Don't start buying the Netflix Inc. takeover rumors just yet.
With Twitter's 14-per-cent plunge in early Monday trading offering a cautionary tale of what can happen when acquisition rumours come to nothing, it may be worth paying attention to analysts at Deutsche Bank AG who pour cold water on speculation that the streaming service will be bought by reported suitors the Walt Disney Company or Apple Inc.
Deutsche's dour view comes as Netflix shares have been struggling this year after being one of the top performers in the S&P 500 in 2015, with a surge of 134 per cent over those 12 months.
"Companies with unique technology, [intellectual property], or other capabilities, but without strong business models, are ideal targets because of the financial upside that is not reflected in their standalone market valuations," said the Deutsche Bank team, led by Bryan Kraft. "However, Netflix has a fully formed business model that is richly valued in the market, making it very hard for a strategic acquirer to acquire Netflix and earn its cost of capital on the purchase."
Deutsche is initiating its coverage of the stock with a 12-month price target of $90 (U.S.) – or a fall of about 15 per cent from where Netflix closed on Friday – with much of their skepticism based on the notion that the company is unlikely to be acquired and certainly not at a premium to its current market value. Here are some of the reasons for their disbelief.
The types of companies that are most likely to get acquired by Disney or Apple have a business model that is not yet fully formed, Deutsche argues. Netflix knows what it's doing and where it's going, so there's little room to create value if someone came in to buy them. "It seems to us that if Disney or Apple acquired Netflix and used it for the betterment of its core business, then it would be value destructive to Netflix's core business value, requiring the acquirer to create more value somewhere else than is destroyed in Netflix's core business, a very tall order," the analysts said.
Dilutive to Disney shareholders
The deal is particularly troublesome in the case of Disney, where Deutsche Bank estimates a deal would destroy shareholder value. "Netflix would, naturally, provide a new source of earnings growth for Disney, but with Netflix trading north of 100 times 2018 earnings, the dilution would be roughly 25 per cent even through fiscal year 2021," they wrote, adding that integrating the two platforms could prove to be quite difficult as well.
Netflix wouldn't help ESPN
Perhaps the biggest hurdle facing Disney as a company is the aging of sports channel ESPN, which wouldn't benefit from a purchase of Netflix, according to Deutsche. "We don't see how Netflix would resolve any of these challenges as a non-sports, ad-free service that sits outside of the pay TV ecosystem," the analysts wrote.
Lack of synergies
Mr. Kraft and his team see little potential for synergies such as reduced costs or additional revenues to result from this deal. From program licensing to television production, there is little room for either company to boost its profits by merging. The team says there's one clear area where Disney could benefit from the purchase: overseas growth.
"Disney could be interested in Netflix because it sees an even bigger international opportunity than is priced into Netflix's shares today," they write. "All of that said, the strategic rationale for putting Disney and Netflix together is not all that compelling," they conclude.