Apple Shouldn't Buy Netflix, Rather Hulu

| About: Apple Inc. (AAPL)
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Netflix's shares have risen thanks to an article proposing Apple buy Netflix.

I believe reaction to this purchase would be extremely negative.

While Apple plans on its own service, a Hulu acquisition would make sense.

On Monday, shares of Netflix (NASDAQ:NFLX) were on the rise, as a Seeking Alpha market news detailed some potential discussion of a takeover by Apple (NASDAQ:AAPL). The discussion was started in a Forbes article, seen here, detailing how Apple would leapfrog into the streaming space and past a number of key competitors with this purchase. I disagree with the premise that Apple should buy Netflix, for a variety of reasons. If Apple were to decide an acquisition is the right strategy to help launch its own streaming service, I think Hulu would be a better purchase.

The first reason I disagree with a Netflix buyout is that it does not fit with Apple's strategy of mainly buying small, private firms. Apple received a lot of criticism for its purchase of Beats, and that deal was valued at $3 billion. Imagine the reaction to a purchase of Netflix, which the Forbes article states would be in the $60 billion to $70 billion range. That price tag would be about double what Apple would pay for Tesla Motors (NASDAQ:TSLA), something widely discussed.

Additionally, there are some statements in the Forbes article that are either somewhat misleading or require a bit hope. Here are the main ones I have issue with.

The P&L contribution from Netflix will make an immediate and meaningful impact on Apple financials right off the bat...

The dilutive effects on the share count would more than likely be easily offset by a re-energised Apple shareholder base that would take Apple shares higher right off the bat...

The synergies from a combined Netflix/Apple would also be immense. Think about the cross-marketing and synergistic potential of a combined Apple and Netflix.

While a Netflix purchase would help Apple immediately on the revenue line, it wouldn't do that much. Netflix is forecast for a little under $2 billion in revenues during calendar Q1 2016, while Apple is forecast for more than $50 billion. On the bottom line, the impact is tremendously less, because Netflix in an investment quarter has guided to net income of just $11 million, while Apple has guided to a profit of more than $10 billion. While there could be some synergies between the two, "immense" seems a bit much. I also don't know if Apple's shareholders would be invigorated right off the bat.

Back in November 2015, it was reported that Hulu was looking to sell a stake in the $5 billion to $6 billion range. Thus, Apple could step in and have the company for less than $10 billion, a fraction of the price for Netflix. While Hulu doesn't have the subscriber base of Netflix, there's a lot less risk involved when you are talking about this size of deal. A purchase of Hulu would also be more in line with Apple's purchase history of private companies.

A purchase of Netflix would also require a very interesting discussion of acquisition funding. In its latest 10-Q filing, Apple disclosed that $200.1 billion of its $215.7 billion cash hoard was located outside the US. For Apple to buy Netflix, it would either need to repatriate a large chunk of funds, thus incurring a large tax bill, take out tens of billions in debt, or use a large amount of stock for the purchase.

Fifty billion dollars of debt, even at 4%, would equal more than $2 billion in annual pre-tax interest expenses, while Netflix last year had a total profit of $122.6 million. With Apple buying back stock to reduce its share count tremendously in recent years, using equity to fund a deal seems like a complete 180. If Apple was going to issue so much debt, I'd rather the company do so for future repurchases. At the least, Apple retires shares and saves on dividend payments, while not incurring the cash burn Netflix is currently facing. That size of buyback would boost earnings per share by a lot more than a Netflix acquisition would, especially in the short term.

A Netflix acquisition would also result in a big management shuffle. Would Reed Hastings, Netflix's CEO, want to work for someone else? I'm not entirely sure. On the other hand, do most consumers and investors even know who the CEO of Hulu is? Perhaps Apple would need to float some big severance package to get Hastings to step aside, and that alone would add to the deal's already large cost. On the other hand, some would speculate Hastings take over for Tim Cook. I'm not sure handing over the keys to the most profitable company in the market today to someone who has never really focused on the bottom line is a good strategy.

Apple Music has passed the 10 million subscriber level, which is probably around the figure that Hulu currently has (estimated at $9 million very recently). Apple Music started out small and has gradually expanded over time. With Apple looking to launch a streaming service, a Hulu acquisition would give Apple that small foot in the door, while not facing the risk of a $70 billion acquisition. Apple could slowly expand the service as it sees fit, using its ecosystem to further its global reach.

Overall, an Apple acquisition of Netflix seems extremely far-fetched. The price tag is extremely high and several times north of Apple's most expensive purchase ever. While I do believe there are reasons to own Netflix's stock, I don't believe an acquisition by Apple is one of them. A purchase of Hulu, which would still end up being Apple's biggest acquisition, seems to fit in more with the company's strategy. There are just too many questions involved regarding a Netflix purchase, and the financial impact in the short term would not be pretty.

Disclosure: I am/we are long DIS.

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.

Additional disclosure: Author long DIS, which has a stake in Hulu. Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation.