Previously I have tried to espouse the belief that Netflix (NFLX) faces certain threats to its business model, and that investors purchasing the stock at valuation seem oblivious to these risks. I have also discussed how the potential acquisition of Hulu by any large media company could have a detrimental impact on the ability of Netflix to continue to acquire content at a reasonable price. Another wrinkle will be added to the Netflix valuation argument if an acquisition of Hulu materializes. Recent news reports have DirecTV (DTV) and at least one or two other companies bidding $1B to acquire Hulu. This has implications for Netflix investors, and unfortunately, those implications are negative.
Hulu Valuation And What It Means For Netflix
Hulu is not a publicly traded company, thus its entire financial profile is not available in the same detail as that of a company with quarterly SEC filings. However, some key statistics related to Hulu have been reported during the time the company has been on the auction block. In the Reuters article linked above, it was reported that Hulu had roughly 4M paying subscribers, and generated about $700M in revenue in 2012. Putting aside the competitive risks of Hulu being acquired by another deep pocketed company, the price paid for Hulu will provide a market valuation that can be applied to Netflix. As Netflix has become more focused on licensing television series and producing its own content, it has moved away from being a destination for watching movies on demand. Yes, the company will always have access to a library filled with old movies, but consumer habits are leading viewers to Netflix in the quest to pursue binge viewing of popular television shows. It is this fact that puts Netflix close to being in the same league as Hulu as far as the value proposition offered to consumes. Likewise, as the business models begin to converge, an acquisition of Hulu could be more readily applied to deriving a fair market value of Netflix.
At a purchase price of $1B, Hulu is receiving a value of roughly $250 per subscriber for its reported 4M subscribers. Alternatively, Hulu would be valued at roughly 1.4x its 2012 revenue.
This has implications for Netflix when considering the valuation the company currently is afforded today. With roughly 33M total paid subscribers at the end of Q1 2013, Netflix is valued $385 per subscriber at its current market capitalization of $12.7B. On a subscriber basis, Netflix would be valued 50% higher per subscriber than Hulu would be if the latter were purchased for $1B. With estimated revenues of about $5B for 2013, Netflix receives a valuation of roughly 2.5x its forward revenue estimate. Compare that to Hulu, which potentially could be purchased at 1.4x its trailing revenue estimate.
One can argue that Netflix is a more valuable brand or platform than Hulu, and thus deserves the premium valuation at which it currently trades. However, this argument receives less credibility once an actual purchase price for Hulu is announced. Investors will begin to realize that an acquisition of Netflix will not materialize, as the valuation multiples for Hulu will provide a guideline for what Netflix could be acquired for. Considering that Netflix is already trading at a significant premium to the rumored multiples that Hulu would fetch in a sale, investors should prepare for downward pressure on Neftlix shares when a Hulu acquisition is announced.