Bidness Etc

There are several reasons for Apple to consider acquiring Netflix rather than compete with it

Recent speculation suggests Apple Inc. (AAPL) has shown interest in acquiring companies including Tesla, GoPro, and Time Warner. Although Apple is mainly a hardware and software company, rumors suggest it is considering diversifying its business.

Some people associated with Apple previously have suggested that is has Netflix in its crosshairs. This acquisition could help Apple maintain growth, especially since reports suggest that Apple might be interested in rolling out its own TV subscription service.

Rumors regarding Apple’s search for a media company emerged when a recent Financial Times report said Apple executive Eddy Cue, who heads iTunes, iCloud and Apple Music, had proposed the idea of acquiring Time Warner in a meeting last year. However, investment bankers linked with Apple told the Financial Times it would be more interested in acquiring a streaming company like Netflix, rather than a pure content player.

We look at the top factors that make the move a compelling one:

Apple Needs Netflix

Apple faces the need to diversify itself, and CEO Tim Cook said it was time for the company to make a major acquisition during a recent earnings report. This is owing to the fact that Apple share price has fallen sharply recently. Last month, the stock was down almost 15% due to weaker quarterly results. In its 2Q earnings, it reported revenue at $50.6 billion, and a net income of $10.5 billion ($1.90 per diluted share). Both figures have declined compared to the same quarter a year ago.

The results made investors anxious, because the earnings suggest that the sales of its main profit driver, the iPhone, are nearing maturity. The sales of the iPhone SE were weak, and its latest smartwatch product failed to impress customers. Since the iPhone 5, no product extension has helped the tech giant transform.

Apple stock is down more than 23%, and the stock has fallen almost 10% year-to-date (YTD), trading slightly lower so far this year. Its earnings fell far short of impressing investors, and the company needs a transformation in order to drive its stock price. Right now, investors are waiting to see if Apple’s upcoming product, the iPhone 7, which is likely to be released in September, will succeed in bringing with it a huge sales turnaround.

The company has recently been seeking to expand its Apple TV product into something like Amazon Prime Video, or Disney and 21st Century Fox owned Hulu. However, for more than a year now, observers have suggested that the company is likely to decide to buy an existing product than develop its own. Many analysts believe it will be more interested in acquiring an online streaming company like Netflix.

Apple & Netflix Look Cool Together

Apple and Netflix are bound to turn into a great combination. Each company has a lot to offer for the other: Apple has a platform of millions of devices that could carry streaming media, while Netflix has a huge subscription base.

Netflix says it added 6.74 million subscribers during the first quarter this year, and the total number of subscriptions has now reached 81.5 million. The net additions include 2.23 million subscribers in the domestic market, and 4.36 million globally. This growth has mainly been driven by Netflix’s massive rollout into 130 territories earlier this year.

Total Streaming Net Additions

Source: Company Filings

Netflix Is Cheaper

Netflix trades at almost $92 per share, which is well below its 52-week high of $133. The stock has a P/E ratio of 338 and 7.4X sales. At present, Netflix’s market capitalization stands at $39 billion, while Apple’s current cash pile is $220 billion. That number suggests Apple can afford to be generous with its investments in several directions, and that acquiring Netflix will not be a debacle.

Netflix Is The Future

The company is profitable and within just a few years, has become the largest streaming service provider in the US, with over 81 million subscribers across 190 countries. This gives Netflix a competitive edge over its rivals. If Apple tries to introduce its own streaming service, it would have to build a vast member base from the ground up.

The graph below shows Netflix revenues, which have continued to grow in recent times. The credit goes to Netflix’s original content and exclusive agreements. In the last reported quarter, the steaming giant reported revenue at $1.96 billion, a 24.8% rise over the $1.56 billion in the same quarter last year.

Recently, Jan Dawson of Techpinions said Apple has discovered that the future of profitable content lies with recurrent subscriptions, and Apple’s acquisition of Beats for $3 billion is the foremost illustration of this. Netflix is now a market leader and the first global online Pay TV service. It is well ahead of its competitors, not only in terms of its subscriber growth, but also content.

Many analysts believe that the streaming company has the extraordinary opportunity of becoming a global leader in the video streaming market. This is because it is spending aggressively on developing exclusive content to lure customers in. Many analysts believe that through spending broadly on its content, it has the ability to rapidly learn and drive subscriber revenue growth even in new international markets.

During the past three years, it has generated incremental contribution margins of approximately 50%. Although spending heavily on the development of content might dent its margins in the short-term, it is bound to drive profit margins in the long haul.

Several recent reports had suggested that Apple wanted to produce original content, for which it was reportedly in talks with several TV networks and content creators. Currently, Apple has the iTunes music and video service, where customers can purchase or rent movies, but cannot stream them whenever and as much as they want. A streaming company would significantly enhance its video offerings.

It would be great to see every new iPhone, iPad and Apple TV come with an embedded Netflix app, and for Apple to leverage its costly iOS user base to raise Netflix subscriptions.