Three months ago, rumor had it that Netflix (NFLX +1.69%) was about to launch a buyout bid for Roku (ROKU +4.99%). Fueled by this chatter, Roku's stock price rose nearly 18% in three days. When the buyout talk faded out, Roku shares lost that gain and much more over the next three days.
But investors haven't stopped thinking about this idea. "Should Netflix buy Roku?" is still a popular search term, and for good reason. Let me show you why this merger idea keeps coming back -- and why it probably won't result in an actual deal anytime soon.
NASDAQ: NFLX
Key Data Points
Three reasons why Netflix should buy Roku
The two streaming companies have a lot in common, and they have worked together since before video streams were a thing. In fact, Roku started out as an internal division of Netflix, developing a device called the Netflix Player to move the brand-new digital videos from laptops to the living room TV. Matching Netflix's content expertise with Roku's media-viewing platform makes so much sense. They are the peanut butter and grape jelly of the video-streaming market. These companies belong together, so maybe Netflix should buy its smaller partner.
And Roku is on fire sale these days! An opportunistic takeover is best done at a low price, and Roku's shares are hanging out in Wall Street's bargain bin. Share prices had fallen 56% year to date when those buyout rumors made the rounds in June. Now, the stock is down by 69%. Roku's market cap is down to just $9.6 billion. Factor in $2.1 billion of cash reserves and just $720 million in long-term debt, and you get an enterprise value of $8.2 billion. The enterprise value peaked at more than $60 billion last summer, so Roku is quite a bargain today. Netflix can't quite make that payment in cash, but the content titan is more than 10 times larger than Roku and a stock-swap deal should work.
Finally, Netflix could use something shiny and new right now. Subscriber growth has slowed down in recent quarters and Netflix is considering many new ideas to reignite that stalled growth engine. Taking direct control over the leading streaming platform in North America might do the trick. If nothing else, Roku's experience in video-based advertising should come in handy when Netflix launches an ad-supported service plan.
NASDAQ: ROKU
Key Data Points
Three reasons why Netflix won't buy Roku
I already talked about Netflix's limited cash reserves, which stopped at $5.8 billion in the second quarter. Financing a Roku buyout with more debt would also be uncomfortable since Netflix has focused on paying down its $14 billion long-term debt load recently. Even the stock-based deal structure would make shareholders squirm. This deal would dilute Netflix's stock by more than 10%, nearly matching the total dilution over the last 10 years.
On a strategic level, Netflix is no stranger to buyouts, but the deals are all about adding more content and video games to the company's library. It would be out of character to grab a hardware and software expert like Roku, shoehorning Netflix into some markets that it doesn't want to touch. In fact, when Roku was spun off from Netflix in 2007, the main reason for the move was that Netflix didn't want to compete against its technology partners. This way, Netflix was free to build a platform-neutral streaming service while Roku could create a service-neutral streaming platform. You'll find dedicated Netflix buttons on pretty much every modern TV remote, and Roku's media platform supports just about every video-streaming service worth mentioning. Combining the two companies under a single corporate umbrella would erase these fantastic market positions.
And of course, there are no guarantees that regulators would even allow a Netflix-Roku combination to happen. Putting the largest platform in the hands of the largest content creator is an antitrust lawsuit waiting to happen. I already talked about how a merger would destroy some of Roku's and Netflix's most valuable business advantages, but critics would still call the deal anti-competitive and unfair. The regulatory reviews and court cases could drag out for years. Netflix doesn't need that distraction from its core business right now.
So the merger idea may look sensible on the surface, but it falls apart as soon as you start digging deeper. I'm quite happy to own both Netflix and Roku as stand-alone stocks. Both have tremendous long-term growth prospects ahead of them and both are no-brainer buys today.
