After years of building its subscriber base with a vast library of content, Netflix (NASDAQ: NFLX) is making a risky bet that will see it lose thousands of popular movies in favor of exclusive titles. Is the company making another Qwikster-like mistake, or preparing itself for a bright, new future?

And in the world of discount retailers, Dollar Tree recently reported quarterly results that failed to impress investors. Closing a $9 billion acquisition of the competing Family Dollar chain, the company may have to suffer through growing pains as it brings all 14,000 of its U.S. and Canada locations up to par. 

A full transcript follows the video.

 

Sean O'Reilly: Netflix's library just got a bit smaller, on this CG edition of Industry Focus.

Greetings, Fools! I am Sean O'Reilly joining you here from beautiful Alexandria, Virginia, just south of the nation's capital, Washington D.C. I'm joined today by the intellectually formidable Vincent Shen. How are you, sir?

Vincent Shen: How are you, Sean?

O'Reilly: You like my little -- yeah? First up, we're talking about Netflix, everyone's favorite streaming movie and television show service. Their library is about to get a little bit smaller, which is not the right direction to be going in. What are the details here? What's going on?

Shen: They've come up in our show a few times recently, and this is a pretty big change for them. We'll see if this ends up being like their last major shift, which was quite a disaster when they split with Qwikster. In this case, they've done something like this before. They had this five-year deal with Epix, which is jointly owned by a few studios like MGM and Lions Gate.

Basically, this gave them some rights to distribute a lot of their big, Hollywood blockbuster films. They're ending this deal. It's going to run through September.

O'Reilly: I'm surprised it had such a short tail. You remember back in the day -- this is a little bit of TV history -- Ted Turner created CNN, but he also had TBS and TNT; it's the Turner Networks. He paid $1 billion to MGM for access to their entire vault. Literally, everything. That's why, when we were kids growing up, old westerns and MGM movies would just be playing. He wanted cheap content that he could play over and over again and have ads.

I'm surprised Netflix hasn't done anything longer tailed like that.

Shen: You bring up a few points with that which I think are relevant here. First of all, that five-year agreement is reported to have been valued around $1 billion. It was about $200 million per year for Netflix.

O'Reilly: That's the standard operating procedure for all these studio execs.

Shen: Exactly. To be putting out these movies. The thing is, the service is really losing a pretty significant portion of its library.

O'Reilly: I was reading through this, and I thought it was somewhat troubling. Is Netflix's plan to go with all original content now? I love House of Cards as much as the next person.

Shen: I think a bit of the rationale behind the decision making -- by the way, now that Netflix is passing on this, Hulu is stepping into the void. It's not like Hulu has exclusive rights. Amazon signed up with Epix back in 2012. There are a few different services now, but Hulu is stepping in to take over that deal. What is Netflix thinking here?

O'Reilly: Can they give up this ground? It almost seems like they don't quite have a monopoly yet, so they can't give up this.

Shen: They're not exactly doing this on a whim. Part of their blog post where they announced this, they acknowledged the fact that they're losing a lot of these titles, but the way the licensing rules work from the studios, it means they can't even stream them for their subscribers until a year after their theatrical release.

By that point it's admittedly available through a lot of other channels and mediums. Be it through your cable service, competing streaming services -- things along those lines.

O'Reilly: They definitely did some thought and analysis when they made this decision.

Shen: Yeah. It's not like the company isn't still signing other deals with content producers. They have big agreements with Sony, Universal, DreamWorks, and they have a huge one coming up with Disney.

O'Reilly: That is the big one.

Shen: The really big one, because that includes Pixar, Marvel, and Lucasfilm with some really big movies coming out. That's also a very favorable one for Netflix because they have some exclusive first-access rights where they'll have that content to stream before anybody else does.

O'Reilly: That lends itself to a point I was going to make. I was sad when I read this, but on the flip side, I was going out on a bullish note. Netflix has me and my 18-month-old son pretty well-invested in their content offering. He watched old Sesame Street episodes this morning on Netflix, and they've got Winnie the Pooh. As he gets older, they have all those -- I'm sure you're familiar with The Clone Wars, Star Wars things that was on Cartoon Network. They've got the next generation of kids, it seems.

Shen: They're not giving up all their good content. Keep in mind, a recent pull that has helped boost their subscription numbers is their original content. I think this is really a company shifting its focus to the production and licensing of some of its long run series like House of Cards, Orange is the New Black, and they have been doing pretty well with those.

I think this year at the Emmys, they had over 30 nominations for their titles. In a blog post, the company mentions some full-length feature films with some really big names like Brad Pitt, Angelina Jolie, Judd Apatow, and it potentially has...

