Starz Could Just Be The Tip Of The Iceberg At Netflix (NFLX, CSTR, AMZN, BLOAQ, LSTZA, DIS)

What a difference a couple of months can make.  Netflix, Inc. (NASDAQ: NFLX) has gone from the hottest controversial stock in the market to a controversial stock in trouble, and the drop on today’s news has all of the hallmarks of signaling more trouble ahead.  The paid cable channel Starz has ended talks to renew its streaming content pact with Netflix.  While this may seem a small issue today, the impact and the ramifications go to the core of the challenges for the company.

What hurts so bad about this news is that Netflix is in the midst of reeling from a change to its streaming versus delivery model because of its change in the monthly subscriber costs.  There is an old saying for salespeople called “resistance to change” and changing the pricing structure of a subscription during challenging economic times is biting the company on the back-side.

The San Jose Business Journal in Silicon Valley noted, “Starz has been an important source of newer movies and original programming for the Los Gatos-based video rental giant… now look like that won’t be renewed after it expires in February, making investors very nervous.”  The claim is that Starz “only” makes up about 8% of subscriber viewing.

“ONLY 8%?”… What happens if (or when) other networks turn to Netflix and say that they want more money for their content as well?  To call this the beginning of the end would be silly.  It is also possible that Starz will come back and play the “Do Over!” card in a month.  It is also possible that the well is running dry.

A report from Morningstar shows just how much implied risk is still here in Netflix: “Our fair value estimate of $150 implies forward 2012 price/earnings of about 25 times, and a free cash flow yield of 5%. Our valuation model assumes that Netflix’s total subscriber count reaches about 52 million by 2015, with about 20% coming from outside the U.S.”  25-times earnings, even after an implied 25% drop further?  Ouch.

Bank of America Merrill Lynch maintained a “Buy” rating, but it lowered its price target by a whopping $50 to $285 this morning.  The hope there is that the firm says it could be a game of chicken.  It also noted, “Starz provides some of Netflix’s highest value content through its redistribution of Disney and, at least historically, Sony movie content.”

This morning, Gabelli reiterated a “Sell” recommendation as the valuation remains very high and it projected that Starz encompasses 10% to 15% of the usage.  Gabelli further noted, “We believe competition as well as increasing cost of content rights will weigh on shares.”

Coinstar Inc. (NASDAQ: CSTR) is weak with the overall market today, but the Redbox just got one more boost as buyers can just pay as they go there rather than having a paid monthly subscription on their credit cards.  Amazon.com Inc. (NASDAQ: AMZN) also just may have scored an indirect win ahead of its tablet launch for the holidays.  Too bad that Blockbuster Inc. (BLOAQ) is pink-sheet listed.

Liberty Starz Group (NASDAQ: LSTZA) controls Starz and the deal does not end today.  The content distribution pact expires February 28.  Walt Disney Company (NYSE: DIS) may be too big to notice, but this pact may be a real game-changer.  If other studios want more and deals cannot be reached, Netflix could find itself in a real pickle in 2012.

Netflix was down over 10% around the open and the stock is down 8% at $214.40 this morning.  What is amazing is that the 52-week range is $132.61 to $304.79.  What is amazing about how much Netflix ran up is that the stock closed out 2010 at $175.70, so the stock is still up more than 20% for 2011.

JON C. OGG