Should Apple Buy Netflix? First In A Series
There has been a lot of chatter over the past few years that Apple should make a more drastic move into the media/entertainment industry. While the company has been nibbling at the edges it made a major move this past week hiring two Sony Pictures Television executives where they have served as presidents since 2005. Jamie Erlicht and Zack Van Amburg have been instrumental in more than tripling Sony’s original primetime shows and utilizing Amazon, Hulu and Netflix for distribution.
One acquisition that investors and analysts have been calling for Apple to do is to buy Netflix. While there are strategic reasons that this acquisition could make sense (but would also have its challenges in various ways) I’ve built a financial model for the combined company with projections three years out. I’ve downloaded it into a Google Doc that is available via this link so that you can see my assumptions.
The first set of assumptions are for Apple’s and Netflix’s revenue, gross margin, operating expense ratio, other income and interest expense, tax rate and share count three years out from their last fiscal year.
The second set is the premium Apple will have to pay above Netflix’s current stock price (I’m using 30%) and how Apple pays for it using debt and/or stock. I’ve run three cases with 100% debt, 50% debt and stock and 100% stock. These provide EPS estimates and can be compared to a three year base case if Apple does not buy Netflix.
Obviously making three year projections is imperfect and more cases than the ones I have done would be run by an acquirer. However the results at least provide some insight what the financial ramifications would be with the merger.
Apple is a slower growth company than Netflix and has a longer history to make some rational projections. However given that the company’s iPhone hit driven revenue stream that makes longer term projections harder. That being said these are my Apple assumptions over three years.
- Average revenue growth of 5% per year
- Gross margins decrease from 39.1% to 37.0%
- Operating expenses as a percent of revenue fall slightly from 11.2% to 11.0%
- Operating margin falls from 27.8% to 26.0%
- Other income increases from $1.3 to $2.0 billion per year
- Tax rate stays essentially the same at 25.5%
- Share count decreases by 4% per year
When you run these assumptions Apple’s EPS increases from $8.47 in fiscal 2016 to $10.45 in fiscal 2019. So the $10.45 of EPS becomes the baseline to compare buying Netflix.