The financial market has seen a lot of deal activities recently, especially in tech. Most recently, everyone was talking about Twitter. Once the crown jewel of Silicon Valley, the media and the market were both going on a frenzy trying to understand if Twitter would be acquired. There were many interested parties, including Apple, Disney, Google and Salesforce.com. Ultimately, all of them withdrew their interests in acquiring Twitter. Many of these players, however, should be looking at a different tech company as a potential acquisition target: Netflix.
Netflix’s stock continues to go up, now trading around $120 and valuing the company at over $50 billion. Though it’s a big company already, most of the firms that were once interested in acquiring Twitter are multiple times bigger and have the balance sheet to digest such a big acquisition target. For companies that deal with hundreds of billions of dollars, going from buying a $25 billion company to buying a $50 billion company is totally doable. Here, we examine potential rationale of how Netflix could be beneficial to each of the major tech and media firms that might be interested in acquiring Netflix.
Apple has been facing some headwinds in the smartphone market, especially given the lukewarm response to its pace of innovation. However, its brand still attracts plenty of brand loyalty from its customers globally. To bring more value to its customers, it has been trying to differentiate in the level of software service, especially in entertainment. By introducing Apple Music and acquiring exclusive content from the top musicians, it wants to provide the best experience to customers.
What if this tech behemoth acquired Netflix and made the service entirely free to its device users (or provide a discounted rate)? Netflix’s popularity is growing rapidly, and it already has almost 90 million subscribers globally. This could potentially tilt the balance in Apple’s favor and be the boost that Apple has been desperately needing in terms of growing its market share. But could it be beneficial economically?
We think it will be. For example, take our back of the envelope calculation below. Apple currently makes about $600 per iPhone, which is typically replaced about every 2 years, and makes about 40% gross profit on the sale. This translates to roughly $113 of gross profit per year per device ($600 divided by 2 years and multiplied by 40% gross margin). In comparison, Netflix currently makes about $9 per month per subscriber, for a total of S$104 per year. This means that, even if Netflix were to become completely free to Apple users, Apple will be increasing economic value per customer by almost 10%! This math looks even better if you start to incorporate numbers for iPads and Mac, which have higher ASP than an iPhone.
|Back of the Envelope Calculation on Apple and Netflix|
|Replacement Cycle||2 years|
|Adj Annual Income per Unit||$298|
|GP per Unit||$113|
|NFLX Monthly ARPU||$ 9|
|NFLX Annual ARPU||$104|
Caveat is that Apple will depend on the customers to remain loyal to its devices and services for a long time, but that’s the whole point; adding services like Netflix would be a great way to increase customer loyalty just the way Amazon has been adding stuff to its Amazon Prime program over the years.
Currently, Apple only commands about 12 % of the global smartphone market. Although Apple only competes in the high-end portion of the market, Samsung has a whopping 23% of the global market share. Even if Apple were to tilt the market to its favor by 3-5%, it could be increasing its revenue from iPhones by about 40%, which could pay for the acquisition in a matter of few years even if Apple were to pay a meaningful premium.
Disney has been the reigning king of media in the US for a long time. This is because high quality content is king, and live sports is the king of high quality content. To get live sports, however, scale is crucial, especially number of subscribers you have. ESPN has enjoyed this benefit for a number of years, and is likely the most valuable media asset in the country. For example, NFL will sell the right to broadcast their games to the highest bidder. To be the highest bidder, then, you need to be able to make most money by broadcasting NFL games. In order to do this, the most important thing is to have more number of viewers than your competitors.
However, recently, this dynamic has hit a wall as millennials did not sign up for the traditional cable TV service, and went over-the-top to services like Netflix and HBO Go. Not only that, other big media conglomerates have been desperately fighting for their take in live sports, as Disney, FOX, CBS and NBCUniversal have been driving up the cost of sports rights in a bidding war.
From this point of view, Netflix bring something fresh to the table for ESPN. Not only does Netflix have the best over-the-top distribution channel in the world, it also has the ability to build significant scale on a global basis. While the US market has been always capped at below 100 million households, Netflix can bring to the table the global subscriber base on which to amortize your content cost.
Interestingly, even Netflix has been trying out live shows on its platform, starting with Chelsea Handler show which was shown live on Netflix three times a week. While Netflix has continuously been reiterating that it will not be interested in getting involved in that segment of the market, its technology platform is clearly prepared to do just such thing. If and when Netflix has a huge global subscriber base, say 150 million, it could be a serious challenger to any media company that cares about live sports content.
It wouldn’t be a bad idea to think seriously about acquiring this asset, especially with another potential media giant emerging if CBS and Viacom merger ends up happening. After all, John Malone, the cable king of the US, has even said once in Liberty Media’s analyst day that Netflix will be a seriously dangerous asset for everyone in the media industry if it were backed by a big balance sheet (to acquire a lot of expensive content and distribute through its platform, thus garnering a lot of subscribers).
You cannot count Alphabet (i.e. Google) out of this picture. First, the fact that Google just launched its own high-end smartphone Pixel to compete against Apple makes its rationale easy to understand. It could be driven by the same incentive that we wrote about Apple above. Not only that, Netflix has an extremely valuable set of data on what its subscribers like to watch, and what types of contents do well globally. As a data science company, Google could leverage such data to improve its search result & artificial intelligence product. It also just signed CBS to plan a web TV service together. Writing is on the wall.