The buyout buzz is starting to fade when it comes to a couple of tech giants, and at least one Wall Street pro believes this is a good time to dump shares of Netflix (NFLX 2.50%). Deutsche Bank analyst Bryan Kraft is slapping a sell rating on the dot-com darling, fueled by Netflix's lofty valuation, near-term revenue and cost-containment challenges, and the growing unlikelihood that someone will acquire the leading premium video streaming platform.
Kraft feels that the one-two punch of escalating content costs and top-line misses will squeeze out the market's current optimism when it comes to Netflix stock. With Netflix already penetrating more than half of the country's U.S. broadband-backed homes and international growth facing hurdles on the path to profitability, Kraft feels that Netflix isn't worthy of its present $45 billion market cap.
One thing that has been lifting shares of Netflix lately is the chatter that Disney (DIS -1.83%) or Apple (AAPL 0.83%) will swoop in and buy it out at a healthy premium. Kraft feels that neither buyer is likely to wreck its own stock for the pricey pursuit of Netflix. He's probably right about that, but it doesn't mean that he's right about urging investors to dump the stock.
The audacity of Netflix as a takeover target
Netflix was the S&P 500's best performer in 2013 and again in 2015. You don't have a stock that leads the pack of 500 blue chips in two of the past three years typically on the bidding block, and if it does make itself available for sale, it certainly doesn't come cheap.
Disney as a buyer never made a lot of sense. Wouldn't rival studios move to block content availability on Netflix, or at the very least make it more expensive? You need to be studio-agnostic to make this model work, something that Apple has achieved through iTunes, but even the consumer tech giant would be an odd parent. Apple rarely spends big money on acquisitions.
We then get to valuations. Apple and Disney trade at earnings multiples of 13 and 15, respectively, if we look out to the new fiscal year. Netflix trades at nearly 120 times next year's earnings, and that's before we even consider a buyout premium. In an all-stock deal -- something that Disney would have to do and Apple would probably prefer since so much of its cash is parked overseas -- it would explode the P/E ratios of Apple and Disney.
The bullish argument in the sea of pessimism
Netflix doesn't make sense for Disney or Apple, but what about individual investors? They don't have to buy all of Netflix. They win if Netflix is worth more than $45 billion in the future. That may be a tall order these days, with stateside subscribers slowing, but a little churn is natural when you tell longtime subscribers that they have to be paying 25% more like Netflix did this summer. The lull should prove temporary, and it will be more than offset by folks paying more.
International growth is still in the early innings, and Netflix is starting to turn a profit in some of its earlier foreign markets. The model works, and nobody is even close. It may seem scary to see Netflix with $13.2 billion in streaming content obligations on its books, but that's also a huge barrier to entry for anyone that wants to match its catalog.
Kraft may be right about the stock's unsustainable inflation in recent weeks given the seemingly baseless takeover speculation, but instead of selling into mania, the smarter play could be the buy in when the speculators start to unload their stock. Netflix has a model of a lifetime all but locked up. It may not repeat as the S&P's best annual performer anytime soon, but it has all of the right ingredients to continue expanding its reach and testing its pricing elasticity to the benefit of its public shareholders.