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Despite DreamWorks Animation Skg Inc Deal, There's Still a Bear Case for Netflix, Inc.


The online streaming and DVD rental company just signed a new landmark deal with DreamWorks, but some are still skeptical about its future.

Shares of Netflix Inc. (NASDAQ:NFLX) popped over 7% after the company announced a new partnership with DreamWorks Animation SKG, Inc. (NASDAQ:DWA).

Under the multi-year agreement, Netflix's largest-ever content deal, the company will receive over 300 hours of new and original DreamWorks programming, chiefly animated children's TV series featuring characters from DreamWorks movie franchises such as Shrek, Madagascar, and Kung Fu Panda.
DreamWorks Animation could soon start producing cartoons for Netflix based on characters from Kung Fu Panda.

This agreement is part of Netflix's new strategy of growing its library of original content to enhance its unique selling proposition, "to become HBO (NYSE:TWX) faster than HBO can become us," as Netflix chief content officer Ted Sarandos once famously quipped.

Earlier in the year, Netflix launched high-profile original series like House of Cards and Arrested Development, both of which appear to have provided a nice boost to the company's streaming traffic, though Netflix has yet to offer any internal viewership figures.

And with the new DreamWorks animation deal, investors seem to be happy with Netflix's expansion into original children's programming, which explains the stock's rise on Monday, the day the deal was announced.

"So, here's the burning question for families with children: Would you rather park the kids in front of Nickelodeon, or just hand over your Netflix login information, given that the average cable television subscription costs about $70 per month, and a Netflix subscription costs $7.99 a month?" wrote Minyanville's Carol Kopp, surmising what is probably the bullish thinking of many Netflix stock holders.

(See also: Is Netflix, Inc the Next HBO? DreamWorks Animation Skg Inc Deal Hits Big Cable Where It Hurts.)

But while Netflix is riding high (its stock has risen an eye-popping 148% in 2013), not all Wall Street analysts are bullish about its future prospects.

Of the 36 Wall Street analysts who cover Netflix, 10 have Buy ratings on the stock, while nine have Sell or Underweight ratings and 17 have Hold ratings. The average price target of all 26 analysts is $192.78

One analyst who's still less than sanguine about the stock's prospects is Wedbush Securities' Michael Pachter.

"Under prior deals, Netflix does not own the rights to the underlying content, but instead agrees to fund a portion of the development costs in exchange for the rights to exhibit the content on an exclusive basis for a limited period of time," he wrote in a client note, adding that "Netflix's rights extend to the premiere of each show, but may not extend for many years beyond."

"We continue to believe that Netflix's original content deals are costly, and although we believe that they will serve to add subscribers for the company, it is not clear to us that original programming will have a lasting benefit," continued Pachter, who has an Underperform rating on Netflix, with a $65 price target.

(See also: Is the Netflix Stock Boom a House of Cards?)

Of course, the big worry for Netflix bears is the company's ever-rising content costs, which prevents profitability from improving even if Netflix is growing its subscriber base consistently.

In April, after Netflix released its first-quarter earnings results, Pachter also commented on the issue on CNBC.

"I think that all investors have to do is look at the last page of their investor letter, and you can see that revenue sequentially went up $49 million and content cost went up sequentially $16 million. That is unsustainable," he said.

"If I can notice that in the first half hour after the call, I think every content owner can see that. Netflix is not paying enough of revenue to content owners. They're profiting by paying less for content. That's not sustainable," added Pachter.

Indeed, original content is not cheap to produce (no financial details were disclosed for the DreamWorks deal, but it has been estimated that the two seasons of House of Cards, for example, will cost $100 million).

And with big media players like, Inc. (NASDAQ:AMZN) and Apple Inc.'s (NASDAQ:AAPL) iTunes all bidding for programming from content producers, Netflix will find it hard to keep content acquisition costs down as well.

But, of course, some analysts say the threat of competitors like Amazon is overhyped.

"I've been a skeptic, and the biggest argument against Netflix was that competition was going to crush them," said Josh Brown of Fusion Analytics, according to CNBC. "I'm now listening to that for 12 years. It hasn't happened."

"Everyone's about to kill Netflix," he said, noting then Amazon, Hulu, Time Warner Cable (NYSE:TWC) and Comcast Corporation (NASDAQ:CMCSA) have all at one time or another be cited as likely Netflix killers. "Let me know when it happens. In the meantime, [Netflix is] controlling the story."

Additionally, bulls also say that as Netflix grows larger and gains greater power at the bargaining table, it will be able to better control content costs.

"If Netflix is able to gain footage into the next 30% of households, not only will it position itself to better negotiate future licensing deals on content to lower operating costs, Netflix will be in a position to substantially threaten current cable providers such as Comcast and Time Warner, in becoming a serious competitor," commented Seeking Alpha.

Indeed, Jefferies analyst Brian Fitzgerald argued the power shift has already begun.

"Netflix is starting to get to a degree where content companies are considering them a viable distribution partner" for new programs, said Fitzgerald, according to Bloomberg. Studios are "coming to Netflix for deals instead of vice versa," he pointed out.

Twitter: @sterlingwong
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