Why I'd Be Terrified of Apple, Inc. Acquiring Netflix
January 17, 2017, 12:30:00 PM EDT By Evan Niu, CFA, Motley Fool
Image source: Apple.
People have been speculating about Apple (NASDAQ: AAPL) acquiring Netflix (NASDAQ: NFLX) since the dawn of time. While there are some valid   strategic rationales for doing so, the financial justification   for such a deal would be untenable largely due to Netflix's lofty   valuation.
Consider the fact that Netflix's current enterprise value is   around $60 billion, before even factoring in some sort of   acquisition premium. That's already about 20 times as large as   Apple's biggest acquisition to date, the $3 billion purchase of   Beats in 2014. The size of the Beats deal was itself   unprecedented, about six times as large as any Apple acquisition   before it. A Netflix acquisition also would be extremely dilutive   to margins (Netflix's net margin is about one-tenth of   Apple's).
Beyond all that, there are signs that Apple is looking to   dabble in original video content. While the company has explicitly stated that it has no intention of competing directly with video   streaming services, instead clarifying that any original video   content would serve as a differentiator for Apple Music, Apple's   growing interest in video will only spark even more speculation   about a possible Netflix acquisition going forward. Meanwhile,   CEO Tim Cook has said that price will no longer be a limiting   factor for potential acquisitions. Here's Cook just a few months   ago on the November earnings call:
We are open to acquisitions of any size that are of     strategic value where we can deliver better products to our     customers and innovate more. And so we look at a whole variety     of companies, and based on that, we choose whether to move     forward or not. But we're definitely open and we definitely     look.
So yeah, I'd expect the speculation over a Netflix acquisition   to only intensify from here. Here's why that terrifies me.
An unflattering comparison
To be clear, I'm a shareholder of both companies, and as such   my Netflix position would benefit quite nicely if Apple were to   scoop up the dominant video streamer at a hefty premium. Yet if   that ever came to fruition, I'd be scared of what that says about   Apple.
If Apple were to acquire Netflix, it would be an   incontrovertible admission on Apple's part that it's running out   of ideas for its core business, and the expansion via acquisition   into online video streaming services would not only be   ridiculously expensive but also desperate. We've seen this play   out before. When growth companies start to mature, organic growth   becomes more elusive and management teams sometimes turn to   blockbuster acquisitions as a way to get investors excited again,   buying growth in new markets instead of creating it   organically.
In general, the risk that an acquiring company takes is   commensurate with the price tag, since the magnitude of the   premium directly affects how much goodwill is subsequently   recorded on the balance sheet -- goodwill that may be written   down and impaired if the deal fails to create value. Even now,   the book value of Netflix's shareholder equity is just $2.5   billion.
Furthermore, it's not as if Apple investors are pricing in   considerable growth expectations right now. Shares are currently   trading at just 14.4 times earnings and 2.9 times sales, far   cheaper than peers. You might argue that Apple could spur   multiple expansion if it increased investor growth expectations   (such as with an acquisition), but the flip side could be that   investors hate the deal because of the financial implications and   what it says about Apple's ability to innovate on its own, which   may send shares lower and contract its valuation multiples. It's   rather common for shares of acquiring companies to fall when they   announce deals due to investor skepticism, particularly large   ones. They bigger they are, the harder they fall.
If Apple were to ever announce this mythical Netflix   acquisition, I would consider it the first sign that Apple may   indeed entering a lost decade similar to what its software rival from Redmond experienced in   the early 2000s. It wouldn't be a coincidence that that company's lost decade included numerous blockbuster acquisitions,   many of which failed and collectively resulted in tens of billions of dollars in shareholder value   destruction . Note that the initial rationales for many of those deals   wouldn't be dissimilar to why many believe that Apple should   acquire Netflix.
Please don't do it, Tim.
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Evan Niu, CFA owns shares of Apple and Netflix. The Motley Fool owns shares     of and recommends Apple and Netflix. The Motley Fool has the     following options: long January 2018 $90 calls on Apple and     short January 2018 $95 calls on Apple. The Motley Fool has a disclosure policy .
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.