O'Reilly: It is not taboo to work with Netflix, or Amazon Prime for that matter.

Shen: Exactly.

O'Reilly: That lends itself to creativity and all that good stuff.

Shen: Exactly. Ultimately, the comments section beneath the announcement from Netflix are very negative. People are saying they're ruining the service, and [...] is stepping away and now this is the final straw that breaks the camel's back, and they're not going to be paying monthly anymore.

O'Reilly: "I'm not going to pay you $8."

Shen: In the end, it's their business.

O'Reilly: In your professional opinion, is this a good idea or a bad idea? Weighing the evidence.

Shen: Sure. Just to give you an idea, the initial market reaction, their stock was down over 2% yesterday, but the market was also in the red, but it was less than 1%. Initially it seems a little rough. Today the stock is really tumbling. It's down over 6% last time I checked it.

O'Reilly: The market is down 2% or 3%.

Shen: I also think that has to do with something we're going to talk about next.

O'Reilly: Competitively, what's going on with Apple (NASDAQ: AAPL)?

Shen: Other than the fact that Netflix is now shifting its identity, going from where it used to have a massive library to attract as many subscribers as possible, now it's this HBO, Showtime model, where people join a lot of times for the big series like Game of Thrones. Now, I think Netflix is trying to get into that.

Also, I'm sure the company has looked at the data about how people view their content. There's a report that said that current subscribers stream 75 million Epix titles on a monthly basis. This is obviously not a small loss for them. The company is making a very calculated bet.

What's hurt their stock today is going to be something they're going to have to keep in mind for longer term. There's a report from Variety that says Apple may be dipping its toe into the world of original content production. The thing is, the company already has very well established relationships with Hollywood studios and networks, considering the fact that they have to acquire a lot of that content for iTunes.

Another thing to keep in mind is that the company has several hundred billion dollars to put into play here. I think its cash value is about $200 billion.

O'Reilly: Pick a studio. MGM, DreamWorks...

Shen: Yeah, go ahead.

O'Reilly: DreamWorks.

Shen: That's a smaller one, but sure.

O'Reilly: Their market cap: $1.69 billion. Apple could invest their cash forward in some T-bills for several months, use the interest to buy DreamWorks. Apple could just buy a major studio. They wouldn't, but speaking in hyperbole to make a point ...

Shen: There aren't many details out yet, but the options have potentially included partnering with an existing player, and people did mention buying a studio outright. The thing is, it's massive how much ...

O'Reilly: Apple could actually buy Walt Disney. Its market cap is $170 billion.

Shen: With that amount of cash, we've seen this happen before where Apple mentioned that they might be dipping their toes into a business, and then all the competitors in that space take a dive.

O'Reilly: They have been flirting with some kind of something for years.

Shen: An update to that is supposed to be coming, right?

O'Reilly: Right. Now they've announced "Coming 2016." I'm not going to hold my breath for an Apple TV, but it's interesting because I almost wonder if Apple is sitting there, like, "Jeff Bezos is making all this original content? Really? We can totally do that." I don't know if that's entering their calculations at all. I enjoy Amazon Prime's original content. Like Alpha House. They had -- what's the one that just won all the Emmys?

Shen: I'm not sure.

O'Reilly: I'll post it in the comments section when this gets posted on Fool.com later, when I remember. I almost wonder if that's entering into their calculations at all. "If Amazon can do this, we can do this."

Shen: Some investors are probably scratching their heads wondering why a technology and hardware company is even considering something like this. Ultimately, I think it's the same reason why they've been so successful. That's creating the ecosystem.

O'Reilly: Pushing the boundaries.

Shen: Creating this ecosystem where people want their entertainment through this one source. Between iTunes, the Beats acquisition -- it's really creating this full world for consumers, essentially.

O'Reilly: Thanks for your thoughts. Next up we're going to talk about Dollar Tree (NASDAQ: DLTR) losing some leaves. Before we move on, I want to make everybody aware of a very special offer for all of Industry Focus listeners. If you found this discussion informative, and you're looking for more Foolish stock ideas, Stock Advisor may be the service for you. It is our flagship newsletter started more than 10 years ago by Motley Fool co-founders Tom and David Gardner.

We're offering the lowest price out there for all of our Industry Focus listeners. It is $129 for a two-year subscription to Stock Advisor. Just go to focus.fool.com to take advantage of that deal. Once again that is focus.fool.com.

