Nightmare on Netflix Street

Netflix StarzFew companies have been able to radically transform their business model. But Netflix (NASDAQ:NFLX) is one of the exceptions. For the most part, it has done a great job of transitioning from mail-delivery to video streaming.

But the process has not been smooth. For example, yesterday Starz announced it would not renew its content deal with Netflix. On the news, the shares of the company fell 9% to $212.12.

The Starz agreement — which was formed back in 2008 — set the template for future content deals. It allowed for the streaming of newer releases from Sony (NYSE:SNE) and Disney (NYSE:DIS). But unless negotiations revive, the contract will terminate on Feb. 28, 2012.

While losing Starz is a big setback, it still is not a killer. Keep in mind that Netflix has been aggressive with the acquisition of content from the major broadcast/cable networks, as well as various studios like MGM and Paramount. In fact, by the fourth quarter, the Starz content will only account for 5% to 6% of the domestic Netflix viewing.

Fine, huh? Well, there still are concerns. The Starz blow-up points to the fact that the licensing fees for content are escalating. Companies like Amazon (NASDAQ:AMZN) and Apple (NASDAQ:AAPL) are likely to attempt to lock up streaming deals.

So, does Netflix have the wherewithal to deal with such pressures? As seen with the Starz situation, it seems the company is not going to get too wild with its wallet. Consider that a deal could have cost $300 million per year.

Yes, the fiscal discipline is good news. But this does not necessarily make Netflix a good investment. The shares still are far from cheap, trading at about 53 times earnings. This valuation could be hard to sustain, especially in light of the slowing economy and the pressures from rivals. Thus, for investors, it probably is a good idea to be cautious on this one.

Tom Taulli is the author of various books, including “All About Commodities.” He does not own a position in any of the stocks named here.

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