The beginning of the end for Hulu?

January 8, 2013: 7:04 AM ET

The video streaming service is losing its charismatic CEO at a spectacularly bad time.

See correction below.

By Janet Morrissey, contributor

Something for Phil Dunfee to cry about?

Something for Phil Dunfee to cry about?

FORTUNE -- It came as little surprise when Hulu's maestro Jason Kilar confirmed long-time speculation that he would be leaving his post as the video streaming giant's chief executive. He dropped the bombshell in typical Kilar fashion -- on his blog. This post contained none of the brash, in-your-face dissertations that had so often vexed Hulu's media company owners. This one was poignant, almost melancholic, as Kilar reminisced about a company he transformed from an empty office suite in 2007 into one that has attracted more than 3 million paying subscribers and generated $700 million in revenue in 2012.

"My decision to depart has been one of the toughest I've ever made," he wrote, but gave no reasons for his exit. No finger-pointing. No long diatribes about the industry or Hulu's owners. Zilch. In fact, the blog left more questions than answers, especially about Hulu's long-term future and its viability in an industry that has become fiercely competitive. (See Hulu's network drama in Fortune.)

At least one other employee -- chief technology officer Richard Tom -- is also leaving, causing industry experts to wonder how many others may follow the two out the door. Some speculate that many of the people Kilar brought in with him -- colleagues from Amazon (AMZN) and buddies from Harvard Business School -- may also exit, which could create considerable uncertainty at Hulu. "Anytime you start to see key management personnel that have been involved in building a company leaving, then yeah, there's concern about the future of that franchise," says Channing Smith, managing director of equity strategies at Capital Advisors.

Some industry analysts even wonder if this is the beginning of the end of Hulu.

With big-name media giants News Corp (NWS), Walt Disney Co (DIS), and Comcast's (CMCSA) NBCUniversal among its owners and Kilar as its chief executive, Hulu had been on a growth trajectory that had surprised even its toughest critics. Industry skeptics dubbed the entity "Clown Co" when it was first formed because they didn't think a bunch of big media companies could get a sophisticated technology product off the ground. Kilar, a former Amazon whizkid, is largely credited for the company's growth and success. Its revenues climbed 65% in 2012 alone, the company claimed in a blog in December.

MORE: Hulu's network drama

However, tension between Kilar and the media owners had been escalating for some time. Missteps and internal bickering over Hulu's direction had been rising behind the scenes. In some cases, it spilled out into the public domain.

In February 2011, Kilar had a Jerry Maguire moment when he issued a 2,000 word diatribe on his blog, basically claiming old TV was dead -- a manifesto that didn't set well with media owners like News Corp's Fox and Disney's ABC. The previous year, he opposed the owners' plans to add a $9.99 a month subscription plan, suggesting instead a more reasonable $4.99 fee to stay competitive. In the end, Hulu's owners compromised with a $7.99 rate for what became Hulu Plus. Kilar also made frantic calls to owners when he learned some were making content deals with rivals, such as Netflix (NFLX), a move he felt undermined Hulu's product.

Then there was Hulu's proposed IPO that never happened in 2010, and the failed effort to sell itself in 2011. There was a firm -- and high -- offer to buy Hulu on the table, according to one person familiar with the situation. But the owners were reluctant to sell the venture because they wanted to maintain control over the pricing and licensing of their content thereby ensuring Hulu didn't cannibalize conventional TV ad revenue, the person said. This came as competition was heating up in the sector from Netflix, Amazon Prime, Google (GOOG), DISH Network's (DISH) TV Everywhere, Comcast's Xfinity, NimbleTV and others.

All of this turmoil vexed both Kilar and the company's fourth owner, private equity giant Providence Equity Partners. Providence had acquired a 10% stake in Hulu for $100 million in 2007, but had a put option, which became exercisable last Fall, to sell the stake back to the company for $200 million.

In October, Providence exercised that option, raising eyebrows and opening up a Pandora's box of speculation about Hulu's future. Afterall, Providence's sole interest is in seeing its investments, like Hulu, grow and profit. So, why would it sell its stake in Hulu if it believed there was still considerable growth ahead? Since Providence's interests were aligned with Kilar's, rumors went into overdrive that Kilar's days at the company were likely numbered. "Someone who wanted to see financial growth, audience growth, wasn't so thrilled anymore" says James McQuivey, a media analyst at Forrester (FORR) Research. "I was surprised Kilar stayed as long as he did," McQuivey adds.

MORE: The future of TV (maybe)

He believes the media owners have more or less lost interest in Hulu. "They don't want it to succeed," says McQuivey. "It's media economics -- if it succeeds, it will do so by cannibalizing the currency of the television media business today which is television ratings. So they made a decision to make sure Hulu didn't get too good or become too successful."

When the media companies first formed Hulu, it was aimed at satiating the booming consumer appetite for TV content over the web and to prevent consumers from seeking pirated material. They thought peer-to-peer file sharing was going to do to video what it did to music. That led them to make content available online a day after broadcast. In the mean time, that fear dissipated as authentication-based models -- where people can access programming if they prove they paid for television -- proved successful. "That model allowed the media companies to avoid direct cannibalization and the need for Hulu evaporated," he says. Media firms don't want to swap analog dollars for digital dimes.

Disney chief Bob Iger said in a statement to Fortune, "Jason has been an integral part of the Hulu story, transforming it from an interesting idea into an innovative business model that continues to evolve. We are proud of his achievements, we appreciate what he's built, and we share his confidence in his team's ability to drive Hulu forward from here." The firm's other media owners did not respond to request for comment.

Kilar's dedication and belief in Hulu ran deep. He turned down overtures last year to head up Yahoo (YHOO), after Scott Thompson resigned. Instead, Kilar continued to plead with Hulu's media owners, requesting a $200 million infusion to help Hulu fund more original programming that could further differentiate it from competitors. But the media giants were reluctant to open their wallets, according to people familiar with the situation. Afterall, Hulu already had to borrow $338 million in October to buy out Providence's stake and cover a $134 million employee equity-based compensation package in 2012, according to a Nov. 21 filing by Disney.

This all likely led to Kilar's decision to throw in the towel. "Kilar had to do some long hard thinking that his company was never going to be all of the things he had promised his employees and that he had signaled to the market that company could become," says McQuivey. "I suspect there was some disagreement on the business model going forward and strategically how to shape the company," says Smith.

MORE: What the hell is going on with TV?

Most believe Kilar will have no trouble landing on his feet. "Obviously he has immense respect in the industry and great pedigree," says Smith. "So I'm sure whatever he chooses to endeavor, he'll be successful." McGuivey agrees. "The man's talents are very well-respected and I think there isn't a person in the tech industry who didn't see what he went through and consider him the martyr."

As for Hulu itself, that may be a different story.

A previous version of this story mistakenly suggested Jason Kilar went to Harvard Law School. Fortune regrets the error.

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