Summary – Flixster discussion 6/27/11

• Flixster (recently acquired by Warner Bros), potentially launching Ultraviolet retail services by August, 2011, has asked SPHE to license product at time of launch

• Though UV is a critical priority for SPE, the Flixster service design, launch timing and ownership each present potential risks

• Current recommendation is to engage in discussions with WB regarding the service, but not license to it unless our concerns are adequately addressed

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Flixster was recently acquired by Warner Bros, as part of its “Digital Hub” strategy – Stated goal to “accelerate uptake of Ultraviolet”

• Currently Flixster has between 10-20mm monthly unique visitors, with a focus on information and social discussion of theatrical titles (eg – Rotten Tomatoes), from pre-release through home entertainment window– Links to iTunes for content transactions

• WB intends to make Flixster the core of its Digital Hub strategy, with the stated goal of Flixster becoming the go-to brand for information and consumer sharing related to all forms of Hollywood content– Content purchases (UV) and rentals, powered by Roxio (Sonic Solutions’ white label

service)– Single place within which to track your content interests

• Ultraviolet for ownership• Netflix queue and other rental titles• Titles that you are interested in, but may or may not own

– Single place within which to convert your existing DVD collection to digital rights– Launched on Facebook, and integrated into the Facebook user experience

• Expected launch date with Ultraviolet content is August, 2011, in advance of other UV retailers– WB’s stated belief is that a launch of UV on Flixster will accelerate other retailers’ times to

market with UV product (need to validate this in market…)– SPHE’s current expectation is for UV retailers to be in the market in the

November/December timeframe, though this timing is pending confirmed retailer support

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A more likely rationale for Flixster purchase might be to create an over the top service as a hedge for TW against potential cable cord cutting• Contrary to accelerating UVs time to market, Time Warner is actually holding onto a number of

inhibitors to a successful UV launch– HBO holdback on locker rights for WB, Fox and Universal continues (rumored to be in negotiation)– WB withholding licensing HD content online today– WB reportedly not in the market yet to other retailers with defined, attractive UV terms

• In fact, WB has also reportedly communicated to Apple that it may consider relaxing the HBO holdback only for UV retailers. A potential plus for UV, but– Beyond this, HBO would be within its rights to only relax its holdback for Flixster, and not other

retailers, or perhaps delay resolving the HBO issue for other, non-owned, UV services

• An early Flixster launch on Facebook would have a strong advantage as a consumer service– Social network effects (a la Zynga) that drive and lock consumers to Flixster as their default content

source, creating switching barriers to later services launching on Facebook– Library conversion switching barriers (a la CDs ripped to Apple iPod)– A strong consumer proposition founded on all forms of content consumption, whether owned or not

• Result of the above, even on only 3 studios’ content, could make Flixster the dominate consumer service for over the top Hollywood video consumption, which could be far more valuable to Time Warner shareholders than an acceleration of the launch of UV– Strategy analogous to HBO’s launch on then emerging cable systems in the 70’s, with subsequent

Warner merger in 1989 (Jeff Bewkes was HBO CFO from 86-91 )– Great story for Time Warner to Wall St analysts, especially if cord cutting accelerates

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Whatever the real goal today, Flixster as described likely represents a threat to SPE home entertainment economics longer term

• Benefits from accelerated UV time to market are slight, especially if retailers are launching within 3 to 6 months of Flixster anyway– Potential retailer backlash may work against acceleration objective, or even be felt in physical channel

• Risks exist as designed, as Flixster will tend to devalue content ownership and raise other economic risks if successful– Risk to value of ownership, as no distinction between owned content and content that was rented or

simply viewed. UV locker becomes a subset of larger Flixster locker– Reduced importance of buying content to be able to create collections, from simple user interface from

which to add un-owned content to profile by adding box art and title name – Risk of monopolist in transactional landscape on UV content, especially so to the extent that HBO

continues to withhold locker rights from other potential UV retailers – Reduced value of SPE’s DVD conversion programs to other, better-scaled retailers

• Further, Flixster ownership by a competing studio raises further challenges– Disadvantage to non-WB titles sold within Flixster, as WB controls the user interface and content

algorithms– Potential disadvantage to SPE titles longer term, due to non-preferred access to Flixster consumer

information– Challenges directly addressing service attributes, as WB suggests SPHE license to Roxio, not Flixster

A comparison of HBO, Netflix and Flixster suggests a better alignment of economic interests with studios at times of HBO and Netflix launches

HBO Netflix Flixster

Launch content Subset of studios Subset of studios Subset of studios

Platform Cable Internet Internet/Facebook

Value proposition Commercial-free movies, before network TV

Discs delivered to homeSubscription before PayTV window

Hollywood content at users’ controlPersonalization

Content (as licensed from studios directly) contribution to service value

All All Portion unclear(also netflix queue, box art, other files on computer…)

Revenue model to service

Cable carriage fees, collected from consumers

Direct consumer fees

Unclear – Ads? Consumer information?Transactional retailers always must capture value elsewhere (eg- devices, foot traffic)

Revenue model to studios

License fee for content

License fees and payments/transaction

Transactional proceeds for content sales and rentals

Risk exists if/when WB determines that the value of EST UV transactions (negative margin on new releases tor e-tailers today) to Flixster does not

provide an adequate return on its acquisition investment

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Warner Bros’ asks, Potential SPE responses

• Warner Bros’ asks– License SPE content to Roxio (unaffiliated w/WB), for Flixster to market as front end to consumer– License DVD conversion program to Roxio, to drive adoption of Flixster– Encourage marketplace adoption/support of Flixster as able

• Why is SPE critical to Warner Bros?– Other studios, except perhaps Fox, are unlikely launch partners

• Disney going slow on Ultraviolet (also competitive to Apple) • Paramount not recently active in UV • Universal parent involved in UV, but Comcast likely would not like WB out first• Fox in UV – historically has not been pushing for fast launch though may be changing

– WB only needs 1 studio to drag Universal in as well (DOJ consent decree)

• Recommended SPE position: Continue discussions and then decide on license– Limit Flixster’s use of unlicensed content to protect transactional value from service– Steer Flixster to a delayed, simultaneous launch with other retailers– Steer Flixster to emphasize HD content at launch to all devices, to open HD availability generally– Through license, force HBO to give up its holdback on all retailers, or at least on Sony services– Consider appropriate MG– Consider demanding equity (50%) as part of our involvement, however…

• Equity may not be as attractive if service characteristics devaluing content are resolved• Universal may not be dragged in if SPE has equity (consider option to acquire later?)

Notes

• Flixter can get access to SPE movies even if we do not join flixster, unless we withhold LASP license which I thought we were not going to do.

• Paramount has been active in UV from a standards perspective and commercially active in the UK • Flixsters ability to sign up millions of UV users is a huge benefit UV• UV is open, and there are no barriers for retailers to enter the market after flixster• WB believes that launching on Flixster will accelerate retailers to market • WB is withholding HD for Hardware root of trust – unrelated to issues discussed• Thomas told me they are going out with term sheet shortly• It is possible that launching flixster will accelerate studio negotiations with HBO• Not sure I agree with Lock scenario. UV is open Any third party service gets access to all consumer UV information to

build services• If retailers are really 3 months away, I do not think Flixster with change that• UV will always be a subset of a larger locker• Not aware of HBO/SPE holdback issues except recently licensed S.W.A.T• MG? Really

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