Netflix at 100 Times Profit Means Tough Sale: Real M&A
After failing to strike deals for companies from Lions Gate (LGF) Entertainment Corp. to Mentor Graphics Corp. (MENT), Carl Icahn now must convince suitors that Netflix Inc. deserves one of the highest valuations in America.
The billionaire investor disclosed this week that he took a 10 percent stake in Netflix, and said Amazon.com Inc. (AMZN) and Verizon Communications Inc. (VZ) could seek to buy the world’s largest streaming service as a way to capture the lead in online video. Netflix, after plunging 74 percent from its high last July, still trades for 102 times this year’s estimated profit, the second-highest price-earnings multiple in the Standard & Poor’s 500 Index, according to data compiled by Bloomberg.
Icahn, after last year ending his battle for control of Lions Gate and unsuccessfully bidding for Mentor Graphics, said he invested in Netflix because the company is undervalued based on its market position and prospects for international expansion. While Netflix’s more than 30 million streaming subscribers may be attractive, slowing U.S. growth and high content costs could be a deterrent to a deal, according to Macquarie Group Ltd. Given Netflix’s $4.3 billion market value and a takeover premium, companies may find it cheaper to invest in content on their own, said Dawson James Securities Inc.
“It’s Carl Icahn and he’s shaken things up before,” Tim Nollen, a New York-based analyst at Macquarie, said in a telephone interview. “He’s gotten some things wrong, but he’s gotten some things right.”
With Netflix, “the fundamentals are tricky,” Nollen said. “It may not be the best time for an acquirer to come in.”
Jonathan Friedland, a spokesman for Los Gatos, California- based Netflix, declined to comment on whether the company had been approached by any buyers, would be open to a sale or had held any further discussions with Icahn.
“We have many shareholders, now including Mr. Icahn, and we’re always open to their perspective on how to build on our success,” Friedland said in an e-mail.
The investor, who buys shares in businesses he deems undervalued and then pushes management for changes to boost the stock prices, said in an Oct. 31 regulatory filing that he accumulated 5.54 million shares of Netflix (NFLX), including options for 4.29 million, and that he may seek talks. Icahn also said Netflix may have “strategic value” for a variety of larger companies.
“There’s so many possible combinations,” Icahn said on Bloomberg Television the same day. He said in a phone interview yesterday that while a takeover is a possibility, it’s not the only way to boost returns for Netflix shareholders.
“I do think it’s a very attractive acquisition candidate at the right price, but I’m not saying it has to be acquired to see its fulfillment,” he said. “It’s just a very undervalued situation and one that I believe would demand a big premium and might get acquired.”
While Icahn often advocates for companies to put themselves up for sale or makes offers to acquire them, his recent investments haven’t led to many deals, said Caris & Co.’s David Miller.
“His track record as an activist is mixed,” the Los Angeles-based analyst said in a phone interview.
Icahn dropped a buyout offer for Lions Gate in December 2010, after the company marshaled enough investors to block his bid for five board seats. In August 2011, he agreed to sell most of his shares, ending a standoff between him and the company.
Mentor Graphics last year rejected his $1.86 billion offer that was designed to lure other suitors. The software maker was never acquired. He also failed to draw a buyer for Clorox Co. (CLX), even after offering to backstop an auction.
Icahn bought Netflix shares as they plunged from a high of $298.73 in July 2011 to as low as $53.80 in September. The stock closed yesterday at $77.69.
Today, Netflix fell 1 percent to $76.90.
From Icahn’s list of buyers, the only logical suitor for Netflix is Amazon, which could be lured by the company’s large subscriber base and the opportunity to cross-sell its own products, according to Michael Pachter, a Los Angeles-based analyst at Wedbush Inc. A deal would also allow the world’s largest online retailer to trim expenses tied to content purchases, he said.
Still, even Amazon may be unlikely to pursue a deal since the company has already entered the streaming video market with the introduction of its $79-a-year Prime Instant Video service, according to Pachter.
