Summary
- Shares of Roku are up 11% due to speculation that Netflix may acquire the streaming platform.
- Netflix risks losing its focus as a content publisher if it also wants to become an advertising company.
- Roku will no longer be a neutral CTV advertising outlet if the merger takes place.
- The deal could be highly dilutive to Netflix shareholders as Netflix will need external financing and Roku isn't a profitable business.
- I see a better path for Netflix to stay focused on creating the most engaging content in the streaming space.
Shares of Roku, Inc. (NASDAQ:ROKU) are up almost 11% on speculation that Netflix, Inc. (NASDAQ:NFLX) may be looking to acquire the streaming company with more than 60 million households. While a potential merger between both companies could make sense from a vertical integration standpoint, I believe it is unlikely to happen for several reasons.
First, Netflix's position as a content publisher requires massive investments (e.g., $17 billion in 2022) to keep customers engaged. By diverting its attention to becoming an advertising platform, Netflix risks allocating less resources to producing the best films and series to compete against the likes of Disney+, HBO Max, and other AVOD offerings. In 1Q22, Netflix lost 200,000 subscribers and guided another 2 million subs loss in 2Q22.
As ARPU becomes a key metric following subs loss, Netflix is looking to explore an ad-supported tier and raise prices on its 100 million users who share passwords. In an inflationary environment, consumers are likely to react to Netflix's price hikes by either canceling the service or trade down to a lower-priced tier. As a result, content must be nothing short of spectacular just to keep users from leaving, and Netflix cannot fully devote itself to its core activity if it also wants to become an advertising company.
Second, Roku will no longer be perceived as a neutral platform (though it does have the Roku Channel which competes with other AVOD providers) if Netflix becomes the owner of the TV OS operator. It would be very difficult to imagine a Netflix-owned Roku to ask for ad inventory from any scaled SVOD or AVOD services such as Disney+ and Peacock, as Netflix essentially competes for the same eyeballs. Roku does have a history with Netflix given it was an internal project that got spun out of Netflix in 2008, but the spinoff took place out of Netflix's concern that having its own streaming platform would impact the distribution of its streaming app.
Third, the deal doesn't make much financial sense in an increasingly challenging environment where investors are looking for profits more than anything else. Roku is not a profitable business, as the company guided 4% adjusted EBITDA margin in 2022, implying a negative operating and net margin. The company had a market cap of ~$12 billion before the merger headline emerged vs. Netflix's $88 billion. Assuming a 30% premium on Roku, Netflix would be paying $15.6 billion, or almost 18% of its market cap, for Roku. Given Netflix has $6 billion of cash and $14.5 billion of long-term debt, it will need external firepower to materialize the deal either through more debt or share issuance. Obviously, this will be dilutive to Netflix shareholders.
In short, the deal does look interesting at face value but is unlikely to take place in my view. Netflix management has shown interest in offering an ad-supported tier, but it would be surprising to investors if it wants to go as far as transforming itself from a pure-play SVOD player to a CTV advertising platform. In short, I see a better path for the company to stay focused as a world-class publisher of critically acclaimed series such as OzarkandStranger Things.
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