Why Comcast Needs to Partner With Netflix

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When I read Will Richmond’s recent article on VideoNuze calling for Comcast (CMCSA) to partner with Netflix (NFLX), my initial reaction was “Yeah! What he said.” Since my editors won’t take it kindly if I end my commentary there, I will elaborate.

Comcast Sign

As I recently noted, Time Warner’s (TWX) plan to offer its premium HBO cable channel as an online streaming service next year won’t just disrupt the decades-old model of the pay TV industry, but it will completely dismantle it.

Freeing HBO from the shackles of the cable and satellite box will lead other companies, such as Viacom (VIA), to follow suit with its popular channels, such as Comedy Central. Other channels, like A&E’s History — which is co-owned by Disney (DIS) and Hearst — and Discovery Communications’ (DISCA) OWN (Oprah Winfrey’s network), would be crazy not to consider the same thing.

The possibilities are endless — and for Comcast, that is a problem.

Why Comcast Is in Trouble

Among the many superlatives that one can use to describe Comcast, founded in 1963 by Ralph Roberts, is the world’s largest provider of cable service. CMCSA has more than 22 million video customers and, despite concerns about “cord-cutting” trends, that business remains hugely important.

During the third quarter, Comcast’s video business generated $5.18 billion in revenue, a 1% increase on a year-over-year basis. It is the company’s second largest business behind NBCUniversal, which posted $5.92 billion in sales.

Once HBO Streaming launches, the number of people who quit pay TV service will climb although it probably won’t destroy Comcast’s video business. Estimates are that about 7 million people have cut the cord, but in its Thursday earnings report, Comcast said the rate of cord-cutting has slowed.

Many Comcast customers will probably stay put because of a combination of inertia and fear of the unknown. Also, CMCSA will be able to hold on to many of these people as Internet customers because cord-cutters will still need a broadband connection stream their video content.

Indeed, one of the main reason why Comcast wants to buy Time Warner Cable (TWC) is to expand its Internet business, a fact that CMCSA’s many critics have pointed out. The deal, though, as Richmond notes, is far less of a sure thing than investors may realize.

That being the case, CEO Brian Roberts (Ralph’s son), is probably worried about his margins being pressured since HBO Streaming will make its much-hyped triple-play package — a cable, phone and Internet bundle — less attractive.

That’s why it makes sense for CMCSA to partner with NFLX sooner rather than later.

As Richmond notes, the timing is right for NFLX, which recently reported a disappointing quarter and suffered a steep drop in price:

“A Comcast deal would help re-energize subscriber growth, as it’s quite possible that just 6-8 million of Netflix’s domestic subscribers are also Comcast subscribers. That means 14-16 million are not — a huge pool Comcast could help Netflix access cost-effectively. A deal with the biggest U.S. pay-TV operator would also cheer investors, as it would be a bellwether for other deals to follow.”

I think the partnership looks so smart that Comcast should even consider buying Netflix.

CMCSA has a market capitalization of about $133 billion, so it can easily afford NFLX, which the market values at about $23 billion. Shares of NFLX stock are certainly much cheaper than they used to be because of the disappointing earnings report. NFLX shares are basically flat for the year to date — trailing the S&P 500.

With a price-to-earnings multiple around 100, Netflix shares are hardly cheap, but that’s all relative. Its five-year high valuation is 318 according to Reuters. NFLX stock is volatile and won’t stay this inexpensive, so the time for investors with a high tolerance for risk to buy the shares is now.

The big question that CMCSA would have to answer with any NFLX acquisition would be what would happen to NFLX’s unpredictable CEO Reed Hastings. CMCSA would have to pay him about $10.5 million under the change-in-control provisions of his employment agreement spelled out in the latest NFLX proxy.

Money, though, may not be a motivating factor for Hastings, whose reported net worth is near $1 billion. Moreover, Brian Roberts may not want Hastings to walk either.

Roberts has never craved the spotlight that Hastings seems to enjoy. In theory, Hastings could become Comcast’s head of original content who would figure out how to find new audiences for the company’s myriad of properties such as the NBC television network and the Syfy cable channel.

Indeed, the idea of merging Comcast and Netflix is so compelling, it almost seems ridiculous not to pursue it.

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 As of this writing, Jonathan Berr does not own shares of the aforementioned stocks.

Jonathan Berr is an award-winning freelance journalist who has focused on business news since 1997. He’s luckier with his investments than his beloved yet underachieving Philadelphia sports teams.


Article printed from InvestorPlace Media, https://investorplace.com/2014/10/comcast-cmcsa-needs-netflix-nflx/.

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