Apple Inc. (AAPL), the maker of the iPhone and iPad, could be drawn to the company to establish an instant pipeline of content and subscribers for its smart TV products, Macquarie’s Nollen said.
“They could use that as a stepping stone to build other exclusive types of content and that could support eventual sales of Apple TVs so there is some logic to that,” he said.
Google and Microsoft aren’t currently considering Netflix as a potential buyout, according to people with knowledge of the situation who asked not to be identified because the matter is private.
Representatives for Verizon, Amazon, Apple and Google declined to comment. A representative for Microsoft didn’t immediately respond to a request seeking comment.
Netflix’s content obligations and slowing growth could give Apple and any other suitors a reason to hesitate, Nollen said.
The company has almost $5 billion in obligations to buy movies and TV shows for online customers, including $2.1 billion due during the next 12 months, according to a regulatory filing.
After signing on fewer U.S. streaming customers in the third quarter than analysts projected, the company trimmed its full-year forecast for new subscribers to as many as 5.43 million from the 7 million Chief Executive Officer Reed Hastings predicted earlier this year.
“You might want to have Netflix on board to help establish your platform and attract subscribers and even push your devices, but on the other hand, you would be absorbing very large content liabilities,” Nollen said. “The subscriber growth is certainly slowing.”
Netflix’s stock traded yesterday for 102 times analysts’ earnings estimates for the company this year, data compiled by Bloomberg show. Only Amazon has a higher price-earnings multiple at 145 times profit among members in the S&P 500, the data show.
Given Netflix’s valuation, it may be more cost-effective for a company to build its own video streaming service than to buy Netflix, according to Justin Colatosti, a Boca Raton, Florida-based analyst at Dawson James.
“For the most part, as far as the content catalog that they’re offering, that part is very easily replicable for another service,” Colatosti said in a phone interview.
Caris’s Miller also said it wouldn’t be cheaper to acquire Netflix than to create a similar service from scratch.
“If you pay where the stock price is, mathematically it’s cheaper to build out the business on your own,” he said.
Earnings multiples aren’t necessarily the best gauges of value for a company like Netflix that has been growing rapidly, said Todd Lowenstein, a Los Angeles-based money manager at HighMark Capital Management Inc., which oversees about $17 billion.
“When you’re in hyper-growth mode you’re constantly reinvesting in the business, and that’s depressing Netflix’s margin structure at the moment,” Lowenstein said in a phone interview. “It doesn’t look cheap on traditional profitability metrics, but it does look cheap in terms of scarcity value. What they’ve created is definitely unique and that would be attractive to certain players in the industry.”
Icahn said yesterday that his success shouldn’t be judged on the number of deals he’s consummated. Lions Gate’s stock has more than tripled since June 2009, when he had boosted his stake to almost 17 percent, data compiled by Bloomberg show. Mentor Graphics has returned 87 percent since he bought shares in May 2010 and said he would hold talks with its management to find ways to maximize shareholder value.
According to a study by Icahn, he has created more than $59 billion of value for shareholders in the stocks he has pursued activist strategies with since 2004, from the time he first took a stake through now, if he still holds it, or until the time he exited.
“There are many ways activism can enhance value without an acquisition taking place,” Icahn said in the phone interview. “An acquisition is the extra icing on the cake.”
He said the same is true for Netflix. For companies like Amazon and Verizon, it would take many years to build a subscriber base as large as Netflix’s and it would be costly to purchase the content, which makes it appealing for a takeover, he said.
“There’s a good chance” that Netflix is acquired, Icahn said. “But even if it’s not acquired that doesn’t mean we failed.”
Macquarie’s Nollen said Netflix’s stock likely has farther to fall and if there are interested buyers, they may be waiting for a cheaper deal.
“It would take a distressed situation for a buyer to come in,” he said. “I wouldn’t say Netflix is distressed. It could get distressed. We think the way the trends are going, they will struggle. It could get worse before someone decides to jump in.”
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