Why A Netflix Buyout By Yahoo Would Ruin Them Both

| About: Yahoo! Inc. (YHOO)

In life many say, "two wrongs don't make a right." In business the same is true. When two companies are ailing, it is not wise to put them together, unless together they will have a strategic advantage they did not before. Yahoo (YHOO) has been searching for a means to differentiate itself in a wake of consistently loosing market share against its largest rivals Google (GOOG) and Facebook. The struggle that Yahoo faces is one that many operators in diverging sectors face all the time. When dial-up was around AOL was at the top of the Internet, when Sears (NASDAQ:SHLD) was vibrant they were larger than Wal Mart (NYSE:WMT). What these companies all have in common is a collective inability to stay ahead of the curve and move their companies to a place of diversified product range and strategic advantages against competition.

(Yahoo: CNBC)

Netflix (NFLX) is a company that is facing similar, but different problems than that aforementioned. Netflix is not yet to the point of being the "AOL" of streaming, but they are on the path to continued difficulty in their business model, a lack of true value beyond their customer base, and a user population that proves extremely fickle. This landscape is not conducive to long-term vitality and is prone to short-term market fluctuations. Needham & Co.'s Charlie Wolf Netflix's comments that "content costs are rising at an unsustainable rate; and in tandem, the profitability of its streaming subscribers is falling." This sets the landscape for an extremely difficult future, which may prove too competitive or too costly in the coming year.

(Netflix: CNBC)

What happens when you put these two together?

Rumors have flown through Wall Street that Yahoo could be a potential candidate to buyout Netflix. Some have commented that this would be a way for Yahoo to differentiate against its largest rival Google, which acquired the media giant YouTube in 2006. Some have also argued that this would be a way for Netflix to gain more internet exposure and bring in advertising fees attributed to Yahoo. Piper Jaffray's Gene Munster told CNBC:

"I wouldn't be surprised if there were some big moves on the content side, to make Yahoo! a more compelling destination for consumers" while he added "In the back of my mind, I wonder if they buy Netflix, that would make a lot of sense."

This kind of sentiment is rooted in idealizations of the truth. The facts are that Yahoo is only holding $2.06 billion in cash, while Netflix has a market-cap of $6.5 billion. Simultaneously, Netflix holds roughly $5 billion in liability to its content providers. This is a recipe for destruction on both parties. Even though it has the power to boost Yahoo's ability to differentiate against rival Google, it would sink both companies into tremendous debt because when you add two companies in crisis, you obtain one company facing bankruptcy. All it takes is for Yahoo to add one more mistake to its balance sheet and the end is near. Though, the more likely scenario is that Netflix will fail solely due to its flawed business model, Yahoo is also on a course of diminishing market presence and less points of difference between itself and its competitors.

Conclusion: As Ron Reisinger says, "Netflix is a company that, like Yahoo, is on the decline." To make these two companies one would be a mistake that would bring down them both and open the doors for Apple (NASDAQ:AAPL), Google, and others to pick up the broken pieces and saturate the market. If rumors begin flowing again of a Yahoo - Netflix buyout, sell both on the news and stay clear of two ailing businesses.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.