After months of uncertainty, Netflix (NFLX 0.10%) investors got the news they've been waiting for. Late last week, the company walked away from a potential bidding war with Paramount Skydance (PSKY 0.55%). The two media companies were locked in a fierce battle to acquire Warner Bros. Discovery (WBD 0.72%). While Netflix only wanted the streaming and studio assets, Paramount wanted the company lock, stock, and barrel -- including its legacy television and cable assets.
Netflix walked away from the deal, refusing to increase its bid for Warner Bros. Since then, headlines have trumpeted how Paramount "won" the deal. I wouldn't be so quick to call it a win.
Image source: Netflix.
Price is what you pay, value is what you get
Paramount paid a high price to convince the Warner Bros. board to accept the deal. After initially offering $30 per share, Paramount increased its bid to $31. In all, the cost of the acquisition stands at roughly $110 billion, in addition to the $2.8 billion breakup fee Paramount paid to Netflix on Warner Bros.' behalf.
Beyond the price tag of the deal, which some believe may have been too high, the combined Paramount/Warner Bros. company will be saddled with $79 billion in debt if the deal closes, in what is being called the "largest leveraged buyout in history." That's not necessarily a good thing.
Mergers and acquisitions are fraught with uncertainty and are uphill battles, even at the best of times. Eminent finance professor Aswath Damodaran is often quoted for saying that acquisitions are "the most value-destroying action a company can take."
For this merger to succeed, the company will have to thread a needle that very few have managed to do successfully, particularly given the size of the deal.
NASDAQ: PSKY
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Parmount expects cost-cutting to produce $6 billion in annual savings over three years, helping to offset the high price and crushing debt the company is taking on to finance the deal. To be clear, there aren't any guarantees that all will go according to plan.
In their book, The M&A Failure Trap: Why Most Mergers and Acquisitions Fail and How the Few Succeed, accounting professors Feng Gu and Baruch Lev approached the subject clinically. They analyzed 40,000 acquisitions between 1980 and 2022 and found that 70% to 75% of those combinations failed. Moreover, the failure rate was higher among larger deals and those that took on substantial debt to finance the acquisition.
Commenting on this specific deal, Gu was not optimistic. He cited the "humongous size of the proposed deal," saying it would be a "major challenge for [Paramount] to get value out of it." He went on to point out that while the "success of acquisition is uncertain, debt service is certain."
There's one major hurdle that remains. Paramount will need to receive regulatory approval not only from the U.S. but also from the European Union and the United Kingdom. While many assume Paramount will sail through the antitrust process, some state attorneys general are considering lining up to challenge the deal.
History is littered with examples of large tie-ups that failed, and while that may not be the case here, Paramount has its work cut out for it.
NASDAQ: NFLX
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On the other hand...
It was clear that Netflix shareholders had concerns about the proposed acquisition of Warner Bros. assets from the beginning. From the time the deal was announced on Dec. 5, Netflix stock had fallen as much as 24%. However, since Paramount raised its bid and Netflix subsequently walked away from the deal, its stock has soared 30%, as investors breathed a sigh of relief that there would be no costly bidding war.
Since then, Netflix has been paid the $2.8 billion termination fee for the deal and is going about its business. The company has announced improvements to its Ads Suite adtech platform, giving marketers new ways to target audiences on its ad-supported tier. Netflix also acquired InterPositive, an artificial intelligence (AI) tech company that develops AI tools for filmmakers. Furthermore, the company's founder and CEO, actor, writer, and director Ben Affleck, will join Netflix as a senior advisor.
Even without the Warner Bros. acquisition, Netflix was firing on all cylinders. In the fourth quarter, revenue of $12 billion climbed 18% year over year, driving dilute earnings per share (EPS) of $0.56 up 30%. The company's forecast calls for revenue and EPS to each rise 15% in Q1. Management also noted that in 2025, Netflix "met or exceeded all of our financial objectives."
The Warner Bros. acquisition would have been nice to have, as it would have bolstered Netflix's content library and streaming business -- but it wasn't necessary. Walking away from a pricey deal kept Netflix from paying too much and assuming additional debt, thereby removing the boatload of uncertainty. With that as a backdrop, I would submit that Netflix was the real winner.
And at 31 times forward earnings, Netflix stock is still reasonably priced.
