Heres Why Time Warner Bought 10% of Hulu

Time Warner (NYSE: TWX) just spent $583 million for a 10% stake in Hulu in large part because the streaming service intends to launch a live-TV cable alternative.

Original partners Comcast (NASDAQ: CMCSA), Disney (NYSE: DIS), and FOX (NASDAQ: FOX)won't be contributing to the original Hulu subscription product. That service offers network content a day after it airs -- a model Time Warner has been critical of. Instead, the company will offer many of its channels including TBS, TNT, and CNN as part of a new live-streaming Hulu service.

Hulu has not shared much information on the product, other than saying it launches next year. On this episode of Industry Focus: Consumer Goods,host Vincent Shen is joined by Fool contributor Daniel Kline to dig into why Time Warner has paid up to be part of a service it has criticized in the past. They also discuss the future of the cable industry and where it's going to go in the next few years.

A full transcript follows the video.

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This podcast was recorded on Aug. 9, 2016.

Vincent Shen: Hulu, next year -- just to clarify what exactly they're going to be offering and Time Warner is buying into -- is a live-streaming service that will actually include live television, which is a little bit different from what it currently does, which is more similar to Netflix(NASDAQ: NFLX).

Daniel Kline: Basically, they're copying Sling, except because some of their partners are networks, Sling does not have any traditional broadcast networks. It sort of the most popular cable channels for younger people. What's happening here with Hulu is they're going to have some of the Fox, NBC, ABC programming. Maybe my mom can get it, and she'll still get the Nightly News. I don't think my mom watches the Nightly News, but if her mom was still alive, she would watch the Nightly News and maybe would have to get this type of product.

Shen: There's not as many details as I was hoping there would be otherwise for the Hulu services coming out next year, but I think it's helpful for listeners just to give some context in terms of how far Hulu has come since it started back in 2008. Compare just for some basic contexts, Netflix, the leader here, has about 40 or over 40 million domestic subscribers that generate about $6.8 billion of revenue in 2015. The most recent numbers I could find for Hulu for example over 10 million subscribers, so a smaller base for sure, generated a revenue of $1 billion in 2013. That grew pretty quickly to about $1.6 or $1.7 billion last year.

The thing is both of these companies, and this includes Amazon, too, all these streaming services fighting for content, they've been spending a lot of money for not only their original programming that all three have become known for, but also $5-$6 billion spent by Netflix in 2016 expected. The most recent number I could find for Hulu is about $1.5 billion in 2015.

Kline: A lot of that is going to Seinfeld.

Shen: Yes, I think it was like $700.000 or $1 million per episode for that.

Kline: I think that's the differentiator between the two. Netflix is a service aimed at people in their 20s and 30s who maybe never had cable. Whereas Hulu, the content is really the stuff you would watch if you had a cable subscription a couple of days later, 24 hours later plus a few originals that feel like network shows. It's not groundbreaking in the way that Netflix is. It's sort of a familiar angle. It's when an older generation says, "You know what? I'm not paying $150 to Comcast anymore, but I still want to watch Law & Order.

Hulu is trying to keep that model, and the challenge is not pushing cable subscribers away, that's the last thing Comcast would want, but also keeping as many of them that were going to leave anyway on the one that they own. You'll do better as Time Warner being a partner in Hulu than licensing your content to DISHor to Sony or the 20 other services like this that are going to start in the next few months.

Shen: There's an interesting dynamic here because, as we mentioned, the joint venture owners for Hulu are the really big companies like Disney, you mentioned Comcast, NBC, Universal. This news just came out yesterday actually where I mentioned that first service is free to access Hulu content or some of the Hulu library, but it's supported by ads. They're actually getting rid of that entirely.

Kline: The interesting thing is they're actually just moving it to Yahoo!. They announced a partnership deal. They're unconfusing the Hulu brand. Basically, Hulu is going to have two products. It's going to have a subscription product where you get access to next-day content from the original partners and not Time Warner, and then it's going to have a live-streaming television service. Having the free product on top of it, which inflated their viewer numbers by another like 40 million but didn't really make them a lot of money because it's really difficult to sell ads on three people watching a Seinfeld from 15 years ago and 17 people watching Family Guy. It becomes a very tough model to prove to advertisers that there's value. They're sort of just shunting that off and taking it off the Hulu brand, which makes sense. It will make it a lot easier for them to sell really their two services that make sense.

Shen: Stepping back now and looking at this in terms of some of the changes that are obviously happening to the industry, big picture, what do you think is going to be happening maybe next year or with these developments as kind of deals like these between Time Warner, Hulu and Hulu service coming out next year? What do you think that's going to mean?

Kline: I think it's the wild west. It think you're going to see every major cable company start a service that doesn't require a cable box in order to keep broadband customers. What's going to happen is you're going to have two or three years where there's 15 choices and then you'll see consolidation again. There's no need for there to be Sling and Vue and whatever they call super Hulu. If Amazon enters that space, if Appleenters that space, a lot of players are going to come here. Eventually, you're going to see it's just going to be like cable, where it doesn't really matter if you have Frontieror you have Comcast, pretty much you're getting the same offer. Maybe it becomes priced in customer service, but there's going to be a lot of announcements and a lot of new companies or existing companies going into the space because the cable box is slowly going away.

Daniel Kline owns shares of Apple. Vincent Shen has no position in any stocks mentioned. The Motley Fool owns shares of and recommends, Apple, Netflix, Time Warner, and Walt Disney. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. The Motley Fool recommends Yahoo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.