Tyco International (TYC) and Netflix Inc (NFLX)'s stock prices are trading higher today following their respective corporate actions news. Tyco, a Swiss based conglomerate whose businesses include residential security, flow control products and commercial fire and security announced plans to split into three independent companies. Netflix, the popular content rental business, announced plans to separate the internet streaming business from the traditional DVD by mail business. While the stock market is responding positively to the news, investors should fade the rally because neither story meaningfully changes the fundamental investment thesis at either firm.
Netflix's new plan calls for the creation of a new business. The DVD rental business will now operate under Qwikster, a company with its own CEO and billing network. This is a reasonable extension of the company's recent decision to change their pricing model for their DVD and internet streaming options. Still, this does not address the fundamental problem behind the companies' recent woes (both to the stock price and earnings guidance) the perception that their recent subscription repricing was a massive price increase. While the DVD business and online streaming business will likely increasingly cater to different subscribers, the repricing exposed investors to an uncomfortable truth - the fact that Netflix lacks pricing power to justify their rich valuations. As of the September 16 close, the stock price has dropped 49% from the 52 week high of $304. Today's announcement clarifies Netflix's intentions but it is not a fundamental reason for investors to pay more for the shares.
The rally in TYC's stock price following disclosure of plans to break itself into three companies is a classic reaction. The general thinking is that corporate breakups make companies easier to value and lead to higher stock market valuations. In addition, breakups also increase the possibility the new companies will become acquisition targets because now that the component companies are smaller and more focused operations, there should more entities willing and able to make buyout offers. While many of these factors could still benefit TYC shareholders, ultimately, we think that the breakup news will do little to increase shareholder value because so much of the company's current competitive advantage centers on their attractive corporate tax rate. As such, TYC is best served as an acquirer rather than an acquisition target.
Just to be clear, there is nothing negative about the news from Netflix and Tyco today, we are simply saying that the actions are nowhere near as positive as the stock market suggests. While Netflix's move could very well put the DVD and online units in play sometime down the line, they do not address fundamental concerns about pricing and domestic demand growth. Bulls may argue that companies like Amazon.com (AMZN) and Apple Inc (AAPL) could develop an interest for the internet streaming operations and that Coinstar (CSTR) or Dish Networks (DISH) could be drawn to the DVD operations, but we do not think these possibilities will drive the stock price in the near future. As such, investors would be wise to fade today's rallies and wait for better reasons to buy.