Not many people have spent a long time analyzing out the move by Amazon last week to take over LoveFiLM in the UK and Europe. The purchase price was leaked to the Financial Times as £200 million for the entire company, around $316 million, although that was not officially given out. But this doesn’t surprise us ‘ LoveFiLM is potentially the Netflix of Europe ‘ unless of course Netflix is.
LoveFiLM is an agglomeration of multiple startups from right across Europe, which all began to copy the Netflix original business model of rental DVDs through the post, but ordered online.
Most of these businesses were founded around 2005, and Video Island in the UK was the core operating company that snapped up most of the rivals in its wake, backed with about £15 million in initial venture funding. It bought ScreenSelect and DVDs365 in the UK and then Brafilm the market leader in Sweden and Norway. Later it bought a major rival LoveFiLM, and took on its name.
That deal brought it into a relationship with LoveFiLM shareholder the Arts Alliance Media, which spent its time licensing movies. Video Island’s backers were Benchmark Capital, Index Ventures, Cazenove Private Equity, and European Venture Partners. At one point the business had White Label deals or marketing deals with AOL, CD Wow, Channel 4, Dixons Store Group, easyGroup, Guardian Newspapers, ITV, MSN, News International, Odeon, Sainsbury, Tesco and Vue Cinemas. Some of these have now lapsed, but the supermarket chain Tesco still has a strong relationship.
There were further acquisitions, mostly not with cash, but with shareholdings, including more deals in Scandinavia at Digitarian and Boxman and it devised a Germany offering working with Deutsche Post World Net Group.
All of this activity took LoveFiLM from perhaps 150,000 paying members in 2005 to 1.6 million today. Its offers go from £5 a month for just one posted DVD at a time and no online film time to around £19 a month for three DVDs out at any one time and unlimited online viewing. So if we guess that revenue per customer is around £8 a month or a very convenient £100 a year, that gives it revenues of about £160 million and the purchase value is a little better than one times revenues. The business has said it has been profitable from around 2006 on, but has had periods when the churn was immense compared to Netflix.
The online side of the business launched in conjunction with AOL in 2006, and began as just a few hundred films licensed for online distribution, but rapidly evolved to quite a bit of content.
In 2006 Amazon bought a company called CustomFlix back in the US and began to be interested in this business. CustomFlix was more about burning a customer DVD with the film you wanted on it and posting that. But the same line of thinking rapidly moved Amazon to build licensing partnerships with all the major studios and begin to experiment with Online DVD rental and where better than in the UK, up against LoveFiLM.
Amazon tried its arm at this and found that it just wasn’t profitable enough. LoveFiLM had streamlined a lot of the Netflix practices ‘ by that we mean it never felt that it had to be quite so generous with customers, and didn’t have to do things like deliver online wishlist DVD rentals in the order they were booked. That way it could carry less DVDs in its portfolio per customer than Netflix did. Probably Netflix would never have crushed its US opposition if it had done this, which was intense, but LoveFiLM got away with it and has probably always been slightly ahead of Netflix in terms of margin, despite being around a tenth of the size.
There were times when Netflix had to operate on 1% or 2% net margins during its early years, until it picked up momentum. But the BIG shift to profitability was as online film delivery grew, and less and less DVDs had to be purchased (at 3 times the street price for a rental disk).
So Amazon first tried this too early and in 2008 gave its operation over to LoveFiLM run, in return for that 42% shareholding, and presumably a marketing leg up.
At first LoveFiLM thought, as Netflix first thought, that online delivery should be free, in order to drive down its online DVD rental churn. If you had to be a DVD rental subscriber to get online videos, it was less likely that you would let your monthly payment lapse. Now as LoveFiLM is starting to see the huge margin gains at Netflix as more customers are using purely online delivery, it is trying to repeat the transition here in Europe.
And that will make it just as hot prospect to reach the levels of profitability that Amazon is more used to, hence the buyout.
But it doesn’t stop there. As Amazon puts resource and marketing behind LoveFiLM it is likely to spread to more territories in Europe and become ever more valuable. If Amazon can sign up more CE manufacturers to make their devices LoveFiLM compatible, then the service has the potential to be bigger than Netflix, given the 500 million population in the European Union. Already it has deals with a number of connected TVs, the Sony PlayStation and PCs. LoveFiLM also offers online ordering of physical game rentals for XBox 360, Xbox, PS3, PS2, Wii and DS.
‘The deal is a winner for the members who love Lovefilm because of its value, choice, convenience and innovation in home entertainment,’ said Simon Calver, chief executive of Lovefilm International. ‘With Amazon’s unequivocal support we can significantly enhance our members’ experience across Europe.’
There will be a lot of work to spread the word throughout Europe though, so far LoveFiLM has 1.6 million customers and 1.2 million of them are in the UK. And clearly there is some potential to harmonize LoveFiLM with the Amazon US online video brand which started as Unbox video. That services launched in 2006 already has deals with Google TV, Panasonic, Roku, Samsung, Sony and TiVo devices.
We would expect that under Amazon this service will grow rapidly and that it can be strategically used to at least attempt to keep Netflix out of Europe. Netflix itself has launched very successfully in Canada using online only, and now that it knows that this is possible, without the DVD rental at all, then there is every reason for it to attack Europe as soon as it has content rights. We’d say that this would take as long as year, and that Netflix would not be in a position to launch in Europe until next Christmas.
Which would give Amazon a fairly short space of time in order to establish supremacy in Europe. What happens at that point is anybody’s guess, but if Amazon can see the benefit of owning LoveFiLM then it can surely now see the benefit of owning Netflix, and once Network Neutrality issues are resolved in the US (if they eveer are), we could see LoveFiLM being offered as a bargaining chip in a merger discussion. But it better not wait too long, or Netflix will have devalued its LoveFiLM operation by moving into Europe, and right now Neflix is still only worth about 10% of Amazon, and that will only go higher.