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This Deal Is Good for Movie Fans: What About Investors?

Erin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I recently had a bad respiratory infection that knocked me out of commission and sent me to bed for a week. With nothing but a laptop and daytime television for entertainment, I turned to Netflix (NASDAQ: NFLX) for help. I love the concept of Netflix. I want this company to do well more than I care about most companies. Someone that will deliver a movie or TV series straight to my laptop or television without commercial interruption (I’m looking at you Hulu) for a low subscription fee? Yes! Please! I want that company to not just survive, but succeed!  I want more shows brought to me without commercial interruption!

But I worry about Netflix. I worry that they are taking too long to recover from past blunders. The recent Disney (NYSE: DIS) licensing news gives me hope as a customer, but as an investor I proceed with heightened caution.

Will improved programming be enough to keep and increase customers? Netflix cannot risk raising prices on customers again, not after last year’s fiasco.

Netflix once dominated their field. But the competition is fierce and comes with deep pockets. Hulu (owned in part by News Corp and Disney) and Amazon Prime are catching up in both popularity and offerings.

But now Netflix has obtained the rights in the U.S. to show Disney movies after theater release, a right once limited to premium pay-TV networks (such as the Disney Channel). Under the new licensing agreement Netflix will be able to share movies from Disney Animation Studios, Pixar Animation Studios, Marvel Studios and Disneynature. The agreement goes into effect in 2016.
The multiyear licensing agreement is a breakthrough for Netflix that desperately needed more programming, particularly more exclusive programming. Netflix has suffered from a dearth of programming since losing the rights to multiple productions over the past year, including Starz (owned by Liberty Media Corporation (NASDAQ: LCAPA). Disney movies had streamed on Netflix through a deal with Starz. The return of Disney films to Netflix is a major boon to the company. To get the rights to Disney films exclusively is a major accomplishment for Netflix, and one that is sure to make both customers and investors happy.

Earlier this year, Netflix struck a $100 million deal with director David Fincher for two seasons of an original programming political drama. The company will also expands its offerings with more original programming in 2013, including Hemlock Grove, Lilyhammer (season 2), Orange is the New Black, and the highly anticipated relaunch of Arrested Development.

Star Wars fans will have to continue to wait to find the beloved franchise streamed online. As most film fans know by now, Disney recently acquired Lucasfilm and the Star Wars franchise, and promised new Star Wars films in the next few years. However, the next Star Wars film debuts in 2015.  The Disney-Netflix deal does not kick in until 2016. Therefore, as things currently stand, Starz will have the rights to Star Wars, not Netflix. (Disney's direct-to-video movies will come to Netflix next year, while classic films will be released to Netflix immediately.)

Netflix also has the rights to DreamWorks Animation (NASDAQ: DWA) films (a deal that will begin in 2013). DreamWorks has produced films including Shrek 2, Shrek the Third, Shrek Forever After, and Madagascar 3: Europe's Most Wanted. While the overall DreamWorks portfolio is not as popular as the Disney offerings, they have been among the highest grossing films of all time, and have their own loyal audience.

A Citigroup survey in September found that 48 percent of Netflix customers are “very or extremely satisfied,” compared with about 45 percent in the first and second quarter. Improved viewing options will only help increase customer satisfaction.

The new expenses of additional video rights will be a major hit to Netflix’ earnings. Netflix owes $5 billion in Internet video licensing fees during the next five years, including $4.5 billion due before the end of 2015. Netflix's annual revenue this year is expected to total about $3.6 billion.
The financial details of the Disney deal were not disclosed. But analysts estimate that Netflix may pay Disney more than $350 million annually. In order to increase revenue to afford its expenses the company will obviously need to increase its customer base.

Company CEO Reed Hastings believes it is possible for the company to reach 60 million to 90 million U.S. streaming subscribers. Netflix had 25.1 million domestic streaming subscribers at the end of the third quarter, up from 21.5 million the year previous. The problem? There are only 81 million broadband households in the U.S. Netflix is limited to the broadband market and its potential growth.

The company has prepared analysts with a warning that it may post a loss for fourth quarter of 2012. Depending on the size of the potential fourth-quarter setback, Netflix could finish this year with its first annual loss in a decade.

The Disney deal is a step in the right direction for Netflix to keep its customers happy. But it isn't enough to keep investors happy. The company still has a long way to go before investors can relax.

Liberty Media Corp., (Starz parent company) shares dropped after the licensing news. Starz's premium channel had 20.8 million subscribers at the end of September, up from 19 million a year ago. In a statement, Starz said it would now have more money to invest in developing original TV series.

ErinAnnie has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com, Walt Disney, and Netflix. Motley Fool newsletter services recommend Amazon.com, Walt Disney, DreamWorks Animation, and Netflix. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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