by Jonathan Berr | March 26, 2014 2:38 pm
Apple (AAPL) CEO Tim Cook and his counterparts at Comcast (CMCSA) and Netflix (NFLX) Brian Roberts and Reed Hastings are no doubt familiar with the famous quote from ancient Chinese military strategist Sun Tzu: “Keep your friend close and your enemies closer.”
It’s an apt line to describe the media industries where everyone is a “frenemeny” with everyone else. Nowhere is this relationship more evident than in the recent reports that Apple and Comcast were in preliminary talks about starting a streaming video service. Shares of Netflix sold off on the report, tumbling almost 20% over past three days.
That move is an overreaction.
Investors with a high tolerance for risk should snap up NFLX stock because it’s going to move back up. People are writing the eulogy for the Los Gatos, Calif., company based on a speculative, anonymously sourced article. That’s crazy.
But beyond the obviously overdone NFLX stock move to the downside, let’s dig into this story and see if we can unpack how this may shake out.
The motivations for Apple and Comcast to join forces are obvious. Apple is coming under pressure from Wall Street to generate the hyper-kinetic growth that investors have grown accustomed to for most of this decade. Comcast needs to protect its cable business, which has been under threat from the growth of cord-cutters (people who quit pay television) and cord-nevers (people who never signed up in the first place.) What better way to solve both of their problems than by developing a business that would target Netflix?
Many analysts and bloggers noted that with its $50 billion in cash, Apple can easily afford to buy Netflix (which has a $22 billion market cap). In fact, an Apple-Netflix merger makes so much sense, it’s surprising that it hasn’t happened yet.
But hypothetical deals are a lot like fantasy football — easier to play than the real thing.
Netflix, which trades at a forward multiple of about 80, certainly would be no bargain, especially since the shares have more than doubled over there past year. Then there’s Netflix’s colorful CEO Reed Hastings. It seems unlikely that he is looking to cash out given he orchestrated the company’s remarkable comeback from the Qwikster fiasco. Also, I can’t imagine Hastings — who started Netflix because he was miffed about his poor treatment by Blockbuster (remember them?) — ever working for anyone else.
There are also lots of problems that Comcast and Apple would have to overcome for any partnership to work. For one thing, creating a Netflix-killer would take time and money — billions — to create a library of original and repurposed content. The IT costs would be huge as well. Netflix, which has 22 million customers, also has a huge head start.
As numerous commentators have noted, figuring out how Comcast and Apple would split their revenue from a partnership wouldn’t be easy. The fact that Comcast is even considering splitting its customer revenue with anyone speaks volumes about the huge challenges that lie ahead for the pay television industry.
Comcast, though, doesn’t have a gun to its head. In the most recent quarter, the Philadelphia-based company posted its first gain in video customers in six years. Wall Street analysts and bloggers often underestimate the power of inertia. People stick with cable companies even though many hate them because they would rather deal with the devil they know.
Then there’s the access to the content. Comcast, the parent of NBC Universal, will demand billions in fees from Apple. Given tremendous price competition in the pay television sector, any Apple-Comcast offering would have to be priced pretty cheaply. Given the thin profit margins, Apple may not be willing to pay the content fees that Comcast will demand. Unlike the music industry — which was on death’s door at the dawning of the iTunes age — Comcast is still profitable and isn’t going let Apple dictate terms of their arrangement to its advantage.
The other issue is Apple’s reported insistence of receiving preferential treatment over the “last mile” of Comcast’s network. Netflix has recently signed a similar arrangement with the cable giant, though CEO Reed Hastings noted in a recent blog post that the company wasn’t “paying for priority access against competitors, just for interconnection.” Comcast and Netflix are continuing to bicker. As Sam Gustin noted on Time.com, Comcast is balking at the notion that it is exacting an unjust tax from Neftlix.
Regardless, It’s unclear whether the FCC would go along with those arrangements. Comcast needs the FCC to approve its $45 billion acquisition of Time Warner Cable (TWC), and net neutrality is an issue that they will closely scrutinize even though the FCC’s rules were thrown out in federal court. For its part, Comcast has agreed to maintain its commitment to net neutrality until 2018 to get approval for the Time Warner deal.
Like everything else involving media and technology, a theoretical Apple-Comcast alliance is much easier said than done.
As of this writing, Jonathan Berr did not hold a position in any of the aforementioned securities.
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