3 Big Reasons Apple Shouldn't Buy Netflix
Every so often, the financial news is deluged by pundits arguing that Apple should buy Netflix . Given Apple's growing interest in the TV space and the widespread concerns about its slowing growth, buying a fast-growing Internet TV leader may seem like a no-brainer.
However, buying Netflix wouldn't make sense for Apple. First, Netflix is so small compared with Apple that its high growth rate would be swallowed up by the slower growth of Apple's other product lines. Second, Netflix is too pricey to be a good acquisition target. Third, if Apple really wants to focus on streaming video, it doesn't need Netflix's help.
1. Netflix won't turbocharge growth
It's true that Netflix is growing quickly. Last year, revenue jumped 21% to $4.37 billion as Netflix added more than 11 million streaming subscribers. On average, analysts expect a similar revenue growth rate for the next two years.
By contrast, Apple only managed to grow revenue by 9% in its 2013 fiscal year, and analysts expect revenue growth to recede to 6% for the next two years. Plenty of pundits believe that Apple's slowing revenue growth is a major reason Apple stock still sits more than 20% below its all-time high.
However, Apple's annual revenue now exceeds $170 billion. Buying Netflix would only boost Apple's revenue by about 3%. Moreover, Netflix's expected $1 billion of annual revenue growth would raise Apple's growth rate by less than 1 percentage point -- even if Netflix kept adding more than 10 million users each year.
2. Buying Netflix would be expensive -- even for Apple
Thus, buying Netflix would not be a quick fix for Apple's slowing revenue growth. It would also be a very expensive proposition.
Proponents of such a deal have noted recently that Netflix stock has dropped significantly in the past month, making a buyout cheaper. In fact, Netflix shares ended the week more than 25% below the all-time high reached just one month ago. However, Netflix bulls (and more importantly, the company's board) aren't going to let Apple buy the company today for less than what it was worth a month ago.
That makes $458 a share the absolute minimum bid that could be taken seriously. More likely, Apple would have to pay more than $500 a share to close the deal. Including stock options, Netflix has about 63 million shares outstanding. That would put the total bill at more than $30 billion.
Apple ended 2013 with about $159 billion in cash and only $17 billion of debt, so this price wouldn't be beyond its financial capacity. However, less than $35 billion of Apple's cash was held within the U.S. as of December. Apple spent $14 billion of that total on share buybacks after its stock pulled back in late January.
Thus, Apple would need to fund a Netflix acquisition with debt, stock, or overseas cash. If it uses debt, it would risk having its credit rating downgraded. If it uses stock, that would undo the benefit of the share buybacks Apple has implemented in the last year or so. If it uses overseas cash, Apple would have to pay up to 35% of the amount it repatriates to Uncle Sam, raising the true cost of the deal to around $50 billion.
This is a lot of money to shell out for a company that would boost Apple's revenue growth by less than 1 percentage point and would add well under $1 to Apple's EPS.
3. Apple could go it alone
Proponents of an Apple-Netflix deal might argue that Netflix would have strategic value to Apple aside from the direct revenue and earnings growth it brings to the table. Netflix has a highly engaged user base, a large content library, an entrenched distribution platform, and a respected brand name. These could help Apple be more successful if it were to launch a smart TV product line.
However, Apple could replicate Netflix's positive attributes for a lot less than $30 billion. Apple already has a respected brand name, a popular distribution platform (iTunes), and hundreds of millions of loyal iPhone, iPad, and Mac users.
That leaves content. Netflix plans to spend nearly $3 billion on streaming content this year. If Apple thinks streaming content would be a big draw for selling an iTV or other products, it could build up a formidable content library quickly. Most streaming content deals have terms of a few months to a few years; "output" deals for recently released movies are the one major exception.
If it wants to attract a big streaming audience, Apple could match Netflix by spending $3 billion a year on streaming content (including exclusive and original content) and then give it away to Apple hardware users. That would be expensive -- but not especially expensive if the alternative is dropping $30 billion or more in one fell swoop to buy Netflix.
On the surface, an Apple-Netflix tie-up might make sense, but buying Netflix wouldn't solve Apple's revenue growth or earnings growth issues. Meanwhile, it would use up tens of billions of dollars of domestic cash and/or borrowing capacity (or an even greater quantity of foreign cash), crowding out share repurchases.
If Apple really wants to get into the streaming video business, it should go it alone rather than overpaying for Netflix. That's also what it's likely to do. Apple has never made a billion dollar acquisition, preferring to develop its main products and services internally. There's no reason for Apple to change this strategy now.
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The article 3 Big Reasons Apple Shouldn't Buy Netflix originally appeared on Fool.com.Adam Levine-Weinberg owns shares of Apple, is long January 2015 $390 calls on Apple, and is short shares of Netflix. The Motley Fool recommends and owns shares of Apple and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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