People have been speculating about Apple (NASDAQ:AAPL) acquiring Netflix (NASDAQ:NFLX) since the dawn of time. While there are some valid strategic rationales for doing so, the financial justification for such a deal would be untenable largely because of Netflix's lofty valuation.
Consider the fact that Netflix's current enterprise value is around $60 billion, even before factoring in some sort of acquisition premium. That's already about 20 times as large as Apple's biggest acquisition to date, the $3 billion purchase of Beats in 2014. The size of the Beats deal was itself unprecedented, about six times as large as any Apple acquisition before it. A Netflix acquisition also would be extremely dilutive to margins (Netflix's net margin is about one-tenth of Apple's).
Beyond all of that, there are signs that Apple is looking to dabble in original video content. While the company has explicitly stated that it has no intention of competing directly with video streaming services, instead clarifying that any original video content would serve as a differentiator for Apple Music, Apple's growing interest in video will only spark even more speculation about a possible Netflix acquisition going forward. Meanwhile, CEO Tim Cook has said that price will no longer be a limiting factor for potential acquisitions. Here's Cook just a few months ago on the November earnings call:
We are open to acquisitions of any size that are of strategic value where we can deliver better products to our customers and innovate more. And so we look at a whole variety of companies, and based on that, we choose whether to move forward or not. But we're definitely open and we definitely look.
So yeah, I'd expect the speculation over a Netflix acquisition to only intensify from here. Here's why that terrifies me.
An unflattering comparison
To be clear, I'm a shareholder of both companies, and as such my Netflix position would benefit quite nicely if Apple were to scoop up the dominant video streamer at a hefty premium. Yet if that ever came to fruition, I'd be scared of what that says about Apple.
If Apple were to acquire Netflix, it would be an incontrovertible admission on Apple's part that it's running out of ideas for its core business, and the expansion via acquisition into online video streaming services would not only be ridiculously expensive but also desperate. We've seen this play out before. When growth companies start to mature, organic growth becomes more elusive and management teams sometimes turn to blockbuster acquisitions as a way to get investors excited again, buying growth in new markets instead of creating it organically.
In general, the risk that an acquiring company takes is commensurate with the price tag, since the magnitude of the premium directly affects how much goodwill is subsequently recorded on the balance sheet -- goodwill that may be written down and impaired if the deal fails to create value. Even now, the book value of Netflix's shareholder equity is just $2.5 billion.
Furthermore, it's not as if Apple investors are pricing in considerable growth expectations right now. Shares are currently trading at just 14.4 times earnings and 2.9 times sales, far cheaper than peers. You might argue that Apple could spur multiple expansion if it increased investor growth expectations (such as with an acquisition), but the flip side could be that investors hate the deal because of the financial implications and what it says about Apple's ability to innovate on its own, which may send shares lower and contract its valuation multiples. It's rather common for shares of acquiring companies to fall when they announce deals due to investor skepticism, particularly large ones. They bigger they are, the harder they fall.
If Apple were to ever announce this mythical Netflix acquisition, I would consider it the first sign that Apple may indeed entering a lost decade similar to what its software rival from Redmond experienced in the early 2000s. It wouldn't be a coincidence that that company's lost decade included numerous blockbuster acquisitions, many of which failed and collectively resulted in tens of billions of dollars in shareholder value destruction. Note that the initial rationales for many of those deals wouldn't be dissimilar to why many believe that Apple should acquire Netflix.
Please don't do it, Tim.