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Netflix-Disney Deal: Can Starz Pull A Showtime?

 December 05, 2012 05:01 PM

(By Mani) The recent movie deal between Netflix, Inc. (NASDAQ: NFLX) and Walt Disney Co. (NYSE: DIS) is a clear negative for Starz Entertainment, which is owned by Liberty Media Corp. (NASDAQ: LMCA).

Netflix captured the exclusive rights for Disney movies in the pay window starting for films released in 2016. The pay window is about a year post film release and so Netflix will start airing the new 2016 Disney film releases on its service starting the end of 2016 / beginning of 2017.

[Related -Netflix, Inc. (NFLX) Q4 Earnings Preview: What To Watch?]

Disney is reportedly getting better pricing from Netflix than its current Starz deal, and the deal means Starz will lose two-thirds of its fresh movie content.

"In our view, Starz has three options: (1) sell; (2) find alternative content; or (3) maximize FCF in a wind-down scenario while subscribers slowly burn off in 2017 and beyond (under the assumption the loss of Disney movies will hurt subscriber levels)," Deutsche Bank analyst Doug Mitchelson said in a client note.

Strategically, Comcast Corp. (NASDAQ: CMCSA), EPIX, CBS Corp. (NYSE: CBS) and Netflix have overlap and industrial logic but would likely be price sensitive. Finding alternative content will likely be Starz's first line of defense, but that might require greater spending now to find successful TV shows or capture movie supply, which might depress free cash flow and valuation.

[Related -Netflix, Inc. (NASDAQ:NFLX): Can Netflix Trump Amazon.com, Inc. With New Plans?]

Starz will be saving in excess of $200 million in annual programming spending when the Disney deal expires, but that will not be for 5 years as Starz pays upon delivery, which takes them through the end of 2016 for movies release through the end of 2015.

CBS's Showtime manage to thrive despite dropping its major movie packages, but that was after it had already established success with multiple TV shows and had the leverage of CBS reruns to grow affiliate rates.

"While seemingly the bear case scenario, winding down Starz over the next decade could prove the most lucrative as it could produce significant levels of FCF as subscriber declines are likely to lag the decline in Starz's content, particularly for those subscribers in the premiere packages that have all of the premium movie services bundled in," Mitchelson noted.

Certainly, Starz now has increased incentive to cut online distribution deals for Disney movies during the rest of its Disney contract, boosting revenue. If Netflix is willing to offer Disney $300 million per year for exclusive 2016-2018 movies, NFLX might be willing to pay a healthy amount for nonexclusive access to 2012-2015 Disney films.

It is unclear when Starz has its next major affiliate renewals, but Starz's lack of scale will continue to impact pricing and this news will likely restrain distributors from cutting deals past 2016 until they have a sense of what content Starz might have by then.

Starz's other movie content is from Sony, and that deal is up at the end of 2016 (so deliveries through the end of 2017), and while Sony's output is less appealing than Disney's, Starz could be at risk of losing that output as well, which would leave the service with only older library films.

"We still expect Starz will get spun out from Liberty, though its valuation will likely now end up in deep value territory," Mitchelson added.

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