If you're just joining us, we were just having a very enlightening discussion about Netflix and how they're peeling back their library in the interest of saving $1 billion. Now we're talking about Dollar Tree. It had a rough quarter, and stock is down 8%. What's going on, Vince?

Shen: They recently reported for the second quarter -- this is also a big moment for them, since they closed on their acquisition of Family Dollar.

O'Reilly: Which was a process. I followed that for a year.

Shen: It was a big deal for $9 billion. They closed on that in July. Now, the overall company operates 14,000 locations across the United States and Canada. That's a huge business. The report is mixed at best. Revenue was just over $3 billion, a little short of analyst's estimates. It was up 40%.

O'Reilly: That whole gain was from the Family Dollar addition.

Shen: Yeah. That makes up about 1/3 of the topline now. That definitely accounts for a lot of those gains. There were some positives though. Same store sales were up 4.5%, they saw gains with both their customer count and their average ticket size. Unfortunately, as a lot of companies are seeing, even though only in Canada a 210 basis point negative impact form the currency exchange rates.

On a positive note, that's the 30th consecutive quarter of rising same-store sales, which is definitely very impressive. At least there's a positive note there. For overall adjusted earnings for the company, there was a loss of $0.46 per share. The thing is, you have to keep in mind here the significant one-time acquisition costs and other expenses.

Earnings per share were actually $0.25 when you exclude those. That's still down 59% from the year-ago period. Analyst estimates had it in the $0.60 range, so that's a miss, but if you look at Dollar Tree, the entity by itself, earnings were at $0.67 per share, up from $0.61 last year.

O'Reilly: I noticed in the conference call this morning that Dollar Tree's CEO was pretty positive, as all CEOs should be at all times. "I'm extremely proud of Dollar Tree's accomplishments in the second quarter. We delivered our 30th consecutive quarter of same-store sales growth, broke ground on our southeast distribution center in South Carolina, successfully completed our acquisition of Family Dollar, and quickly initiated our integration plan."

I don't know if you came across any notes in your reading this morning. Did you get a sense of how it was coming along with the cost-cutting initiatives? The major rationale for this deal, a lot of it was they could use half the truck because all these stores were close together.

Shen: I think the integration process is going to take some time for them. Even they note that they're not going to see those hundreds of millions in synergies for three years after close.

O'Reilly: I'm digging through the cobwebs here, but I think the goal was $300 million in cost savings, or something like that. Nobody quote me, sorry.

Shen: The timeline for that was a few years after close for them to really maximize the benefits form that. I think right now they're 100% focused on the integration of the acquisition; it's a huge one. Going forward, that's going to be their target, and they cut down on some of their guidance for upcoming quarters. That's not that surprising when you think about it. They need to see what the effects are going to be as a combined entity.

O'Reilly: I really can't wait. On the one hand, Dollar Store is this boring retail; but on the other hand, this whole Dollar Store story, since the great recession hit, has been a fantastic case study because the recession hit, the U.S. had super-high unemployment, the economy crashed, and that's when these companies really started getting profitable. Their returns on equity were ridiculously high. They were around 20% and 30%.

Shen: You saw it. They have 14,000 locations now. What that allows them to do is open stores in areas where there might not be a Target or Wal-Mart Supercenter.

O'Reilly: They required a much larger footprint.

Shen: It's very convenient for somebody to stop in, run some errands, pick up some things they need, and that has really propelled some of the growth with these companies.

O'Reilly: They made a bunch of money for five years after the great recession, then they've gotten mature, they said they had to merge and save costs. I'm very curious what kind of returns on investment these guys will see in the next five to 10 years. Will it revert to the mean? I don't know.

Shen: I think they've developed a strong customer base, and their prospects are very good for this part of the retail industry.

O'Reilly: Thanks for your thoughts, Vince, as always.

Shen: Thank you, Sean.

O'Reilly: Have a good one. If you are a loyal listener and have questions or comments, we would love to hear from you. Just email us at IndustryFocus@Fool.com. Again, that's IndustryFocus@Fool.com. As always, people on this program may have interests in the stocks that they talk about, and the Motley Fool may have formal recommendations for or against those stocks. So don't buy or sell anything based solely on what you hear on this program. For Vincent Shen, I'm Sean O'Reilly. Thanks for listening, and Fool on!

Sean O'Reilly has no position in any stocks mentioned. Vincent Shen has no position in any stocks mentioned. The Motley Fool owns and recommends Amazon.com, Apple, Lions Gate Entertainment, Netflix, and Walt Disney. The Motley Fool recommends DreamWorks Animation. 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. The Motley Fool has a disclosure policy.