3 Big Reasons Apple Shouldn't Buy Netflix

Every so often, the financial news is deluged by pundits arguing that Apple (NASDAQ: AAPL  ) should buy Netflix (NASDAQ: NFLX  ) . 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.

Should Apple try to acquire Netflix?

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.

NFLX Revenue (TTM) Chart

Netflix's revenue growth doesn't look like much when compared to Apple's scale; data by YCharts.

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.

It would take a whole lot of Benjamins for Apple to buy Netflix.

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.

Apple already has hundreds of millions of loyal users (Photo: Apple)

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.

Foolish wrap
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.

Your cable company is scared, but you can get rich
Apple and Netflix are two of the biggest players in the ongoing war for your living room. But they're not the best way to profit from the Internet TV revolution. When cable falters -- and you know it will -- three companies are poised to benefit. Click here for their names.


Read/Post Comments (12) | Recommend This Article (10)

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  • Report this Comment On April 05, 2014, at 1:19 PM, twolf2919 wrote:

    You forgot the biggest reason of all why Apple shouldn't buy NFLX: there is no money in it! You don't buy a company just because it's revenues are increasing at a higher rate than your own - you buy it because you think its PROFITS will increase more rapidly than your own. NFLX is paying ever more money to content owners - and, more recently, to produce its own content. I bet NFLX's margins are minimal - and APPL likes to be in high margin businesses.

  • Report this Comment On April 05, 2014, at 2:49 PM, pauldeba wrote:

    Yeah sure, no one had any interest at $52 per share and the same company with the same growth they had before Icahn stepped in (October 2012 things already had recovered) is now going to sell at $458 for an absolute minimum. It will sell at $120 for an absolute maximum, no one is stupid enough to pay more. well, maybe Facebook on their foolish acquisition parade, but no one with an Adult CEO

  • Report this Comment On April 05, 2014, at 11:27 PM, peterg wrote:

    biggest reason is who would want to watch netflix on a tiny 4 inch low res display ? it would only highlight the tiny display syndrome.

  • Report this Comment On April 06, 2014, at 2:34 AM, Chiam wrote:

    Great article.. Brilliant. Apple will only buy small companies. It doesn't take on that kind of risk. Besides Tim Cook is standing still. He won't even come out with a big phone for a million years.

    Apple is doing nothing and it is showing how bad the company has become. We are all heralding a big phone. WOW such an innovation. What does Cook do next? Add more colors to the 5c. He is the worst CEO. We would be lucky if he disappeared.

  • Report this Comment On April 06, 2014, at 2:54 AM, deasystems wrote:

    @peterg: Huh? Apple TV supplies Netflix to my 50" HDTV just fine.

  • Report this Comment On April 07, 2014, at 11:03 PM, TMFAeassa wrote:

    Really nice article. Thanks!

  • Report this Comment On April 07, 2014, at 11:43 PM, buddyglee wrote:

    they could just buy the content direct

    and they have the platform already and brand name

  • Report this Comment On April 08, 2014, at 12:31 AM, AceInMySleeve wrote:

    Amazon bought over a billion in content per year and charged nothing extra for it, for several years now. They are likely 3 Billion in the hole. It's gotten them to 5% of the streaming traffic of Netflix.

    Even when common sense fails ahead of time, as it did for Amazon, let's learn from history.

  • Report this Comment On April 08, 2014, at 1:16 AM, kachingpdx wrote:

    They could take a look at buying a company called NanoTech Entertainment, Inc.(NTEK),http://ntek.com, for far, far less than NFLX. NanoTech has the following:

    (1) 4K UltraHD streaming media player Nuvola NP-1 already in production for retail business

    (2) "4k Studios" Rendering & remastering Global Film Libraries located in San Francisco

    (3) 4K Nuvola NP-C Digital Signage Business

    (4) OEM Business (Nuvola "tech inside", licensed or commissioned products

    (5) 4K Nuvola Commercial/Hospitality Business

    (6) UltraFlix 4K Streaming Hub ("Go-to" source for 4K Content)

    (7) 4K Broadcasting & VOP/TVOD/PPV service provider (events, content, live streams- original & in partnership)

    (8) MS3D, Glasses-Free IT/IPTV & 4K/3D Deployment &/or Licensing.

    (9) Advertising, data-mining, licensing, & royalties for ANY & ALL the aforementioned businesses.

    (10) Casino Gaming Products

    4K is the next step in TV evolution and Apple would be taking a big leap ahead of everyone else with this purchase.

  • Report this Comment On April 08, 2014, at 1:40 PM, TMFGemHunter wrote:

    @AceInMySleeve: 1) AMZN just reported that its streaming traffic is triple what it was a year ago. Remember that AMZN is several years behind NFLX in getting into the SVOD market. It only really started investing in Prime in earnest about two years ago. 2) There are hundreds of millions of Apple device users worldwide (and probably over 100 million in the U.S. alone). That's far bigger than the Prime subscriber base. 3) Amazon still spends less than Netflix on streaming content -- Apple could easily outspend Netflix for a fraction of the cost of buying Netflix outright.

    Adam

  • Report this Comment On April 08, 2014, at 7:27 PM, AceInMySleeve wrote:

    Adam, here is the detail on that report for your triple traffic comment:

    "But Netflix is the undisputed champ, and actually gained more share than Amazon over the past year. Netflix represented 57.5% of the video-streaming market in March 2014, up from 52.5% a year ago — compared with Amazon’s increase from 0.6% to 3% share, according to Qwilt. Meanwhile, YouTube’s overall share declined over that period (from 28.2% to 16.9%), and Hulu climbed from 1.5% to 2.8%, the study found."

    So I was using Sandvine data from Nov 2013, this is March and the ratio here is nearly 20:1.So if you think that's progress in the face of the billions spent on prime without any increase in revenue for it, then...

    2) Television viewership is the main mover for video. Mobile is a nice value-add.

    3) Sure Apple could outspend Netflix on content. It does not violate the rules of physics, but I think it's an ivory tower position to think any company would actually do that. Business plan:

    1) Spend 2.5B on content annually (before or after hiring people that would know how to spend that?)

    2) Find some customers and figure out how to charge them.

    3) Realize you have a product inferior to the market leader in ways that you weren't even aware existed.

    4) Spend another 1B on content because you have so much (YES!)

    5) Brag about having triple the # of customers of last year (3% of the market!)

    6) ??

    7) PROFIT!!

    8) Wake up.

    9) Decide to refocus on high margin hardware with your new CEO.

  • Report this Comment On April 08, 2014, at 7:28 PM, AceInMySleeve wrote:

    btw I don't expect Apple to buy Netflix.

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