Why Disney Snapping Up Netflix Makes Surprisingly Good Sense

A marriage between entertainment conglomerate Disney (DIS) and online video streamer Netflix (NFLX) could be the stuff of fairy tales. At least, that's how Bernstein's Todd Juenger see it.

In a Thursday note, the analyst wrote that he is "surprisingly" open to an acquisition by Disney of Netflix, which would come at considerable cost. He added, though, that he is not calling for a deal and has no idea if one is in the works.

Disney stock was rising about 0.4% to $99.50 in mid-morning trading on Thursday. The stock is down about 6% year-to-date. Shares of Netflix, which is based in Los Gatos, Calif., were down 1.3% to $115.37 on Thursday. Netflix stock has risen about 2% so far this year.

A tie-up between the two has been the subject of much recent speculation. The companies have also already set a precedent for working together. In September, Netflix became the exclusive pay-TV service for new movies by Disney's Marvel, Pixar, Lucasfilm and Disney Studios.

Juenger noted that initially he was skeptical of a merger between the two companies because of the cost, which Juenger noted could be as much as $70 billion. In addition, Juenger wrote, "to the extent that Disney accelerated the success of the company being acquired (which is usually the point of an acquisition in the first place), the faster it would cause the demise of Disney's core TV network businesses," he said.

"But then we reminded ourselves -- we believe the demise will happen anyway," he added.

Disney, based in Burbank, Calif., owns networks such as ESPN, the Disney Channel and Freeform, formerly ABC Family. In the 2016 fourth quarter ended Oct. 1, Disney's overall media networks revenue slid 3% year-over-year, led by a 7% decline in cable networks revenue.

For ESPN specifically, the company said that the bottom line was affected by lower advertising and affiliate revenue, as well as higher programming and production costs.

In Netflix's 2016 third quarter ending Sept. 30, the company saw a 36% year-over-year climb in global streaming revenue.

In Disney's case, as its core TV network businesses decline, Juenger argued that it's better to own the dominant solution -- i.e. Netflix. "Imagine the appeal of a Disney/Netflix-branded SVOD service," he wrote. 

But Juenger acknowledged that a tie-up between the two giants would be a "huge, dilutive, transformational event," estimating that a deal of around $70 billion would translate to roughly a 31% dilution in stock value for Disney shareholders.

Juenger noted that Disney could instead invest money in growing its own streaming business, but that the benefits wouldn't necessarily outweigh the negatives. "Disney could build for less than $70bn, but it would take a long time, the expense would flow through [profit and loss] the entire time, and they would still have to compete with NFLX forevermore," he wrote.

Ultimately, he noted that the significant dilution wouldn't matter so much.

"To us what matters is whether the thing you bought is worth, to your shareholders, more or less than what you paid, and how does that compare to the [net present value] of the next best alternative," Juenger wrote.

Juenger has a "market perform" rating and $102 price target on shares of Disney.

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