It’s no secret that Apple Inc. (NASDAQ:AAPL) has a ton of cash, and it continues to pile up at a prodigious rate. AAPL stock adds five to ten billion dollars of cash to its stockpile every quarter, and the total sum has reached an astonishing $268 billion.
For now, the company doesn’t seem intent on spending it too quickly. Much of the cash is held offshore and would be subject to a serious tax bite if Apple brought it home. In theory, President Trump will sign tax legislation that allows Apple and other tech giants to access their offshore billions at a more favorable rate.
In practice, however, there is reason to doubt that any significant tax reform is coming in the near term. The Republican example set by health care reform leaves much to be desired if you’re counting on a bill to pass quickly.
Shareholders and analysts are becoming increasingly anxious for Apple to make a big move with the cash, particularly as doubts build about the pace of tax reform. If Apple holds onto its cash, it can eventually repatriate it and pay more dividends or buy back a lot of AAPL stock. But many people want a bigger move sooner.
Count Barry Ritholtz, columnist for Bloomberg, among these. He posted a controversial article recently suggesting that Apple should buy Netflix, Inc. (NASDAQ:NFLX). Ritholtz suggests that Apple purchase Netflix for $100 billion, roughly a 20% premium to today’s share price. I doubt Netflix shareholders would approve a deal at that price. Even putting that aside though, there’s plenty of reason to suggest that Apple take a different course.
Netflix: Dilutive to Profits
Ritholtz suggests Apple purchase Netflix with newly issued AAPL stock. His reasoning? He says that: “Apple would be wildly overpaying for Netflix. However, the world’s most valuable company has a not-so-secret weapon: its own wildly expensive currency.”
Regardless of whether the deal went down with AAPL stock or its cash pile, this reasoning doesn’t work. AAPL stock is hardly wildly expensive, at least compared to other tech stocks. AAPL stock sells at just 18x trailing and 14x forward earnings. It’s cheaper than that once you subtract out the company’s cash pile. In reality, it’s probably around 11-12x true forward earnings.
Sure, the AAPL stock price is up almost 50% this year. But that doesn’t mean it’s necessarily wildly overvalued now just because it has run up a lot. Perhaps it was significantly undervalued last year?
In any case, using Apple’s cheaper-than-the-market stock to buy Netflix is hardly a merger of equals. NFLX stock trades at almost 200x trailing earnings and around 100x forward earnings. Apple did $48 billion in net income last year, Netflix made less than half a billion. While Apple can easily afford a $100-billion price tag, even to Apple, that’s significant money to buy a business that would add less than 1% to Apple’s annual net income.
Not Enough Synergies
In theory, Apple could add a lot to Netflix. The magic of Apple is that it merges industry-leading hardware with strong software. Companies like GoPro Inc (NASDAQ:GPRO) have largely failed, by contrast, because their hardware exists on an island. Users have to interact with third-party software to get the most out of their devices. It breaks immersion and makes it much easier for customers to buy different hardware next time around. Apple, by contrast, has lock-in. And Netflix might help.
Apple could help push Netflix on its native hardware. Unfortunately, the killer device for Netflix is television. And there, Apple TV’s market share has slumped to fourth place. Roku Inc (NASDAQ:ROKU) has run away from the competition. And both Amazon.com, Inc. (NASDAQ:AMZN) and Alphabet Inc (NASDAQ:GOOGL) are ahead of Apple TV in market share as well.
As Ritholtz mentions, Apple has failed to keep up with innovation lately outside of its core phone business. That said, wildly overpaying for Netflix isn’t the easy answer. Several of the points Ritholtz makes in favor of an Apple/Netflix deal seem to favor Netflix more than Apple. Among them, bringing Reed Hastings into Apple’s management, providing cheap capital to Netflix, and providing funds to bankroll more of Netflix’s original content.
Netflix Is Heading for a Difficult Patch
Fundamentally, Netflix has a problematic couple of years ahead. In the past, Netflix was the one-stop video-streaming platform, in the same way Spotify is for music. However, this happy quasi-monopoly has fallen apart.
Now, many of the content providers have concluded that Netflix was undercharging for their shows and videos. As a result, they are pulling their products off Netflix and rolling out their own subscription streaming services. Walt Disney Co (NYSE:DIS) confirmed this trend with its recent decision to unleash an aggressive streaming platform against Netflix.
Sadly for shareholders interested in profits, what’s coming up is a race to the bottom. Disney intends to price its service for less than Netflix, which will make it a real competitor given that Disney has arguably the best content library in the world. This will further cheapen content for consumers. Why pay a premium price when each new streaming service cuts pricing to pick up subscribers?
Netflix’s strategy, it appears, is to produce yet more original content. So far, it’s done well at this from a technical level, if the number of awards it has won is any guide. But it hasn’t resulted in profits. Apple buying Netflix would simply divert more capital from Apple into a television production business that hasn’t proven it can operate profitably and which is facing rising competition from the likes of Disney.
Verdict for AAPL Stock
At the right price, using Apple’s cash, or AAPL stock, to buy Netflix is an interesting idea. However, the price is totally wrong at this point. Ritholtz thinks Apple should buy Netflix since its own stock is up a lot this year, and thus “wildly expensive.” However, NFLX stock is up even more (55% year-to-date) and that as it faces an increasingly existential crisis from other streaming services.
The seemingly dozens of new streaming services springing up are going to result in a brutal pricing war. Consumers aren’t going to spend more money for video content. Instead, you’re seeing an intensifying fight for a largely fixed-size market. To buy Netflix now, you’d have to offer a premium to its all-time high stock price. That’s simply foolish for Apple, as Netflix enters a maelstrom of competition. If Tim Cook wants Netflix, he can almost certainly get it cheaper in a year or two.
At the time of this writing, the author held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.
