Which Company Will Buy Netflix?

| About: Netflix, Inc. (NFLX)

It is hard to tell who is soaring higher: shares of Netflix (NASDAQ:NFLX) or the investors that saw a glimmer of hope just six months ago when the stock was trading at $55. With the stock currently trading at $170 (having come down after bouncing off of the $198 resistance level several times), those early-October visionaries have more than tripled their investment. The rally seems tired, though, as shares have broken through the $170 level in the negative direction for the first time since the huge run-up in late January where the stock exploded 65% in two days.

What's next for shares of NFLX and the investors who still hold steadfast in their investment? Can they sustain this Amazon-like (NASDAQ:AMZN) valuation? Will they underperform market expectation like Facebook (NASDAQ:FB)? Will the stock fall back down from the stratosphere like we saw after Apple's (NASDAQ:AAPL) terrific performance? Will they be able to continue their newfound pattern of innovation and take advantage of new lines of business like Google (NASDAQ:GOOG)? I don't think we'll have too much time to find out; NFLX should be acquired, and it should be acquired quickly.

It just so happens that all four of the companies above are prime targets to takeover NFLX. All four have much to gain with a deal. That should come as great news to NFLX investors, because with the momentum that the company has given its recent results and optimism over future product lines coupled with the dynamic existing user base (30 million subscribers), if any deal is brokered, it will go through at a significant premium to the company's current price.

The Netflix Snapshot

Investors in the content distribution giant have had a wild ride over the past decade. After the stock's IPO in 2002 at $15, investors saw somewhat choppy waters before a precipitous rise from $60 to $300 in fifteen months during 2010-2011. After bouncing handedly off the $300 resistance level, the stock plummeted back down to $60 in just four months and has traded in a $50 range for the past year before exploding upward earlier this year. Even though the stock is trading at a 45% discount to its 2011 highs, it is still running at a 120x forward multiple, a valuation that many analysts don't think will be sustainable. While the company is expensive on a P/E and Price/Book valuation, its Price/Cash Flow multiple (4.74x) speaks to a competitive pricing. It seems as though the operating cash flows are not yet fully reflected in the share price.

Let's take a look at the players in this game. Who will win the battle for NFLX?

Amazon "Primed" for Deal

AMZN is currently one of the largest competitors for NFLX. The company's Amazon Prime service is continuing to grow on every measurable metric; subscriptions are increasing while the service drives new content to the platform. Additionally, AMZN's foothold in the mobile space is essential for any company looking to broadcast content. Part of the reason Prime is growing at such a high rate is because of the widespread adaptation of the Kindle products. So, if AMZN is already playing with both feet in the space, why would it want to take on such a large investment like NFLX? The answer is ownership. A deal with NFLX would launch AMZN far beyond any other competitors in the field. Hulu and Redbox Instant would be stymied by the capacity the new service would offer. In a January letter to shareholders, NFLX explained that in an analysis of their most popular content, the competition was not on the same page:

To examine this, we looked at the top 200 titles on Netflix: our 100 most popular movies and our 100 most popular TV shows in Q4. Of these 200, 113 are not on Amazon Prime, Hulu Plus or Redbox Instant. Of the 87 that are available on at least one of these services, Hulu Plus offers 27 of the 200; Amazon Prime 73 of the 200; and Redbox Instant 12 of the 200, with significant overlap in TV between Hulu Plus and Amazon Prime, and in movies between Amazon Prime and Redbox Instant. In other words, when it comes to the most popular content with members on Netflix, none of these services are good substitutes to Netflix.

AMZN wants to own all spaces in which they play. They've begun a multi-year warehousing project that will redefine the way e-commerce is done. With the Kindle and their other forays into mobile, they've sought to perfect a low-cost tablet specifically for content viewing. A deal with NFLX will help perpetuate ownership of this streaming content market.

Facebook: The King of Acquisitions?

It seems as though FB has quietly begun to build a portfolio of brands. There was the acquisition of Instagram for $1 billion before the hip photo company had made one single dollar of revenue. There is the partnership with burgeoning music giant Spotify and a newly-announced alliance with GOOG to introduce Facebook Home exclusively on Android-powered devices. CEO Mark Zuckerberg is no stranger to building a portfolio of brands that will serve as both individual businesses and parts to the mega-whole. The focus at the newly-IPO'ed social media giant has only recently shifted to maximizing profitability, but it's the opinion of many investors and analysts alike that Zuck is still singularly motivated to build out the product and connect people.

