So Hulu won't be sold. Now what?

By Michael Carney , written on July 12, 2013

From The News Desk

Hulu’s lengthy search for an acquirer has never been about injecting new money into the company to keep it afloat. There’s no shortage of cash among the streaming video platform’s owners, 21st Century Fox (formerly News Corp), The Walt Disney Co., and Comcast-owned NBCUniversal. The plan has always been for these owners to extract themselves from an unnatural partnership and to inject additional competition and independence into the premium content ecosystem. Which is why today’s decision by the owners to continue kicking the can down the road by investing a fresh $750 million, rather than taking definitive action to sell the company, comes as a surprise.

We still don’t know the specific details of the proposals submitted by Hulu’s would be acquirers, so it’s hard to speculate where the deal broke down. What we do know is that DirecTV and a partnership between The Chernin Group and AT&T emerged as the two most viable offers, both of which were reportedly valued at more than $1 billion. Our sources, and many other outside observers, pointed to DirecTV as the frontrunner as the negotiations drew to a close.

A third offer from Time Warner Cable proposed a minority investment that would place it alongside Hulu’s existing three media conglomerate owners. Lesser bids by Guggenheim Digital, KKR, Silverlake Partners, and Yahoo were either dismissed by Hulu’s owners or retracted by potential investors over the multi-month bidding process. Hulu’s owners were reportedly seeking $2 billion, an amount the company initially attracted from Dish, Yahoo, and Amazon when put up for sale in 2011 but which was rejected at the time. Notably, Providence Equity Partners’ sold its 10 percent stake in the company in October 2012 at an implied valuation of, you guessed it, $2 billion.

Since Hulu’s M&A saga began two years ago, the primary hurdle in getting the deal done has always been the conflict between the desire by acquirers to retain its existing content rights, many of which were granted by the company’s current owners, and the owners’ desires to unshackle themselves from these agreements in favor of a more freely negotiated marketplace. One of Hulu’s most popular features, its ability to stream popular TV shows like "Modern Family" and "Parks and Recreation" the day after their television broadcast, is viewed as a likely casualty in any sale.

The Hulu deal was a hot topic of discussion at this week’s Allen & Co. Sun Valley retreat, where former Disney CEO Michael Eisner predicted such a change in an interview with Bloomberg TV:

If [Hulu] is bought by a content-oriented production kind of company, it will then move from a company that is basically repeat broadcasting to original broadcasting. That is very expensive. Therefore, the price you pay for the actual asset has to be tempered by what you need to spend to make that asset work, because NBC and Fox and ABC are not gonna give you a great deal on their own content.

DirecTV and AT&T aren’t dumb, which means they are well aware of the value of the current next-day arrangement, which is viewed as a key differentiator between Hulu and competitors Netflix and Amazon Prime. It’s likely then that these rights proved a sticking point in the negotiations and represented a gap that couldn’t be bridged between the buyers and sellers. Notably, it appears that it wasn’t the buyers that walked away, but the sellers.

For the company’s 30 million monthly unique viewers and 4 million Hulu Plus paid subscribers, however, today’s outcome should be viewed as a big win. The company is likely to retain the majority of its more than 400 content partnerships for foreseeable future and things should otherwise remain business as usual.

In a joint statement released by Hulu’s owners 21st Century Fox president and COO Chase Carey said:

We had meaningful conversations with a number of potential partners and buyers, each with impressive plans and offers to match. But with 21st Century Fox and Disney fully aligned in our collective vision and goals for the business, we decided to continue to empower the Hulu team, in this fashion, to continue the incredible momentum they’ve built over the last few years.
What we don’t have is clear resolution on a long term solution for Hulu. It seems unlikely that 21st Century Fox, The Walt Disney Co., and Comcast can continue playing nicely together forever, especially since the latter holds no voting power due to regulatory concessions made during its acquisition of NBCUniversal. Given this, it’s still entirely possible that Hulu will once again find itself on the block in the coming years.

Hulu generated $690 million in 2012 revenue, including both subscription and advertising revenue, but was unprofitable. Hulu plans to spend the $750 million in new capital on marketing, technology, program acquisition and program development, while setting the goal of producing 20 original or exclusive series by the end of 2013, and to increase that number in the coming years.

The company has suffered numerous high-level executive departures over the last year, including CEO Jason Kilar, CTO Richard Tom, VP of Product Robert Wong, Co-Head of Content Robert Schildhouse, Head of HR John Foster, Principal Project Manager Josh Siegel, and Director of International Strategy and Business Development Simon Gallagher. Hulu is currently under the interim leadership of VP of Content Andy Forssell, but is in search of a more permanent CEO. Kilar often clashed with the company’s ownership over strategy, but he was widely viewed as the reason the seemingly unnatural partnership between the three rivals worked at all. The company will need strong leadership to navigate the murky waters ahead.

But given the context that Hulu's owners apparently didn't receive a bid they were pleased with, the logic of the follow on investment makes sense as the best remaining option, says Plus Capital founder and veteran media investor Adam Lilling:

It would seem that they are going to use a chunk of that money to pay themselves license fees, which go to their yearly income instead of long term capital gains. This sets a precedent which needs to be matched by Yahoo, Amazon, et al [when they seek to license content] which represents billions of dollars worth of nonexclusive licensing fees. Couple that with the unknown value of a platform that has authentication at scale and is on deck on almost every device platform. It may not be sustainable long term, but it's perfect for the next 3 years. I'd say this is the best move they could have made.
As one Hulu employee not to be named wrote on their Facebook wall in response to this morning's news, "Blue Balls..."

[Illustration by Hallie Bateman]