June 10, 2022

Breakingviews: Netflix M&A ad ponder has expensive logic

by Breakingviews.

Netflix co-Chief Executive Reed Hastings has opened the door to running advertising on his streaming service, after years of resistance. That shift could pry loose another opportunity to make a rare acquisition to kickstart the initiative. The problem is that prices are too high.

It would make sense for Hastings to consider buying an ad platform rather than building one out. The company already is dumping loads of cash into acquiring TV shows and movies—content obligations are at more than $22 billion. Building out a business has risks, and it could end up wasting money. Plus with competition ramping up among rivals like Walt Disney and Amazon.com, he can’t afford to be distracted.

Roku is one candidate that makes sense. The $14 billion platform sells devices that stream content from other video services, including Netflix. Additionally, it has an advertising network that makes up a chunk of its top line. First-quarter platform revenue, which primarily consists of ads, rose 39% year-over-year to $647 million with a gross profit margin nearing a chunky 60%. Plus Roku has a history with Netflix – it was spun out from the streaming service in 2008. And shares of Roku have fallen more than 50% year-to-date, making it much cheaper than it was several months ago.

That could be one reason employees at the company believe Netflix is sniffing around as a buyer, according to a report from Insider. The trouble is that Netflix’s stock price is down almost two-thirds since the new year. So Roku is relatively expensive. Its enterprise value is worth about 70 times estimated 2022 EBITDA, according to Refinitiv. Netflix is a measly 14 times. Rivals aren’t much better. The $26 billion ad tech firm Trade Desk is valued at around 40 times forecasted EBITDA this year. Software firm Adobe, also in the ad space, is at least in shooting distance, at 22 times. However, Adobe’s market capitalization is more than twice as big as Netflix’s.

That’s not to suggest Hastings and his co-CEO Ted Sarandos won’t get creative. Netflix’s fortunes have changed: It reported it lost subscribers and many of its competitors including Warner Bros Discovery’s HBO Max and Disney’s Hulu, already have commercial-supported cheaper tiers. It just means Netflix shareholders are going to pay, one way or another.

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