Disney Deal May Be an Empty Win for Netflix

Netflix (NasdaqGS: NFLX) jumped 14% on Tuesday after it signed a new deal with Walt Disney Co. (NYSE: DIS) for the exclusive rights to show Disney’s movies. Under the agreement, Netflix will begin showing new Disney releases, as well as older classics, starting in 2016.

The move was notable because Disney bypassed the major cable companies in favor of the online streaming service. Terms of the deal were not disclosed, but some analysts speculated that Netflix could be paying Disney upwards of $300 million annually over the agreement’s three-year span.

The Disney contract helps shore up Netflix’s film offerings, which some users have found wanting. Netflix chief content officer Ted Sarandos called it a “game changer.”

Still, the fact that the films won’t be available on Netflix until at least 2016 raised concerns among some analysts: “The heart of the deal doesn’t come into effect for more than three years,” wrote media analyst Tim Nollen of Macquarie Securities in a note quoted by the L.A. Times. “This isn’t nearly close enough to shore up subscriber numbers, which we view as Netflix’s No. 1 problem.”

Amazon.com Has Netflix in Its Sights

The move comes after Amazon.com (NasdaqGS: AMZN) signed a $200-million deal with Epix in September to show films from Paramount, MGM and Lions Gate Entertainment (NYSE: LGF) through its Amazon Prime Instant Video service. Amazon will be able to stream the movies 90 days after they appear on Epix’s pay TV channel. Netflix had held the rights to these films until last August but declined to ante up again, though it does retain the non-exclusive rights through at least August 2013.

The deal includes the right to stream about 2,000 films, including hits like The Hunger Games and The Avengers. That would bring Prime Instant Video’s library up to 25,000 titles, including movies and episodes from TV series, which is more than double its total a year earlier, according to a recent Fox News article. Netflix, by comparison, is estimated to have upwards of 60,000 titles.

Amazon’s Prime service is also cheaper than Netflix. For $79 a year, Prime members get unlimited video streaming plus free shipping on all their Amazon purchases. A Netflix subscription costs $7.99 a month, or $95.88 annually.

New Redbox Instant Service Could Be Another Strong Competitor to Netflix

The company is also facing rising competition offline from Coinstar’s (NasdaqGS: CSTR) Redbox movie-rental kiosks, which offer low-cost movie rentals without a membership fee. Moreover, Coinstar and Verizon (NasdaqGS: VZ) are working on Redbox Instant, a new online streaming service that will directly compete with Netflix. According to tech website GigaOM, Redbox Instant will launch in the spring of 2013. Its library won’t be as large as Netflix’s, but it will reportedly be $2 cheaper, with a membership costing $6 a month.

In the U.S., the company also competes with Hulu Plus, another video-streaming service that charges the same rate as Netflix. Hulu is a joint venture between Disney, News Corp. (NasdaqGS: NWSA) and Comcast (NasdaqGS: CMCSA) and has around 2 million subscribers in the U.S.

Rising Competition, Pricing Misstep Make It Tougher for Netflix to Compete

As Investing Daily’s Jim Fink pointed out in a September 2011 article, many of these competitors have much deeper pockets than Netflix. Consider that the company ended its latest quarter with $370.3 million of cash, compared to Amazon.com, with $3 billion. Others, like Redbox Instant and Hulu Plus, have the backing of huge investors like Verizon and Comcast.

That, along with the rising cost of content, is a huge challenge for Netflix. As Greg Sandoval points out on CNet.com, Netflix only earned $226 million for all of 2011, less than what will likely pay per year for the Disney films. Moreover, prior to the Disney deal, the company already owed $5 billion in content licensing fees, $4.5 billion of which is due before the end of 2015.

Ordinarily, a company would raise its prices to offset increasing costs like these. But the heightened competition, as well as the fact that Netflix is still recovering from its aborted attempt to raise prices by 60% last year, will make it extremely difficult to pass its rising costs on to its subscribers. In fact, Netflix already said yesterday that it will not raise prices due to the Disney deal.

Loss Expected in Q4

Meanwhile, costs related to the company’s ongoing international expansion continue to put pressure on its earnings. In the third quarter, its net income plunged 88%, to $7.7 million, or $0.13 a share, from $62.5 million, or $1.16 a share, a year earlier. Netflix also said that it expects the cost of its recent launch in Sweden, Finland, Denmark and Norway to push it to a loss in the current quarter. That comes while revenue rose to $905.1 million from $821.8 million.

But the company faces considerable competition overseas, too. For example, in the U.K. and Ireland, which Netflix entered last year, it’s up against LoveFilm, a recent acquisition of Amazon.com. In addition, as Investing Daily’s Jim Fink wrote in October 2011, Netflix’s overseas expansion differs from its U.S. experience because it’s basically starting from scratch:

“Unlike in the U.S., where Netflix had a huge head start in streaming due to its existing consumer base in the DVD rental business, Netflix has no such consumer base head start in these foreign lands. The whole international expansion concept is flawed and will be a cash flow black hole for years to come.”

Netflix shares are up over 25% in the past 12 months, and the company is continuing to add subscribers, though that growth rate has slowed (up 2 million, to a total of 29 million in the latest quarter). Still, it will likely have a hard time improving its earnings given the relatively low barriers to entry in its business and the sharply rising cost of content.

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