This Changes Everything at Netflix

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I can't believe that everybody's going to let Netflix (Nasdaq: NFLX  ) get away with this.

The Los Angeles Times is reporting that the digitally prolific movie rental service is striking a deal with Epix to offer up its releases through Netflix's fast-growing streaming option.

Epix is the nascent premium digital television service bankrolled by Lionsgate (NYSE: LGF  ) , MGM, and Viacom's (NYSE: VIA  ) Paramount. In other words, it may not be long before Netflix subscribers have streaming access to some of this year's big hits including Iron Man 2 and Dinner for Schmucks.

It won't come cheap. Netflix is apparently willing to fork over nearly $1 billion for licensing rights to stream the flicks over the next five years. However, that's the kind of payday that Epix can't turn down, even if title availability for Netflix members on unlimited plans at no additional cost will eat into its own subscriber-based offering.

It remains to be seen if there will be a release window here, along the lines of Netflix holding back on DVDs from certain studios during the first four weeks of their retail release.

In the end, this is the kind of deal that no one else can match.

Coinstar's (Nasdaq: CSTR  ) Redbox plans to unveil its digital strategy later this year, but it's likely to tiptoe into this niche. Blockbuster is strapped for cash. The tech darlings toiling away for years in digital distribution are focusing on elusive piecemeal rentals.

This could be a real game changer for Netflix. It has already inked deals with Relativity Media and Liberty Starz' (Nasdaq: LSTZA  ) Starz to get fresher content available through its streams, but this would make Netflix's lead in this niche practically insurmountable.

Who could scale this quickly? Nobody.

What does this mean for conventional movie channels including Time Warner's (NYSE: TWX  ) HBO? Toast.

The question will no longer be who can compete against Netflix digitally, but -- rather -- how is it going to go about carving up its empire.

Tiers for cheers
The only real knock of the Netflix model during its past few blowout quarters is that its subscriber base is growing faster than its top line. In other words, revenue per account keeps going down.

There's a simple explanation for this. New members are being wooed by the entry-level unlimited plan, where couch potatoes are allowed 24/7 streaming and can have a single DVD or Blu-ray out at a time. As more film buffs realize that they don't need to have three or more discs out at a time, they too will downgrade to the economical $8.99 monthly plan.

Netflix will have to do a lot of soul searching at this point. Does it let average revenue per user slide all the way down to $8.99, or does it do something about it by creating more digital value for its higher-priced offerings?

After all, we all know that the optical disc is dying. It's really just a matter of time. Do we really think that Netflix is going to settle for everyone flocking to the unlimited $8.99 plan?

I doubt it. What if some of the premium streaming content is reserved for those paying nearly twice as much for the flagship plan that offers three discs out at any given time? Not only would it translate into revenue per subscriber actually climbing for a change, but it would also give studios more leeway in licensing hot content to Netflix's higher tiers.

After all, studios don't mind Blockbuster or pay-per-view broadcasters renting out their releases because they are charging top dollar.

Poetry in motion
It's perfectly fitting that Netflix is only a handshake away from streaming Dinner for Schmucks at some point soon. The flick deals with corporate executives who compete to see who can bring the biggest idiot to a dinner party.

Let's face it, any rival that Netflix brings to the soiree is going to be a model idiot.

Netflix has pulled off this digital mastery in full view of its incompetent competition. As it brokered deals with TiVo (Nasdaq: TIVO  ) , all three video game consoles, and various Blu-ray player and television manufacturers to allow streaming through their devices, everybody else was trying to get folks to pay up for individual rentals through their PCs.

With every content licensing deal that Netflix strikes, its digital catalog gets that much larger while everybody else is still either trying to make piecemeal rentals work, or trying to launch fledgling subscription services along the lines of Epix.

What did everybody else not see? Did they not catch on to the heady subscriber growth, pitted against their own piecemeal failures or tardy arrivals in the cinematic buffet line?

Netflix had this game won years ago when everyone else was paralyzed.

