Where Does Starz Stand in a Netflix World?

By Markets Fool.com

I am awed by the sheer quality of Amazon Prime'sMozart in the Jungle. I find myself rooting for, arguably, the villains Frank and Claire Underwood in Netflix'sHouse of Cards.If I'm looking for something fun to watch just to kill some time in the evenings, HGTV's Househunters International, a Scripps Networks property, is a solid choice.

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Each of these programs is, in its own way, exceptional. This is not to say, emphatically, that they are on the level of Shakespeare'sOthello, but I definitely rearranged my schedule on a recent weekend so that I could soak up the glory that was Season 4 of House of Cards. We are in the midst of a renaissance of high-quality, and easily available, entertainment. Put simply, this is a big deal. Not just for consumers, but for investors as well.

After all, the leader of this trend, Netflix , has long been a Motley Fool pick, and for good reason. Americans (heck, everyone) crave satisfying content at a reasonable price and Netflix's streamable suite of offerings at $9.99 per month is tough to beat. But with leadership comes the incentives for competition, and that is where we are today.

Luke Arnold as John Silver in Starz's Black Sails. Image Source: Starz.com.

Take Amazon , for example, which is slated to spend $2.6 billion this year on content acquisitions. That's enough scratch to ensure the online retailer is a major player in Hollywood, and yet it's half of what Netflix is about to spend this year. This is a lot of money we're talking about, and I think we all know it's only going up from here. Which of course raises the question: With juggernauts like Amazon and Netflix battling it out for content, where do smaller fish like Starz fit in? Amazon is going to spend an amount equivalent to Starz's entire market capitalization this year acquiring content -- not the best situation to be in for Starz; it's not unthinkable that the company could simply get outbid on top-notch content. This leads us to a very important question: Is Starz in danger of becoming irrelevant in the battle for content?

Content Costs
To answer this question, we need to first look at what it costs Starz and its peers to create and acquire their content offerings:

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STRZA Cost of Goods Sold (% of Annual Revenues) data by YCharts

What is plain to see is that Netflix is outspending its peers, by a wide margin. Despite the fact that Netflix is light-years ahead of its streaming content competitors, it seems that the second it gets cash flow, it goes out the door in the form of new content creation and acquisitions. This is probably wise at this juncture, and explains Netflix's sky-high multiple and "lack of profits."Netflix knows it's out in front, and wants to stay that way. Reed Hastings & Co. are no doubt fully aware that if they slack off, there are plenty of competitors waiting to give the people what they want -- so spend they must. This does not mean profits will never materialize, especially as Netflix continues to scale on a global basis, it just gives us an extremely useful insight into the industry itself at present.

Spend they must
The inevitable conclusion, one no doubt reached by the executive team over at Starz, is that its an arms race for content. This explains Starz's massive drop in profitsin the fourth quarter of fiscal 2015, which was almost entirely due to increased spending on content creation. After all, doesn't Starz's epic pirate-basedBlack Sails just sound expensive? It has Michael Bay as a producer! For more color, just take a look at Starz' quarterly cost of goods sold for the past two years:

STRZA Cost of Goods Sold (Quarterly) data by YCharts

Foolish thoughts on Starz's competitive position
Starz clearly knows where it stands: reasonably well-positioned, but with some work to do. As I noted recently, Starz (due primarily to valuation) is probably one of the best buys today for those looking to take advantage of the shift away from the cable bundle, if only because it is a reasonably valued player that's making moves in content creation.Starz is also partnering with Amazon to distribute content through Amazon Prime Video, and "Starz Play" will soon be (fingers crossed) as accessible as Netflix is on streaming devices.

Starz's current strategy -- buying back its stock while simultaneously ramping up content spending -- carries some risks. Often when a company tries to do too much, it finds that it can't meet any of its objectives (i.e., bringing in new subscribers with high-quality content) extremely well. The market is clearly willing to reward companies that execute well in the battle for content -- just take a gander at Netflix's valuation. While it will probably turn out for the best, and I am as big a fan as you'll ever find of well-timed stock buybacks, that is where Starz stands today: balancing good corporate finance practices with the massive (but probably worthwhile) spending required to compete for viewers' eyeballs today.

The article Where Does Starz Stand in a Netflix World? originally appeared on Fool.com.

Sean O'Reilly has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon.com and Netflix. The Motley Fool recommends Scripps Networks Interactive and Starz. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.