Citi analysts released a note stating Netflix (NASDAQ:NFLX) as one of the most likely acquisition targets (40%) by Apple (NASDAQ:AAPL). My take is these acquisition talks are hogwash and the probability is likely closer to 0%.
Netflix is way too expensive for Apple
Beats Electronics has been by far the most expensive acquisition in Apple's history. At a price of $3 billion, the cost is 5x more than the second most expensive acquisition: NEXT at ~$600 million (accounted for inflation). With Netflix's current pricing of ~$90 billion ($212/share), it is way over Apple's usual acquisition appetite.
Apple's preference for cheap and small companies can be seen from its track record. Apple has never bought a listed company. Out of 93 known acquisitions (March 2, 1988 to Jan 2, 2018), none was listed. This is likely attributable to the much higher valuation of public companies.
With Apple's historically conservative approach to acquisition, Netflix is just too expensive.
Netflix's acquisition does not make sense for Apple
Netflix is able to become the leader in video streaming due to its first mover advantage and foresight to produce original content. Its main competitive advantages lie in its huge user base and exclusive highly popular programs (House of Cards, Narcos, Stranger Things). The former allows Netflix to bring down per-user costs (licensing and production costs) while the latter helps to attract and retain customers. With the termination of Disney's (NYSE:DIS) licensing agreement, Netflix is transforming from a distribution focus company to a content focus media company.
Apple has never been a company looking for a huge user base exposure. It is more focused on acquiring the appropriate talent instead. Netflix does not seem to have the unique talents that can produce hit video content. Later entries into the streaming services are able to produce hit series like The Grand Tour by Amazon (NASDAQ:AMZN) and The Handmaid’s Tale by Hulu.
While Netflix has found more success than its peers in original content creation, it also spent a lot more to do so. Apple can replicate Netflix's success if it wants to by utilizing its $250 billion war chest. It might have to spend far more than Netflix to achieve the same level of success, but that will still be way cheaper than buying Netflix outright.
To sum it up, Apple does not much to gain from a Netflix acquisition. It will just be wasting valuable cash that can be better utilized elsewhere.
What is likely to happen?
Apple will not buy Netflix. Instead, Apple will either go it alone or partner with Disney.
Go it alone: Apple has demonstrated some indication of developing its streaming service with a $1 billion budget allocated to original programming in 2018.
Unlike Apple's foray into music, the network executives are resistant to Apple's effort to unify all programs into one distribution network. This problem is intensified with the networks developing their individual streaming services. Without established older content, it will be challenging to attract new users (which is how Netflix got started).
Original content programming is riskier than ever. The market is flooded with original series due to intensified competition in the content streaming space. And only a small percentage of U.S. consumers are willing to take a chance on a new series.
Apple going it alone will be an unwise move. It will have to spend billions on content and the streaming service will likely remain cash hemorrhaging for a substantial period.
This is the best-case scenario for Netflix. Netflix would be able to capitalize on its already established original content to retain significant market share while Apple plays catch-up.
Partner with Disney: Under Disney's CEO, Bob Iger, Disney has developed a close working relationship with Apple. Over the years, Disney has been very accommodative of Apple's move into the video category. Disney was the first to get on board with listing movies on iTunes and subsequently on the Apple TV streaming service. This was in spite of Apple facing strong opposition with the rest of the TV industry (a stark contrast to Apple's foray into music, in which Apple had the upper hand).
Apple has one of the largest international content distribution networks, but it lacks the content. Disney has the content, but it lacks the distribution channels. Coupled with their strong established working relationship, an Apple-Disney streaming service makes sense.
This is the worst-case scenario for Netflix. An Apple-Disney streaming service would prove to be a bigger threat than Amazon. This service would have an international outreach, great established content and a much cheaper price point. In this scenario, Netflix would be able to expect a substantial erosion of its market share.
Investors should take analysts' reports with a huge pail of salt. If they are investing in Netflix on the sole "thesis" (more of false hope) of an Apple buyout, they should dispel that thought. Instead, they should be wary of an Apple-Disney collaboration that will threaten Netflix's dominant position in the video-streaming business.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.