means itstotal cost in licensing deals is typically higher than Amazon's,said the executive. But Amazon's cost basis, when adjusted forsubscribers, is typically higher since its customer base issmaller.

Amazon does not disclose how much it pays for content.Barclays analyst Anthony DiClemente estimates that Amazon spendsabout $1 billion a year on content for its streaming servicewhile Netflix spends close to $2 billion a year.

Netflix shares dropped as much as 11 percent the dayAmazon's Epix deal was unveiled, although they have recoveredsince then.

Netflix stock jumped more than 10 percent on Monday afterMorgan Stanley upgraded the company, saying Amazon was unlikelyto separate its streaming video subscription service from itsbroader Prime offering, making it less of a direct competitor.

However, keeping Prime Instant Video packaged with its Primeshipping program will help Amazon pay more for video content,because it can subsidize content costs from profits made whenPrime customers buy more physical products through the company,Wedbush's Pachter said.


Amazon, which ranks as the world's largest Internetretailer, has been a leading purveyor of DVDs, but sales arefalling as more viewers download and stream video instead.

The downward spiral of DVDs sales dovetails with Amazon'sface-off against Apple Inc in tablet computing. Amazonis pricing its Kindle Fire devices lower than Apple's iPad withthe aim of using it as a loss-leader to generate profit from theproducts and services consumers buy on its site, includingdigital movies, TV shows and books.

That means that gaining access to digital movies and TVshows is crucial for Amazon's future.

Since the middle of 2011, Amazon has announced streamingvideo deals with more than 10 media companies, includingNBCUniversal, part of Comcast, News Corp's Fox, andABC, part of Walt Disney Co .

Amazon has been selective about which content it will buy,in contrast to Netflix, which has opted to pursue a broaderrange, according to media executives who have done deals withboth companies.

"The fact that they have spent a lot of money on a fewthings has been very interesting," said Netflix's Sarandosduring last month's investor conference. "We're obviouslykeeping a good eye on it."


Some media companies are treading carefully with Amazon,though, given its track record of driving prices down.

In the book and e-book market, where Amazon grew to be thedominant player, it has battled publishers for the right to setits retail prices below wholesale.

Amazon will have more difficulty commoditizing movies and TVshows because it is competing for content with a growing list ofstreaming video on demand rivals. And Hollywood controls how andwhen its content is distributed more tightly, with big-budgetfilms traditionally heading to theaters first, followed by DVDand pay TV.

For example, one media company has short-term agreementswith Amazon that allow for quick exits if the deal does not goaccording to plan, said an executive.

(Reporting By Alistair Barr in San Francisco; Additionalreporting by Lisa Richwine in Los Angeles; Editing by PeterLauria, Martin Howell)

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