Netflix Is on a Roll!

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Netflix (Nasdaq: NFLX  ) is on a roll. The streaming movie catalog is going from deep-but-aging to a more crowd-pleasing mix of old and new movies as film distributors line up at the door, contracts in hand.

The biggest knock on the instant streaming model has always been a lack of new, big-name releases. For that, you typically have to settle for a red envelope in the mail -- and even that solution now suffers from a 28-day delay when compared to your friendly neighborhood Blockbuster store or Coinstar (Nasdaq: CSTR  ) Redbox vending machine.

That's old news now
That's changing in a hurry. A partnership with pay TV veteran Liberty Media Starz (Nasdaq: LSTZA  ) has been feeding a modest selection of fresh material to Netflix for a couple of years now, and smaller rival Epix joined the party a few weeks ago. Signing up Time Warner (NYSE: TWX  ) subsidiaries HBO and Cinemax plus CBS (NYSE: CBS  ) service Showtime would improve the library dramatically, but then you might as well go straight to the studios behind the TV outlets. Cut out the middle man, you know.

And that's what Netflix is doing now. The ink is still drying on a contract with action movie specialist Nu Media, led by industry legend Avi Lerner. Starting with next year's The Son of No One, starring Al Pacino and Ray Liotta, Netflix will get streaming rights to movies that would otherwise go to those pay TV channels at that time. This follows a similar arrangement with Relativity Media in early July and clearly shows where Netflix is going: right to the movie producers.

The company is not afraid to spend money to secure these streaming licenses, and the increasing profitability of the whole operation provides plenty of fertile capital for doing exactly that. If anything, I'm disappointed to see that Netflix is buying back historically expensive shares rather than pumping even more cash into growing its streaming library.

The tipping point
The magic moment will come when the really big studios jump aboard the Netflix bandwagon with both feet. I'm talking about Time Warner, Walt Disney (NYSE: DIS  ) , and Sony here, folks. For now, they are all watching from the sidelines to see how much havoc these agreements will play with the business models of Relativity and Nu Media. But licensing movie rights is a very cost-effective model, and anything that's good for margins should work out well for the studios.

Ergo, that day will come eventually. The only questions in my mind are, "When?" and "Which studio jumps first?" Whenever one of the big Hollywood names opens the door to serious licensing discussions, Netflix will gladly sign on the dotted line even if it's ludicrously expensive. Nobody else is doing anything even close to the Netflix streaming business, as the rest of the movie rental industry seems intent on making pay per rental work. So far, they've had minimal luck with that. I don't see that changing anytime soon.

Polish up that crystal ball!
So here's how I see the market for movie rentals working out in the coming years:

  • Nu Media, Relativity, and perhaps a couple of other small fry prove decisively that there's good money to be made in selling streaming licenses to Netflix, and they aren't shy about shouting it from the rooftops.
  • Netflix leverages the hard evidence to sign the first really big digital distribution deal, probably with a studio like Warner or Disney because they have shown some signs of waking up to smell the coffee already.
  • One year later, that pesky 28-day disc rental delay will be forgotten as every studio that matters has signed with the proven leader in digital movie subscription services.
  • The rest of the industry struggles to catch the crumbs falling from Netflix's overflowing banquet table, but nobody has taken the time, effort, and expense necessary to build the technology and industry relationship you'd need to make an impact. No, not even Apple (Nasdaq: AAPL  ) , despite Steve Jobs being the largest shareholder of Disney with a board seat to show for it.

That's why this is the beginning of a beautiful investment opportunity. If you think Netflix looks expensive today, you're just not looking far enough into the future.

Fool contributor Anders Bylund holds no position in any of the companies discussed here. Walt Disney is a Motley Fool Inside Value recommendation. Apple, Walt Disney, and Netflix are Motley Fool Stock Advisor choices. Try any of our Foolish newsletter services free for 30 days. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. You can check out Anders' holdings and a concise bio if you like, and The Motley Fool is investors writing for investors.

Read/Post Comments (6) | Recommend This Article (20)

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  • Report this Comment On September 08, 2010, at 3:01 PM, rrobster wrote:

    I would (now) have to agree. I bought in around $88 and was thinking "sell" up until last week. Now, I'm just going to ride along for awhile and see how this stock does. Does Netflix have any real competitors? Currently, it appears not to. Like the article asks, I am wondering if I should add to it in the $140s or just hang on to what I already have? Decisions, decisions..........

  • Report this Comment On September 08, 2010, at 3:36 PM, emptygestures wrote:

    Anyone who buys NFLX right now is falling right into a trap. First off streaming has a ways to go.

    1.) Look at bandwidth use and if people are constantly streaming how much bandwidth providers are going to cut down. For instance, Comcast (which also offers ondemand) is going to recognize this and make bandwidth more expensive to those who want to stream from a competitor instead.

    2.) What at all implies that NFLX now has new releases streaming? Do people think that they will be able to buy into the $8.99 plan and stream new releases when they come out for free??

    3.) As consumer demand grows for streaming and NFLX's mailing services decays, they will be at a bottle neck for new subscriptions which has already plateaued.

  • Report this Comment On September 08, 2010, at 9:04 PM, JudasTouch wrote:

    emptygestures says:

    "First off streaming has a ways to go."

    Have you tried Netflix's streaming service? While there is some room for improvement (rewinding and fast forwarding is a bit cumbersome), it doesn't appear to have all that far to go. Even if it does have a ways to go, Netflix is a leader in streaming, so there's a good chance it will be the first to arrive at whatever you think the destination is.

    1.) Bandwidth restrictions could indeed be an issue. The trouble for Comcast/Xfinity, Verizon and other cable providers is that the value of their on-demand options pales in comparison to Netflix's subscription smorgasbord.

    2.) I think a price increase is all but inevitable, but I think it won't be more than a buck or two. $9.99 or $10.99 for a one-disc-out plus unlimited streaming of new releases is still an incredible value. But I also think Netflix will offer new releases at the $8.99 price point for a while. They know how sticky the service is, and I think they'll successfully gamble that a 10% price increase won't cause a lot of churn.

    3.) Not sure what you're trying to say here. A bottleneck implies more demand than supply, which is the opposite of what you're arguing. What makes you think the mailing service will decay? The transition to an online-only service is indeed inevitable, but it's a long way off, and Netflix leadership knows this. Also, where did you get your data showing subscription growth has plateaued?

  • Report this Comment On September 09, 2010, at 12:56 PM, jrmart wrote:

    A key changing event for NETFLIX occurred after APPLE announced APPLE ITV on September 1, 2010. The APPLE ITV will stream NETFLIX movies right to your HDTV. I immediately ordered one from Apple and also bought NETFLIX stock. Since then, in just 5 trading days, NETFLIX posted a 20 point gain.

  • Report this Comment On September 09, 2010, at 4:57 PM, morrisjd wrote:

    Is it true that the cable companies have a stranglehold on internet access and bandwidth? Isn't there competition from DSL and Cellular? Doesn't this bode well for price competition and lower cost per bit for data transmitted?

    Am I missing something here?

  • Report this Comment On September 09, 2010, at 6:39 PM, ChrisBern wrote:

    To add to emptygestures concerns, will the licensing costs of these new deals be sufficiently offset by new subscriber revenue? Color me doubtful.

    For example, Netflix will be paying "smaller rival" Epix a cool billion over the next 5 years. Netflix's COGS last year was slightly over $1B. So the COGS number will go from $1B to $1.2B with the Epix deal.

    Is Netflix 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, Netflix 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 had BETTER bring on tons of new subscribers, or else that $115M in net profit could easily turn downward, to a loss even.

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