The Battle to Buy Hulu Heats Up

Hulu has been part of the Internet video scene since 2007, the same year that Netflix (NFLX) — the company that now dominates the stream-on-demand market — decided to add web video to its DVD mailing business. This was just months after Google (GOOG) acquired YouTube and Amazon (AMZN) launched its Amazon Unbox streaming service (which later became Amazon Video on Demand).

That’s big-name competition, but Hulu was a joint creation of News Corp (NWSA), Disney (DIS) and Comcast (CMCSA). Being owned by some of the biggest players in the broadcast and content world, you’d think Hulu would have been the breakout streaming service, but things didn’t turn out that way. In 2011, Hulu was put up for sale, but bids fell short of the $2 billion asking price despite the growing popularity of streaming video with consumers. The owners eventually took it off the market.

However, it appears a new Hulu bidding war is now breaking out.

This all started back in April when Peter Chernin, a former News Corp COO, offered $500 million for the site. Things started to get interesting two weeks ago, when Yahoo (YHOO), fresh off its acquisition of Tumblr, offered a reported $600 million to $800 million for Hulu. According to Bloomberg, the number of companies interested in Hulu continues to climb, with at least three of them — including DirecTV (DTV) — pushing the offers into the $1 billion range.

If we make the assumption that Hulu is going to be sold, which of its growing list of suitors would represent the best fit?

Let’s start with market share. CNET says consumer demand for subscription-based streaming TV was up 34% in Q1 2013 compared to the same time last year. Netflix continues to dominate that market with 89% of the customers, while Amazon Prime is at 2%. Hulu’s paid TV streaming service Hulu Plus managed to claw its way up to a 10% share. (The 101% total is due to rounding.)

According to Hulu’s acting CEO, Andy Forssell, the company streamed more than 1 billion videos in Q1 2013, and subscribers to its paid Hulu Plus service surpassed 4 million (it was a little more than 3 million in Q4 2012). In 2012, subscriptions to its ad-supported streaming service doubled. The company trumpeted its advertising effectiveness, pointing out its ad-supported site is ranked No. 1 in user engagement and delivers one in three premium video ads to the U.S. market. Revenue was $695 million for 2012, up 65% year-over-year.

Sounds good, right?

But Hulu also has around $330 million in debt, and it lost CEO Jason Kilar in January amid public infighting with the media owners, raising eyebrows about Hulu’s future. Content agreements signed with those current owners might hobble Hulu’s attractiveness.

So, Hulu’s numbers are up considerably in the past year. But any new owner will face programming requirements that could threaten that growth, not to mention considerable debt and uncertainty caused by months of bickering between an outgoing CEO and the current owners.

Suitors DirecTV and Time Warner Cable (TWC) are worried about Internet video as a threat to their paid TV subscriptions by satellite and cable, respectively. Both of these companies would be looking at Hulu to hedge their bets — if their customers bail in favor of an Internet video service, Hulu might let them scoop up at least some of the lost business.

But at $7.99 per month (the current price of Hulu Plus), it’s tough to make the argument the purchase would be worth it. For example, if you lose 1 million customers paying $30 per month for satellite, convert all 1 million to Hulu Plus and retain the existing 4 million Hulu Plus subscribers, you’ve only tacked on around $10 million in monthly revenue. And for that, you shelled out $1 billion along with $330 million worth of Hulu debt.

So it’s a very long-term bet, at best.

As for private equity companies — like KKR & Co. (KKR), which is in the Hulu running, or Peter Chernin and his partners — they would be investing in Hulu with the expectation of growing it and making money by selling it, or with an IPO. With Hulu’s current content contracts and the Netflix’s domination of the market, those strategies seems like long shots. Hulu might be racking up some impressive numbers, but Netflix is still on top in a big way, and I can’t see a scenario where Hulu becomes compelling enough to consumers to be a real contender to Netflix.

The best fit among the current round of Hulu bidders might actually be Yahoo. It currently lacks a real YouTube equivalent, and with Marissa Mayer’s current strategy of rebuilding Yahoo as an Internet portal, Hulu could be a good fit. Hulu Plus subscriptions would provide additional recurring revenue, Hulu’s stellar ad performance would contribute further to the bottom line, and finally having a destination video service as part of its web portal should boost traffic and Yahoo’s ability to sell online ads.

The downside is, bidding has gotten significantly higher than Yahoo’s original offer, and after paying $1.1 billion for Tumblr, Yahoo might not have the stomach for another billion-dollar acquisition so soon.

Of course, there’s always the possibility that a last-minute bidder will join in the auction. Google and Amazon were interested last time around but haven’t yet made a move. And it’s possible that Hulu could be pulled off the market. Bids of $1 billion are still only half of what the owners were looking for in 2011 — Hulu’s numbers and public interest in streaming video have increased significantly since that time.

So, expect further developments in coming weeks, and consider the Hulu watch officially on.

As of this writing, Brad Moon did not hold a position in any of the aforementioned securities.

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