Never Mind the Netflix Poison Pill: a $5 Billion Land Mine Lurks Off-Balance-Sheet
Carl Icahn is hawking video subscription service Netflix (NFLX) as a takeover for the era; a deal in serious billions that would wed Netflix to a Google (GOOG) or Amazon.com (AMZN) or some other sexy tech firm that just nibbles at its massive market share now. But do any of these smart, hypothetical bidders really need Netflix and its baggage to fulfill their video streaming dreams?
Certainly, there are plenty of big, rich companies that would love to have Netflix’s 30 million subscribers. That number swamps by many factors the competition, which includes video services at The Walt Disney Co.’s (DIS) Hulu.com, Amazon Prime, Google Play, Apple (AAPL) iTunes, cable company Comcast (CMCSA) and satellite company DISH Networks (DISH). Icahn has named Microsoft (MSFT) and Verizon (VZ) as potential (hypothetical) suitors too. This is hardly a complete list. With plenty of capital here, Icahn says this industry is ripe for consolidation.
Yet a near-dearth of buy recommendations on Netflix shares now reflects the skepticism that anyone is about to bid for this company. Never mind the poison pill that Netflix put in place after Icahn acquired a near-10% stake. There are bigger hurdles to an investor’s ability to make money on a Netflix takeover now. And it would take quite a big price on one to make up the losses to its longer-term shareholders.
One of the biggest obstacles to any Netflix takeover lies in an off-balance sheet liability that shows up in its latest 10Q: $5 billion in commitments to pay for content over the next several years, including about $2.1 billion over the next 12 months. (Netflix says this debt doesn’t show up because the content is not yet delivered.) These are fees in excess of the $1.22 billion in current liabilities Netflix officially reported, and its $400 million of long-term debt.
That $5 billion covers mainly the rights to movies and television programming that will be available elsewhere too; aka, potential suitors likely have their own agreements for a lot of this stuff already. Netflix’s costs for content have been rising, and competitors have refused to license it some of the most popular programming.
The price of a Netflix share now also represents a turn-off to potential suitors, although Icahn pooh-poohs a focus on the company’s incredible PE ratio. (It’s easy to see why. On this measure, Netflix is the most expensive stock in the S&P 500. Icahn purchased his shares at an average $60, which represented a PE of 33 in the second quarter.) But it’s hard to find a measure that looks particularly enticing. An enterprise value ratio that might be a better indicator for such a growing company but it gets skewed deceptively lower because that $5 billion commitment doesn’t get calculated as debt.
The general slide of the EV/Revenue figure, however, probably indicates lowered expectations about Netflix’s future sales prospects. A slowdown in domestic subscriber gains reported with its latest earnings didn’t help this impression. Most of Netflix’s earnings now come from a DVD-by-mail business that’s dying.
None of this makes Icahn’s merger plans impossible. Viewers flock to Netflix now because it’s a cheap service with the biggest library, despite its limitations, and swallowing it whole must be tempting. But don’t be too surprised if all those potential bidders decide to wait, to see whether this growth, and this share price, can really last.
Dee Gill is a contributing editor at YCharts, which includes the just-released YCharts Pro Platinum for professional investors.