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Netflix Inc. (NFLX - Analyst Report) recently signed an agreement with Warner Bros. Television Group, which will enable it to stream eight current (produced in 2012-2013 season) television shows to its domestic subscribers. The licensing deal will allow Netflix to offer highly acclaimed television series ‘Revolution’, ‘Political Animals’, ‘666 Park Avenue’ ‘The Following’, ‘Longmire’, ‘Chuck’, ‘Fringe’, and ‘The West Wing’ in 2014.

The addition of these popular television shows would not only diversify the Netflix’s streaming portfolio but will also strengthen its position in the video-on-demand (“VOD”) market. We believe that the deal would be incrementally beneficial for the company in attracting new subscribers as well as retaining the old ones.

The recent deal reflects Netflix’s continuous endeavor to provide diversified content to its subscribers. To accomplish that goal, the company has entered into a number of licensing agreements with big Hollywood production houses. Recently, the company entered into a multi-year licensing agreement with Walt Disney Company (DIS - Analyst Report) for the exclusive right to stream the latter’s content to its U.S. subscribers.

The improved content has also driven customer engagement lately. In the recently concluded third quarter of 2012, the total unique subscribers (Domestic and International) jumped 25.7% year over year to 31.8 million.

We believe that the improved content makes its streaming services distinguishable from other service providers such as HBO, Inc. (AMZN - Analyst Report), Hulu as well as the newly-launched services from cable and media companies such as Comcast Corp. (CMCSA - Analyst Report), Dish Network Corp. (DISH - Analyst Report) and Verizon Communications (VZ - Analyst Report).

However, the company continues to see cost escalation due to higher license and renewal fees. Netflix needs to pay $5.0 billion for streaming content obligations, out of which $2.1 billion is to be paid within the next 12 months.

Moreover, higher capital expenditures due to international expansion will hurt earnings growth in the near term, in our view. Moreover, when compared to some of its cable and communications peers who have diversified revenue and cash flow streams, Netflix relies solely on streaming for future growth, as its DVD rental business continues to lose subscribers. We believe that the streaming market is becoming overcrowded and this will hurt Netflix’s margins going forward.

Currently, Netflix has a Zacks #3 Rank (Hold).

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