Does the Netflix-Disney Deal Actually Change Anything for Netflix?

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

With just a passing thought, the fact that Netflix (NASDAQ: NFLX) was able to score exclusive rights to certain movies from The Walt Disney Company (NYSE: DIS) is a huge reason to start feeling optimistic about the struggling video-on-demand company. As investors mull the details of the deal, though, questions arise. This so-called coup may actually underscore the bigger problem Netflix will be facing going forward, the problem that’s keeping it from becoming investment-worthy again.

Details, Details

Though the financial terms of the deal weren’t disclosed, the technical details were made clear. Beginning in 2016 after the contract with Starz expires, Netflix will be able to air – exclusively - new Disney films seven months after they stop playing in theaters. It’s the first time a premium cable channel won’t have that first post-theater access to new films, losing out on those rights to the higher-bidding Netflix.

The upside is clear. Netflix has significantly ramped up the quality of its digital content at a time when it desperately needed to do so. While subscribers are still finding a fair amount of choice through Netflix, the quantity and general quality of what’s accessible now has been measurably waning. This will help on that front.

At What Cost?

On the flipside, the fact that the deal’s financial terms weren’t disclosed is the scary part.

As yours truly penned back on July 9, Netflix has loaded itself up digital-content obligations that don’t show up on the balance sheet until that content is actually used. The problem is those obligations are still there, and as of that time totaled $3.7 billion. No big deal, except for one thing: Netflix is only on pace to generate $3.6 billion in revenue this year, and only $4.1 billion in revenue next year. The company has only earned $146 million over the past four quarters, and only earned $226 million in fiscal 2011 – its best year ever.

Don’t get the wrong idea. Netflix pays obligations as they come due with current revenue; it can likely handle that $3.7 billion. On the other hand, the fact that expenses are rising at a faster pace than revenue should be alarming, since it’s not sustainable.

And that may be the most alarming part about the Disney deal. Netflix clearly doesn’t mind paying pretty big bucks for mediocre content, so how much does top-tier content like Disney’s cost? As was said, the financial terms of the deal weren’t disclosed, but we can get some basic perspective from Jassica Shambora, who described these studio/cable-outlet deals as worth hundreds of million of dollars. Showtime, as an example, had reportedly been paying Paramount $350 million per year for exclusive rights to the studio’s films after they left theaters but before they were turned into DVDs. And, we know that Netflix’s total content costs are apt to jump to something just under $2 billion for this year, from last year’s $800 million.

That still doesn’t put a specific price tag on how much the Disney deal cost Netflix. But, Disney being Disney, and Netflix winning those rights in a bidding war, it’s not unreasonable to assume the deal wasn’t a cheap one for Netflix. Problem: there’s not a lot of room for expensive exclusivity deals when your current share price is 111 times trailing income, when your forward-looking P/E is 196, and when your net margins for the past four quarters have averaged 1.26%. 

A Big Gamble

Netflix was already betting big on its growth. The Disney deal is just another piece of that puzzle, though a very pricy one to be sure. And to be fair, it will beef up Netflix’s shaky content library. Will it actually draw more new subscribers than the company was going to bring on board anyway, before or after 2016 (when the contract begins)? Those mulling a subscription will certainly be impressed, but given that Disney only releases about eight new films per year, this deal may not be the game-changer Netflix needs. It may just end up being an expensive trophy.

jbrumley has no positions in the stocks mentioned above. The Motley Fool owns shares of Walt Disney and Netflix. Motley Fool newsletter services recommend Walt Disney 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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