Goldman Sachs thinks Apple (NASDAQ:AAPL) should counter AT&T's (NYSE:T) $85 billion bid for Time Warner (NYSE: TWX), according to The New York Post. That suggestion might be in Goldman's own self-interest, since it didn't get to advise the AT&T bid, but Apple has expressed interest in acquiring Time Warner before.
However, people familiar with the matter recently told CNBC that Apple was no longer interested in buying the media giant. If that's true, I think Apple shareholders should breathe a sigh of relief.
Apple might seem flush with cash, but most of that hoard remains overseas. On the domestic front, it had $21.6 billion in cash and equivalents and at the end of the fiscal fourth quarter. This means that to top AT&T's half-cash and half-stock offer, Apple must drain its domestic cash reserves, use its own stock, or take on more debt.
Why buying Time Warner would be a bad move
Buying Time Warner would make some strategic sense for Apple. It might revive its streaming TV effort, which was suspended last December because of pricing conflicts with content providers. Time Warner's diverse portfolio of cable shows, films, and video games would also diversify Apple's top line away from the aging iPhone, which generated 60% of its sales last quarter.
However, acquiring Time Warner would reduce Apple's margins. Over the past few years, Time Warner's net profit margin has remained consistently lower than Apple's, which has itself been weighed down by lower hardware margins.
Apple would also inherit Time Warner's cord cutting woes, which have cast a long shadow on its relationships with advertisers and pay-TV providers. To counter that shift, Time Warner launched its stand-alone streaming service, HBO Now. Many investors consider HBO to be Time Warner's crown jewel, but Apple has already integrated HBO Now into iTunes and Siri.
Since Apple already reaps the benefits of streaming HBO shows, it seems silly to buy all of Time Warner and inherit its ongoing problems. Buying Time Warner also wouldn't give Apple digital exclusivity to its entire media library, since the company will remain bound to existing agreements with other pay TV providers.
Smarter uses for its cash
Instead of spending over $85 billion on Time Warner, Apple could make a lot of smaller acquisitions that come with a lot less baggage.
If it's looking to expand its media portfolio, buying Lions Gate (NYSE:LGF.A), which has an enterprise value of just $4.4 billion, makes more sense. Lions Gate produces movies and network TV shows, and it will soon close its acquisition of pay TV network Starz. Its enterprise value-to-sales ratio of 1.8 is also much cheaper than Time Warner's 3.3.
If Apple really wants to make a game-changing media acquisition, buying Netflix (NASDAQ:NFLX) would be smarter than buying Time Warner. As a streaming leader, Netflix doesn't suffer from any cord-cutting woes, and it owns a well-received portfolio of shows including House of Cards, Daredevil, and Stranger Things. Netflix's total paid memberships rose 26% annually to 83.3 million last quarter.
Netflix's two biggest headwinds are high content acquisition costs and pricing pressure from rivals such as Amazon.com (NASDAQ:AMZN). Under Apple's wing, Netflix would probably gain more clout in licensing negotiations with media giants. To counter the cheaper competition, Apple could reduce Netflix's subscription fees to make it a "loss leader" to tether more users to its growing media ecosystem. It could also mimic Amazon and bundle free Netflix trials with hardware purchases. Netflix costs less than Time Warner, with an enterprise value of $55 billion, but it remains "pricier," with an EV-to-sales ratio of 6.7.
The key takeaway
Apple clearly needs to make some big moves to evolve its business away from the iPhone. However, I don't think it should listen to Goldman's advice and engage in a bidding war with AT&T. The disastrous AOL-Time Warner merger demonstrated that bigger isn't always better, and Apple may fall into the same trap if it believes that buying Time Warner can offset its slowing sales and lack of innovation.