Right now, there is one name that's completely dominating the headlines in media and entertainment. Naturally, I'm talking about Netflix (NFLX 0.06%). Netflix is currently in the midst of a heated acquisition bid against Paramount Skydance Corporation for Warner Bros. Discovery's (WBD 0.81%) film and television studios.
While the proposed deal is yet to cross the finish line, I see this transaction as a potentially transformative move in Netflix's pursuit to evolve from a streaming pioneer into a full-blown media service.
Let's explore why Warner Bros. is so valuable in the eyes of Netflix and what could be in store over the next several years should the deal come to fruition.
Image source: Netflix.
Why does Netflix want to acquire Warner Bros.?
For years, Netflix primarily served as a distribution platform for other networks' content. However, over the last several years, a number of media outlets have launched their own streaming services in an effort to compete more directly with Netflix.
While Netflix still offers a variety of licensed shows and movies in its library, the company has shifted its focus on developing original content. So far, this pivot has proved to be quite profitable for Netflix. Exclusive series including Stranger Things, Wednesday, Bridgerton, and The Queen's Gambit were smash hits around the world.
The downside of creating original content is that it is both cost-intensive and time consuming. Moreover, a subtle risk is that even after opening up the pocketbook to bring on Hollywood's best talent, there's no guarantee the show or movie will be well received.
This is what makes Warner Bros. such a strategic asset for Netflix. Warner Bros. is home to beloved franchises, including DC Comics, Harry Potter, Looney Tunes, and HBO's premium cable series which feature Game of Thrones, Succession, The Sopranos, and much more.
With Warner Bros. tucked into its catalogue, Netflix instantly gains prestige intellectual property (IP) that is treasured by people across all age and gender demographics.
Image source: Getty Images.
What the next five years could look like for Netflix
Acquiring Warner Bros. comes with more value than a deeper content library. The IP ecosystem that comes with Warner Bros. opens up new doors for Netflix in the world of theme parks, toys and merchandise, gaming, and more.
In the long run, Netflix could leverage all of the new brands and characters it acquires from Warner Bros. to continue fleshing out its budding advertising business and immersive experience segment, Netflix House.
NASDAQ: NFLX
Key Data Points
Moreover, I think integrating Warner Bros. into Netflix's existing platform provides the company a direct path to acquire more customers without overspending on sales and marketing.
In addition, the various assets that come with Warner Bros. allow Netflix to create new pricing tiers and subscription bundles. From there, I think it's reasonable that Netflix could employ its pricing power and hike subscription costs for viewers with very little risk of substantial churn.
If Netflix is successful in its pursuit of acquiring Warner Bros., it is going to take quite some time before the deal looks accretive. Nevertheless, I think Netflix is on its way to transform its business model virtually on par with that of Disney over the next several years.
Is Netflix stock a buy?
In the table below, I benchmarked Netflix against a cohort of other streaming, media, and entertainment businesses on a price-to-sales (P/S) basis. As the analysis shows, Netflix trades at the highest premium in this peer set. What's even more telling is the disparity in valuation multiples between Netflix and other pure streamers like Roku or entertainment conglomerates like Disney.
NFLX PS Ratio data by YCharts.
The reason legacy media trades at such a discount is because their business models are increasingly vulnerable to linear TV decline and cyclical advertising dynamics. While entertainment businesses generally boast slightly higher multiples compared to legacy media, these companies rely heavily on live events with distribution caps.
Netflix, by contrast, has global distribution and recurring revenue -- two drivers that fuel outsized demand. For this reason, the market views Netflix as more of a tech-enabled platform akin to a software-as-a-service (SaaS) business but with the cultural profile of Hollywood.
Although Netflix stock is pricey relative to its peers, I think the premium is warranted. Taking this one step further, the gap between Netflix's valuation and that of Paramount is striking. To me, this could suggest that a marriage between Warner Bros. and Netflix is much more valuable than with Paramount Skydance.
Ultimately, I see Warner Bros. as a core pillar of Netflix's plan to become a trillion-dollar company over the next five years as it becomes much more than a streaming specialist. For these reasons, I see Netflix stock as a compelling buy-and-hold opportunity for investors with a long-run time horizon.