As the world's largest source of connectivity between people, FB is perhaps the best suitor for NFLX. With over a billion users worldwide and a newfound push to both build out and monetize mobile, FB might be very interested in entering the streaming content space. As noted, NFLX currently has roughly 30 million users, over 82% of which are US-based. In fact, the company has yet to reach profitability outside the confines of the United States. Imagine the possibilities, then, for a company like FB, which already has a reach 35x larger than NFLX, and where most of the user base is concentrated outside of the US. The possibilities are endless and the infrastructure is already in place; FB's acquisition of NFLX makes sense. Maybe one day soon we'll "Like" and "Share" what videos our friends are watching. Or maybe there will be spot-on movies recommendations for us based on our likes and interests.

Apple Needs Netflix

We all know the story of AAPL - its storied rise and its recent fall from grace. The ride up was characterized by innovation on so many different levels. First, it was the world of music transformed by Steve Jobs' visionary leadership; the iPhone was a technological masterpiece and the sexiest machine on the planet. The iPad took what the iPhone did and created a whole new tablet market in the same sexy way its predecessor took mobile phones by storm. Since the iconic CEO's passing, the stock has languished. New leadership hasn't been able to convince the street that AAPL is still the leader that it once was. It seems that a wrist watch device and a more highly developed AppleTV are the two key pieces in the pipeline, but that hasn't done enough to reinforce the culture of innovation. Key competitors are taking market share from AAPL - especially on the international scene - as new devices and platforms alike are sprouting up on what seems to be a daily basis.

It seems that AAPL needs to make a move, and they need to do it soon in order to regain investor confidence. With over $100 billion in cash on its balance sheet, Apple will be able to make a lot of all-cash moves with a relatively short closing time. With NFLX currently trading with a market capitalization of $9.5 billion, a premium deal could be done very quickly. Why, though, is NFLX the answer for AAPL?

The short-term answer is that any punch in the arm is going to awaken AAPL investors. If a deal like this were brokered, there would be renewed confidence that the media, hardware, and software giant was putting its cash to work for shareholder benefit. A NFLX deal would be viewed favorably by investors because it would provide that jolt of new innovation back into the company - something it has been missing for the past year or so.

From a longer-term perspective, a NFLX acquisition would provide AAPL a chance to once again get competitive with the likes of GOOG and FB. Similar to how the company's two competitors recently signed an exclusivity agreement for Facebook Home, with NFLX under AAPL's wing we could see a push towards streaming exclusivity on AAPL devices. If the company didn't want to take it that far they could introduce a tiered level of subscription services that premium channels were only available on AAPL devices. Additionally, a deal with NFLX would bring AppleTV - which has languished as of late - back into the forefront in the home content space. Competitors like Roku could be shut out or limited with the largest content provider and AppleTV would benefit greatly from that. Whatever the jolt is, AAPL needs it soon. Acquiring NFLX is just a drop in the bucket for the tech giant, but it would serve as an adrenaline shot to get them back on track for sustained growth.

Google Takes the Cake (and Netflix)

While an argument to acquire NFLX can be made for each of the companies noted in this article, it is my belief that the best suitor is in fact GOOG. The tech mega-giant has made a name for itself by building (and buying, in YouTube's case) unique businesses that, like FB's acquisitions, work great individually but best as a unit. The question, then, that needs to be answered: how does NFLX fit into GOOG's already dominant portfolio?

Actually, the beauty of a deal here would be that NFLX fits in many different ways with the new parent company. Consider the dominant push that the company has made in the mobile space. By focusing primarily on being a platform instead of a hardware provider, GOOG has enabled itself to capture significant market share in a short period of time with its Android operating system. The most attractive emerging markets for mobile - China and India - are infused with Android and not much else. AAPL, Blackberry (NASDAQ:BBRY), and Nokia (NYSE:NOK) have limited market share in these two burgeoning markets, and these two are perhaps the most important and fastest growing in the history of the world economy. As noted, NFLX has yet to significantly penetrate any emerging market; most of their user base is within the United States, and they have yet to see profitability from foreign users. A GOOG acquisition would set the stage for scaled international growth, which means huge bottom-line increases in the near future.

While mobile is certainly the focus for most tech companies these days, another play could be in the social media space. GOOG's launch of Google+ has seen less acclaim than other product launches (Gmail, Adwords, etc.). A relationship with NFLX could drive Google+ to the next level. Let's take this example one step further down the iteration line. Imagine the shift in the world of education if college courses (which are now being taught for free on sites like Coursera) could be taught via Google+ and subscriptions to services like NFLX? The possibilities here are limitless.

Finally, we can push the envelope one step further and imagine a world where GOOG's newest product, Google Glass, captured the world of content in a virtual, 3D nature. That's years off, but an acquisition of NFLX could set the content stage for what's to come.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in NFLX, GOOG over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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