Loss Of Epix Deal Could Sink Netflix Stock

• Netflix's content deal with Epix is due to come to an end soon.
• Netflix's content deal with Disney won't become valid until 2016.
• This means that Netflix subscribers won't have access to original content for several months.
• This could slow down subscriber growth during the seasonally hot fourth quarter and negatively impact Netflix stock price.

 

Netflix (NASDAQ:NFLX) has come a long way from its origins as a video rental business in the late 90s to the highly successful video streaming company with more than 62 million subscribers that we know today. One of the key pillars that has been driving Netflix’s subscriber growth in the midst of tough competition from the likes of Amazon (NASDAQ:AMZN) Prime (40 million subscribers) and Hulu (9 million subscribers) has been its popular high-quality original content. But that could now be in danger.

Netflix has announced that it will not renew its content deal with Epix. Epix signed a 5-year deal to supply original content to Netflix for a reported sum of $1 billion back in 2010. Netflix, however, is not happy with the deal because a clause in the contract allowed the deal to become non-exclusive just two years later. Epix became the provider of content for Amazon in 2012. Amazon Prime Instant Video has now emerged as a top competitor to Netflix. Netflix still leads Amazon Prime in most viewership categories. But Amazon has now overtaken Netflix in several key categories including number of U.S. subscribers (40 million vs. 39.1 million) and the number of times subscribers use the service, with Amazon Prime members using on-demand video 13.4 times per month compared to 12.7 times for Netflix.

Source: Investors.com

But perhaps what’s even more perturbing for Netflix investors is that Epix has inked a new content deal with Hulu, another top Netflix competitor, recently.

Content gap

Netflix signed a content deal with movie-producer Walt Disney (NYSE:DIS) in 2012 but won’t start receiving content from the company until 2016. This means that there will be a period of several months when Netflix subscribers won’t be able to access original content from the video streaming company. While Netflix is mostly downplaying the issue, reality could prove to be quite different.

The last time Netflix found itself in such a situation was back in 2011 when Starz Pay TV Network declined to renew its content deal with Netflix, the only difference being that it was Starz Pay TV pulling all the strings. Netflix stock hinges strongly on subscriber growth and anything that tampers with this metric places its shares in jeopardy. Netflix shares sold off badly when it lost the Starz Pay TV deal. It’s very likely that the same situation will play out again this time round when the Epix deal comes to an end. Netflix says that 90% of its subscribers engage with its original content. Nowadays Netflix is very picky about the kind of content it buys from media companies and often buys its programming a la carte. The movie streaming industry has become very competitive and subscribers tend to prefer channels with the highest quality of content. Netflix simply has no choice but to hunt for premium grade content, which does not come cheap.

Wedbush Securities analyst Michael Pachter estimates that Netflix could save up to $180 million per year after terminating the Epix deal. While this is great news for Netflix’s bottom line, which is frequently under a lot of pressure due to high content costs, Netflix could end up with a bigger problem--slower subscriber growth.

The fourth quarter is traditionally the strongest for Netflix stock. The shares frequently make double-digit gains after the fourth quarter earnings results are announced. In fact Netflix stock has made double-digit gains after fourth quarter earnings report for the last six straight years. But this bounty is now in doubt given the current backdrop. With no original content available during the hot fourth quarter season, subscriber growth is likely to be negatively impacted.

 

Source: NFLX stock Price chart by amigobulls.com

Netflix shares have been on a tear this year, tucking on huge gains of 107% YTD (as of Sep 3 close).

But Netflix, along with momentum stocks such as Amazon, has lately been caught in the current broader market selloff, with the shares tanking 16% over the past one month.

 

Source: Netflix stock price data by amigobulls.com

In the current choppy environment, maybe investors should now consider taking some profits. Netflix stock is one of the most volatile in the S&P 500 due to the company’s high financial leverage and operating leverage. Netflix carries a lot of content liabilities on its balance sheet and just a small miss on projections can lead to huge selloffs. I normally don’t favor short-term trades but I believe shareholders are better off taking at least some profits now and establishing new positions later when the shares get cheaper.