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Who Would Buy Netflix??

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Todd Sullivan

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Been hearing rumors that as Netflix (NFLX) sees its share price crater (still over valued) it may look appealing to other companies. I guess the question is….who?

Right now we have 4 major players in the streaming video game. Apple (AAPL), NFLX, Google (GOOG) and Amazon (AMZN). Even after its current price drop, NFLX has a market cap of $3.7B + $232M of LT debt and another $200M just announced. FTR, I will grant AMZN’s new service is in third place but the library is growing fast and they can run it at a loss to capture users as their other operations support it. While GOOG does not have the breadth of content yet, it has the #1 platform (#1 among most likely to stream demographics) for video and cash to make its own content deals. Also, don’t rule out DISH who bought Blockbuster’s streaming library as a potential 4th competitor.

Why would either of the other major players want it?

1- Technology? No….if anything, the others have a technological advantage over NFLX as their video offering are paired with their “store” or in the case of GOOG, the #1 video site. This enables customers the ability to both buy or rent video as well as other items on the sites. They have more of a “complete ecosystem” than NFLX

2- Customers? They clearly have tremendous value as NFLX sports >20M of them paying a monthly fee. Doing some cocktail napkin math, if we assume $5B purchase price (low figuring the company was worth >$10B a few months ago) for the 20M subs we get ~$250/sub or 31 months of streaming fees. Worth it? No. Again, that $5B is a VERY low number.

3- Catalog: NFLX, being first in the cue here does have the largest catalog of offerings. But, if we look to the current results of the Starz negotiations, not only is that library shrinking, to keep it, NFLX is going to have to pay through the nose.

That means several things. For a potential acquirer, the “cost” of doing any deal will have to take into account a massive increase over the next few years for content OR if more studios go the HBO/STARZ route, the loss of it all together. Either scenario is very unappealing as it places a huge variety of outcomes on the eventual tally of a deal. Costs will rise and subscribers may just flee.

NFLX has already raised prices this year and as more content deals come up for renewal and users will be faced with further increases. This leads to NFLX’s other problem, switching costs. There are none for users (no annual deals like mobile industry). Simply cancel account “a” and open account “b”. As NFLX ratchets up pricing plans again (they’ll have to) in order avoid deepening losses, existing users will find other platforms offer as much in terms of content (by mid-’12) and more in terms of ancillary products (AMZN, iTunes) and easily make the jump.

For users it is about value. When it started, NFLX had it in spades. That advantage has been steadily dwindling over the past year and I look for that to accelerate going forward. As consumers see the content landscape become more even, price and alternate offerings will prevail. For those who think NFLX can maintain pricing levels over the next year or two, this ignores increases content costs/loss. It just cannot happen. If we assume they can, we must assume a content drain from the company’s library.

Now, there is a wildcard. MSFT. NFLX is integrated into xbox and if MSFT wanted to get into the streaming biz in a big way, buying NFLX at this point would be easier than starting from scratch. MSFT has already proven an deft ability to make head scratching deals (bid for YHOO and $8.5B Skype purchase). There isn’t a reason to assume there is no way they go after NFLX. The main issue with that thought process is the above. The same negative catalysts will exist for the NFLX biz no matter who owns them (increasing costs/shrinking library leading to customer defections). I only mention it because to assume MSFT will not do something because logically it makes no sense is a mistake.

M&A history is filled with mystifying deals that end up being an albatross around the acquirer’s neck. One can’t eliminate the possibility….I just think it is far less likely in this case than seems to be being suggested out there

Finally, I look at NFLX like I do with Research-in-Motion (RIMM). The same reasons no one has stepped into buy RIMM is similar to why I think no one will step into buy NFLX. Both were pioneers in the category. Both essentially have the same business and products they did when the started while the competition has developed superior user experiences (AMZN, AAPL, GOOG) and in NFLX’s case, closed the content gap. For the same reason none of the above have made offers for RIMM, I expect no offers for NFLX. There isn’t a reason to. Neither company has any positive catalysts coming up for it (other than a hoped for buyout) and if anything, the future is filled with even more potholes, not fewer.

Back to the beginning and the thought process about RIMM that we are now hearing about NFLX. It is undervalued. I don’t think either are. I see a cheap current valuation but I also see fundamentals/market position declining. That means a cheap current valuation becomes fairly valued eventually without the stock price going anywhere. Note: I’m not saying either is “cheap” just that others are. We also have a situation like RIMM where the cheap current valuation continues to get “cheaper” as investors see continued fundamentals declining and no reason to assume it will abate.

Time will tell but I think both companies have seen their best days…..

About the author:

Todd Sullivan
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