Apple Needs Netflix, Einhorn Needs Patience, Investors Need Answers

I've been called an unabashed Apple (NASDAQ: AAPL  ) cheerleader. It's a badge I wear proudly. But it's come at a cost. Given that shares are trading at roughly 40% below its 52-week high, I've paid dearly. Nobody's perfect. But somehow the market's expectations presumed this company could execute flawlessly forever. Investors are sad to discover that this company is not being led by magicians. Admittedly, I was shocked as well. But unlike most, I'm not scorned or bitter, nor do I feel the need for revenge. Let's have some perspective.

Has a good thing come to an end?
Lately, this has been the thought process. To that end, Apple's $137 billion cash hoard now offends a lot of people, one in particular being David Einhorn. There has been a deluge of articles demanding that Apple buys back stock, increase the dividend, or perform a combination thereof, with Einhorn's so-called "iPref" proposal leading the charge. It's a tug-of-war between Apple's ideals and how best to serve the interest of investors. Einhorn's proposal and his claims are not flawless, but that's not to say they lack merit.

Just ahead of Apple's annual shareholders meeting on Wednesday, a federal court sided with Einhorn's attempt to stop the company from putting a preferred stock proposal up for vote. But publicly undermining the company doesn't help matters. While Einhorn's proposal talks about ways to artificially create value for shareholders, it doesn't change sentiment. Nor does it address what is really at the center of this debate: Has a good thing come to an end? I don't think it has. With or without iPrefs (which are said to potentially unlock $150 per share), there's still considerable "organic" value in Apple, which is still the cheapest stock on the market.

Is the worst over or are there still execution risks?
I'm still bullish. But knowing now that Apple's leaders are actually human, there's also a degree of skepticism. For example, ahead of Apple's first-quarter report, news surfaced from The Wall Street Journal that Apple had made 50% cuts to iPhone 5 orders while citing "weaker-than-expected demand." This report coincided with concerns that the company had lost its knack for innovation, was losing its cachet to Google, and was also bleeding market share to Samsung. The list was long.

Others refuted the report, calling it "old news." But the stock still took a hit. And whether or not the news was relevant, it also brings up other potential scenarios, none of which were positive. Has Apple finally saturated the market? After all, it's been six years since the iPhone's debut. Management deserves credit for cutting orders (if that's truly what it was), since there's no point in carrying unnecessary inventory. But I do wonder why this supply/demand blockage was not anticipated sooner, especially on the heels of other gaffes related to the maps software.

These execution missteps are expected from BlackBerry and Hewlett-Packard, not at Apple. As an investor, I need to know if the worst is over and if this company is truly back on track to achieving its long term potential. If not, then I have to fully support Einhorn. But I'm not there yet. And what the company reveals on Wednesday should help me decide.

Where's the next leg of growth coming from?
What's next is certain to be a hot topic at the meeting. These days it's rumored to be the iWatch and the iTV, with the latter being the most anticipated. But can it disrupt the market? Apple would need to hit a home run on its first plate appearance. Given current conditions, it can't miss and expect to recover. Apple needs to buy Netflix (NASDAQ: NFLX  ) . Given Netflix's $10 billion market cap, it would only cost $12.5 billion, or 9% of its cash to close the deal. In return, given Netflix's 27 million domestic subscribers, Apple could potentially generate $30 billion in smart TV unit revenue.

As great as Netflix is, content costs are still an issue. That House of Cards cost $100 million was a perfect example. It's a good show. But the math doesn't add up. Besides, Netflix is already at a competitive disadvantage to Apple and Google in digital ecosystems and price/margin. Carl Icahn and others would take Apple's offer and run. For Apple, an iTV would essentially be a 60-inch iPad. But adding Netflix and making it exclusive to Apple-only devices would immediately render all rivals irrelevant, including Google and Samsung -- pretty shrewd. Apple has always had a good-guy image. But the next leg of growth is going to require a killer instinct. Its future depends on it. Investors demand it. And I think Einhorn would be pleased.

There's no doubt that Apple is at the center of technology's largest revolution ever, and that longtime shareholders have been handsomely rewarded with over 1,000% gains. However, there is a debate raging as to whether Apple remains a buy. The Motley Fool's senior technology analyst and managing bureau chief, Eric Bleeker, is prepared to fill you in on both reasons to buy and reasons to sell Apple, and what opportunities are left for the company (and more importantly, your portfolio) going forward. To get instant access to his latest thinking on Apple, simply click here now.


