Is Netflix Crazy -- Like a Fox?

There's a fine line between genius and madness. Netflix (Nasdaq: NFLX  ) is facing some challenges right now, and the outcome will tell us on which side of that divider the company and its leadership stand.

The big Lebowski
CEO Reed Hastings has been pretty cavalier about the Starz deal. Last December, he told a conference crowd that "It isn't essential to our success." Waxing nonchalant, he continued: "The Starz deal turned out to be a great deal for us. We'll try to renew it. But there's no one piece of content that's central for us." In short, "we can live without it."

That idea is being put to the test today as Liberty Starz (Nasdaq: LSTZA  ) said it was done negotiating that renewal. In response, Netflix shares dropped as much as 11.2% overnight.

Liberty is no stranger to new-age distribution methods. For example, corporate sibling Liberty Capital (Nasdaq: LCAPA  ) holds a 40% ownership stake in Sirius XM Radio (Nasdaq: SIRI  ) through a truckload of preferred shares, making the stock a smart alternative to investing in Sirius itself. In fact, fellow Fool Rick Munarriz did exactly that last week. So why walk away from a new deal, which would have to be more profitable than the old one by orders of magnitude?

The perfect storm
Starz CEO Chris Albrecht positions the move as a strategic choice: "This decision is a result of our strategy to protect the premium nature of our brand by preserving the appropriate pricing and packaging of our exclusive and highly valuable content."

Speaking to BusinessInsider, Hastings still seems sanguine about it: "We are confident we can take the money we had earmarked for Starz renewal next year and spend it with other content providers to maintain, or even improve, the Netflix experience."

That remark dovetails right into the other litmus test of the Netflix model that's going on right now, wherein Hastings predicts manageable defections from the recent price changes. That new plan went into effect yesterday. In about a month and a half, Netflix's next earnings report will tell us exactly what happened.

It almost looks like gamesmanship when Starz pre-announces the end of its movie distribution deal right on the start date of the new prices. Did Redbox runner CoinStar (Nasdaq: CSTR  ) put Starz up to this immaculate timing? Did Blockbuster owner DISH Network (Nasdaq: DISH  ) ? Or is it all a big, harsh coincidence that forces consumers to think just a little bit harder about canceling their Netflix plans?

Deep impact?
According to Hastings, this is a storm in a teacup as Starz streams only make up about 8% of instant viewing today and should "naturally drift down to 5-6% of domestic viewing" in the next quarter as Netflix adds more content from other sources.

Some investors obviously see a huge "SELL!" sign flashing above the Starz announcement. Me, I see the best buy-in point Netflix has offered since mid-March. Your view will depend on whether you see Hastings as a shrewd mastermind or a desperate spinmeister.

Remember when Blockbuster, Wal-Mart (NYSE: WMT  ) , the universe, and its cat teamed up to destroy Netflix back in 2004? Hastings looked crazy then and proved all the naysayers wrong. Need I remind you how that opera ended? Hastings has proven his mettle, and I think this guy knows his stuff.

And now, history is repeating itself. What have you learned?

Keep a close eye on digital entertainment:

Fool contributor Anders Bylund owns shares of Netflix but holds no other position in any of the companies discussed here. The Motley Fool owns shares of Wal-Mart Stores. Motley Fool newsletter services have recommended buying shares of Wal-Mart Stores, Coinstar, and Netflix; buying puts in Netflix; and creating a diagonal call position in Wal-Mart Stores. 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. You can check out Anders' holdings and a concise bio, follow him on Twitter or Google , or peruse our Foolish disclosure policy.

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 02, 2011, at 3:12 PM, teeba11 wrote:

    I took this as an opportunity to purchase NFLX in the money call. I believe in Hastings and he made me a lot of money in the run up. I believe there will be some more ups and downs with this stock, but I for one am putting my money on the upside. I just can't bet against these guys.

  • Report this Comment On September 03, 2011, at 6:15 PM, mrnaturl wrote:

    Not buying this until it drops to $150 or less. Too many people are dropping their service.

    I was going to keep it until my 12 year old complained there was nothing for her to stream. Every time she tried to watch something it claimed she had to order the disc. That's clinched it for me.

  • Report this Comment On September 04, 2011, at 12:26 AM, morningstara wrote:

    If you go to consumer websites about seetv.com--they are all saying its a scam. Poor pic quality and nothing outside whats already free. FYI

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