Will Netflix ever stop growing? What can stop the company? Share your thoughts in the comment box below.

Netflix is a Motley Fool Stock Advisor selection. Try any of our Foolish newsletter services, free for 30 days.

Longtime Fool contributor Rick Munarriz has been a Netflix shareholder -- and subscriber -- since 2002. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.

Read/Post Comments (5) | Recommend This Article (16)

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  • Report this Comment On August 10, 2010, at 4:54 PM, chickenlittle4 wrote:

    Why do you bother posting garbage when you, along with your posse, got scared and already sold NFLX ? Now you back in? What, for the 3rd time? Sell low and buy high with no conviction. That's what you guys espouse?

  • Report this Comment On August 11, 2010, at 1:14 AM, ChrisBern wrote:

    I guess I don't get it. I've never heard of Epix, nor have I heard of Dinner for Schmucks. I am a Netflix subscriber (and former shareholder). The streaming is a nice-to-have feature, I suppose, but I rarely use it. I find that it's more convenient to just have them mail me DVDs. It's more convenient than streaming, because streaming (a) is only for a subset of titles and (b) isn't as reliable quality-wise as DVD (especially when streamed to a computer).

    I get that the optical disc will eventually die, but I get I don't get paying $200M/year for the next 5 years just to stream content that subscribers will already get for free by mail. Do they expect to recoup the $1B in additional subscribership? Does streaming lower distribution costs? I'm interested in knowing the expected ROI of this particular licensing deal.

  • Report this Comment On August 11, 2010, at 11:37 AM, CPACAPitalist wrote:

    I personally am not suprised at all to see this revolution in entertainment delivery. Well over a year ago my house switched to watching all our entertainment either through Hulu or Netflix (streaming and by mail). We get our single dvd at a time and thats good and all but we watch a ton of streaming content. In this digital age I expect that physical media will all but dissapear within a few years. The music industry saw it happen first, next up is films and video games. Anyone who is involved in current entertainment will tell you about streaming games bought digitally on xbox live arcade, or watching streaming video on netflix. Its the wave of the future, and Netflix is locking in a sweet amount of the market share early on.

  • Report this Comment On August 11, 2010, at 2:36 PM, bighairydogcat wrote:

    We have been streaming Netflix since it's arrival to the Xbox 360. Wow is all I can say from what it was to what it is. Poor quality? I run the least expensive DSL connection and stream in HD. Sometimes the movie quality degrades during peak times.. normal internet traffic woes. I back out of the movie, launch again and voila! Back to HD.

    The interface has changed dramatically and the algorithm that suggests titles based upon what you have already watched is uncanny(money well spent in their contest).

    The one DVD a month sits on the entertainment center collecting dust. I agree that the dvd by mail content is "newer", but what your missing is that this deal brings that gap even closer. I figured Netflix would cap out about $125.00 a share and then make a gradual retreat to $80-95 per share but this deal clearly shows they are playing for keeps. I would expect the studios to warm up real quick. Who can take them on? Coinstar? I seriously doubt it. Remember cassette tapes? Still have any?

  • Report this Comment On August 12, 2010, at 3:10 AM, ChrisBern wrote:

    Thanks for the feedback on my comments. I love Netflix, too, and am a very satisfied customer. But I must say I still don't get the ROI of this deal. Netflix's COGS last year was slightly over $1B. So that number will go from $1B to $1.2B with this deal. Are they expecting the deal to enhance the top line by 20% as well? And if so, why? Would enough non-subscribers decide to become subscribers simply because of this deal? Enough to make up $1B over 5 years? It seems like it's possible, yes, but by the same token, I would expect a strong possibility of profit reduction in the first few years, even if the arrangement paid off in the long run. To wit, their net income last year was a record $115M (and it's been growing nicely for several years). Adding on a new $200M expense each year BETTER bring on tons of new subscribers, or else that $115M in net profit could easily turn downward, to losses even.

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