Netflix Inc. (NFLX) has entered into an exclusive multi-year licensing agreement with Lionsgate UK, a subsidiary of Lions Gate Entertainment Corp. (LGF), for streaming the latter’s feature films in the United Kingdom (UK) and Ireland. Netflix is expected to launch its online services in these countries in early 2012 and the company is taking every possible measure to make a grand entry into the aforementioned regions.
In lieu of the agreement, Netflix customers in the U.K. and Ireland will be able to watch films from the Lions Gate’s stable including “The Mechanic," "Saw 3D," and "The Expendables." Among the company's well-known back catalog are “Reservoir Dogs," "Blair Witch Project," "3:10 to Yuma" and "Good Night and Good Luck,” which will also be available for streaming.
Additionally, the agreement will allow Netflix to stream new titles from Lions Gate within one year of its release. Lions Gate has three such releases lined up, which are “The Hunger Games,” “The Expendables 2” and a recently announced remake of the 1987 classic, “Dirty Dancing."
Netflix has been consistently pursuing international expansion to boost its top-line and earnings growth and also to compensate on the consumer loss that it had suffered in the previous quarter. Nonetheless, it remains to be seen whether a significant growth in the international subscriber base compensates for this negative domestic trend in the next year or so.
However, we believe that the strategy to expand internationally will benefit the company, providing the necessary platform for raising its profitability on a global basis, as the company significantly diversifies the risk of customer concentration in a particular region.
For the U.K. and Ireland venture, Netflix has recently signed a new multi-year licensing agreement with Hollywood studio Metro-Goldwyn-Mayer Studios Inc. The company has been actively signing licenses and has been partnering with several big Hollywood production houses, such as Paramount Pictures, Twentieth Century Fox, Disney-ABC Television Group, DreamWorks Animation and Miramax studios for new content additions.
We believe that content additions through these licensing agreements would be incrementally beneficial for the company. Additionally, it would reduce its dependence on cable TV operators and also provide the necessary competitive edge over its peers in the emerging market of online video streaming.
We believe that with larger companies such as Amazon.com Inc. (AMZN), Apple Inc. (AAPL) and Google Inc. (GOOG) coming to the online streaming business, it will not only escalate the licensing fees but also affect subscriber additions.
Moreover, with Netflix concentrating on overseas ventures and content additions, cost escalation in the form of license and renewal fees, as well as necessary technology investments would be a headwind going forward. This would put margins under pressure and in turn reduce profits.
It is also evident that Netflix’s decision to raise DVD rental prices has not gone well with subscribers. A substantial decline in the subscriber base (800K during the third quarter) is expected to hurt top-line growth in the upcoming quarters.
Moreover, Netflix’s initial decision of splitting its operations into two halves and subsequent backtracking has created a lot of confusion for domestic customers, thereby increasing chances of further declines in the subscriber base.
We have an Underperform recommendation on Netflix over the long term (6-12 months). Currently Netflix has a Zacks #3 Rank, which implies a Hold rating in the short term.
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