Is Netflix Crazy -- Like a Fox?

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There's a fine line between genius and madness. Netflix (NAS: NFLX) is facing some challenges right now, and the outcome will tell us on which side of that divider the company and its leadership stand.

The big Lebowski
CEO Reed Hastings has been pretty cavalier about the Starz deal. Last December, he told a conference crowd that "It isn't essential to our success." Waxing nonchalant, he continued: "The Starz deal turned out to be a great deal for us. We'll try to renew it. But there's no one piece of content that's central for us." In short, "we can live without it."

That idea is being put to the test today as Liberty Starz (NAS: LSTZA) said it was done negotiating that renewal. In response, Netflix shares dropped as much as 11.2% overnight.

Liberty is no stranger to new-age distribution methods. For example, corporate sibling Liberty Capital (NAS: LCAPA) holds a 40% ownership stake in Sirius XM Radio (NAS: SIRI) through a truckload of preferred shares, making the stock a smart alternative to investing in Sirius itself. In fact, fellow Fool Rick Munarriz did exactly that last week. So why walk away from a new deal, which would have to be more profitable than the old one by orders of magnitude?

The perfect storm
Starz CEO Chris Albrecht positions the move as a strategic choice: "This decision is a result of our strategy to protect the premium nature of our brand by preserving the appropriate pricing and packaging of our exclusive and highly valuable content."

Speaking to BusinessInsider, Hastings still seems sanguine about it: "We are confident we can take the money we had earmarked for Starz renewal next year and spend it with other content providers to maintain, or even improve, the Netflix experience."

That remark dovetails right into the other litmus test of the Netflix model that's going on right now, wherein Hastings predicts manageable defections from the recent price changes. That new plan went into effect yesterday. In about a month and a half, Netflix's next earnings report will tell us exactly what happened.

It almost looks like gamesmanship when Starz pre-announces the end of its movie distribution deal right on the start date of the new prices. Did Redbox runner CoinStar (NAS: CSTR) put Starz up to this immaculate timing? Did Blockbuster owner DISH Network (NAS: DISH) ? Or is it all a big, harsh coincidence that forces consumers to think just a little bit harder about canceling their Netflix plans?

Deep impact?
According to Hastings, this is a storm in a teacup as Starz streams only make up about 8% of instant viewing today and should "naturally drift down to 5-6% of domestic viewing" in the next quarter as Netflix adds more content from other sources.

Some investors obviously see a huge "SELL!" sign flashing above the Starz announcement. Me, I see the best buy-in point Netflix has offered since mid-March. Your view will depend on whether you see Hastings as a shrewd mastermind or a desperate spinmeister.

Remember when Blockbuster, Wal-Mart (NYS: WMT) , the universe, and its cat teamed up to destroy Netflix back in 2004? Hastings looked crazy then and proved all the naysayers wrong. Need I remind you how that opera ended? Hastings has proven his mettle, and I think this guy knows his stuff.

And now, history is repeating itself. What have you learned?

Keep a close eye on digital entertainment:

At the time this article was published

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