Netflix, Starz to break up: One crazy ride ahead to Feb. 28

Summary:Netflix has a bevy of hurdles to navigate now the Starz partnership is on the rocks.

Contract renewal talks between Netflix and Starz have broken down and the streaming movie and television company is facing a stunning amount of uncertainty in the next few months. How Netflix navigates the next five months will either rattle its standing as the Web's darling streaming content service or cement it as an elite Hollywood player.

Starz said Thursday in a statement:

"Starz Entertainment has ended contract renewal negotiations with Netflix. When the agreement expires on February 28, 2012, Starz will cease to distribute its content on the Netflix streaming platform. 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. With our current studio rights and growing original programming presence, the network is in an excellent position to evaluate new opportunities and expand its overall business."

The timing of the Starz announcement seems to be set for maximum impact. After all, Netflix customers have to decide whether to get the company's streaming movie service, DVD delivery or both. If consumers make no pick, many consumers will see their bills jump to $15.98 for streaming and one DVD out a month from $9.99. Analysts largely expected Netflix's churn rates to jump.

Also see: Netflix suffers major setback with loss of Starz content

With the Starz deal in flux it's now clear that Netflix's churn rates are going to be closely watched through February. Here's a look at the moving parts that factor into Netflix's immediate future.

The Starz loss hurts, but is not fatal. Piper Jaffray analyst Michael Olson said that the Netflix loss of Starz hurts, but it's not as damaging as it appears.

While this will be interpreted as a negative by many investors, we believe the termination of this agreement will have one of two outcomes, either of which could prove to be neutral-to-positive for the company: 1) Netflix will spend the $250m-$300m/yr (est) that it would have spent on the Starz deal on other content in order to retain and attract subscribers, or 2) the company will be unable to spend the funds set aside for Starz and will exceed the consensus CY12 EPS number that includes a significant increase in expense from Starz. The loss of the Starz content is a negative for the Netflix streaming library, but given it was only 8% of Netflix subscriber viewing (and going lower), the Starz library is far less important than it was 24 months ago.

Netflix loses negotiating leverage with content providers. Olson's assessment is on target to a degree. However, the loss of Starz has created a situation where Netflix is up against a hard Feb. 28 deadline. Why would a content provider sign any deal with Netflix before Feb. 1? Netflix will have to negotiate other content deals to replace Starz. Movie and TV studios are likely to make Netflix sweat a bit. The closer to Feb. 28 Netflix gets the more likely it's going to pay higher licensing prices. As CNET News' Greg Sandoval noted, it's possible that Starz even comes back for the right price.

The end of Starz is symbolic. The Netflix acquisition of the Starz library put Netflix's streaming service on the map back in 2008. The return on investment for the Netflix-Starz deal, valued at roughly $30 million a year---was off the charts. In fact, Starz accounted for half of the top 50 streaming movie titles for Netflix in 2009 and 2010. The Starz deal was an end run around studios. Now Netflix is expected to pay up with a series of individual deals. Uncertainty reigns. Netflix is likely to go through periods of streaming content flux. Why? No studio is going to sign a long-term deal because digital media is evolving too quickly. Disney chief Bob Iger recently said long-term digital media deals just don't make sense these days. Iger's comments are notable given that Netflix needs a Disney movie deal to offset the titles---Toy Story 3 for instance---it will lose when Starz goes away. Here's Netflix's 10-day chart, which includes a drop after the Starz news broke.

Churn rates under the microscope. A Feb. 28 deadline for replacement content deals may give consumers pause. First, Netflix dramatically changes its pricing in a bet that consumers will complain at first but ultimately stick around. And now many popular titles on the Netflix streaming service, which was light on the latest releases anyway, are in question. At the very least, consumers need to think through other options. Netflix can't lose Disney and Sony Pictures content---both delivered via Starz---and not take a hit. "Given that prices on DVD plans were recently hiked (DVD is especially useful for new film releases), we see upside risk to churn and new customer adds, as a streaming only offering may not meet subscribers needs for newer film content," said Jefferies analyst Youssef Squali. Netflix has some discipline. The fact that Netflix didn't pay up to meet whatever Starz wanted heartened analysts a bit. Netflix has shown it will exercise some restraint in its content deals. The big question is how much restraint Netflix will show as it reaches the Feb. 28 Starz cut-off.

Amazon will pounce. Barclays analyst Anthony DiClemente said it's likely Starz will sell it's library to the highest bidder. That highest bidder is likely to be Amazon. DiClemente argues that Netflix will be fine and has time to land more content deals. However, Amazon could license the Starz library and make a lot of noise about it. DiClemente wrote:

The bears are likely to argue that: 1) Netflix may not have the necessary cash-flow to effectively build out its content offering; 2) this may signal a shift in sentiment away from Netflix by the Studios; and 3) this raises the possibility that Starz may offer its ~1,000 streaming titles to a competitor, like Amazon.

Related:

Topics: Amazon

About

Larry Dignan is Editor in Chief of ZDNet and SmartPlanet as well as Editorial Director of ZDNet's sister site TechRepublic. He was most recently Executive Editor of News and Blogs at ZDNet. Prior to that he was executive news editor at eWeek and news editor at Baseline. He also served as the East Coast news editor and finance editor at CN... Full Bio

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