Read/Post Comments (7) | Recommend This Article (3)

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  • Report this Comment On February 25, 2013, at 8:50 PM, nyc314 wrote:

    "...Given Netflix's $10 billion market cap, it would only cost $12.5 billion..."

    That's an interesting number. I'm not saying it's right or wrong (I have no idea), but I thought that the NFLX leadership was busy adopting poison pills and fending off power grabs. My understanding is that it isn't within Icahn's power to sell something that isn't his, especially in this case. I'm a little baffled by this train of thought and would love a little more background...

  • Report this Comment On February 25, 2013, at 9:18 PM, TMFGemHunter wrote:

    I agree with nyc314 that $12.5 billion probably would not get the deal done: for now. As a NFLX bear, I'm pretty confident that the market cap will drop back down to $4-$6 billion sooner or later. Maybe at that price it would be worth Apple's while. However, spending $12.5 billion on Netflix does not seem like a good policy for Apple. The company could acquire Netflix-like content for significantly less money if it wanted to offer exclusive content.

    I don't understand the (apparent) assumption that most or all Netflix subscribers would buy an iTV. It's one thing to pay $8/month for internet video, and another to pony up $1000-$2000 for a smart TV...

    Adam

  • Report this Comment On February 25, 2013, at 9:52 PM, pauldeba wrote:

    Apple has $1 billion of goodwill, anything over $25 a share would double all of the goodwill they have acquired in 30 years, it is absurd to think they would buy Netflix. Someone did not do their homework.

  • Report this Comment On February 26, 2013, at 12:43 AM, AmcnFndrs wrote:

    This is brand marriage made in heaven - both obvious and brilliant at the same time.

  • Report this Comment On February 26, 2013, at 1:12 AM, Chilaw wrote:

    Apple buying Netflix is an interesting idea and I am sure that it has crossed some minds in Cupertino. It is one of the best ways to break into the complicated and fraught world of TV/movie content. I'm not sure a 25% premium would do it but that's a quibble.

    Other quibbles:

    As mentioned above, just buying the content is not enough. Netflix succeeds where Dish, Blockbuster, Redbook, Hulu and even Amazon fail because the user experience and customer knowledge are so great at Netflix.

    Making Netflix exclusive to Apple devices is probably a non-starter. Part of Netflix's success comes from its ubiquity in devices--Xbox, smart TVs, tablets, Roku, laptops. Take that away and you immediately lose a large % of subscribers--maybe 50%. I am not even sure Apple could do this, given Netflix's commercial agreements for device support.

    Finally, Reed Hastings is/was on the Microsoft board. Microsoft has made a big play for the living room with its xbox and has been an important and reliable Netflix partner. Is he really going to cross the tracks to Apple?

  • Report this Comment On February 26, 2013, at 7:38 AM, greenember wrote:

    If Apple bought Netflix and made it exclusive to iDevices, I'd never use it again.

  • Report this Comment On February 26, 2013, at 12:48 PM, Thurston3 wrote:

    I agree that Apple should buy Netflix - but just as much for the visionary leadership they would be acquiring in Reed Hastings (as I elaborated here http://beta.fool.com/thurston3/2013/02/06/visionary-ceo-sear... .

    Theonly thing I disagree with is "But adding Netflix and making it exclusive to Apple-only devices would immediately render all rivals irrelevant, including Google and Samsung -- pretty shrewd."

    It might be shrewd in the short run but closing Netflix off to users of all of those other platforms could hurt Netflix because it could threaten their ability to negotiate exclusives (like with Disney).

    For several years I have watched Netflix on my Android phone and my HP/Windows laptop. I doubt I would buy an Apple computer so that I could watch Netflix.

    The critical mass Netflix is acheiving makes it almost dangerous for content producers to sign exclusive distribution with competitors to Netflix (the larger their subscriber base becomes). Netflix would lose tens of millions of subscribers by taking their platform away from competitors.

    By keeping Netflix open, they could benefit from controlling it and help it grow (including original programming) with their deep pockets and ultimately win big on their investment.

    I really like the idea of Hastings at Apple.

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