Why Netflix isn’t the key to Apple’s streaming dream

Like a lion stalking a herd of gazelles, Apple has been circling the TV business for years. Rumors of an Apple-branded television gave way to the Apple TV set-top box in 2007, which the company described for years as a “hobby,” but which CEO Tim Cook dubbed a “foundation that we can do something bigger off of” in a 2016 earnings call.

No doubt related to the fact that the latest versions of the device have significantly expanded the storage capacity and processing prowess. And that co-founder Steve Jobs, according to the 2011 biography published just three months after his death, said he had essentially “cracked” the code for building a TV and was reportedly interested in focusing his efforts there in the final weeks of his life.

Apple’s efforts in television have been confounded by on-again, off-again negotiations with content creators that have balked at the company’s terms. With M&A activity in the space white-hot now, with integrations in the air as cord-cutting quickens, those negotiations are only set to become more difficult. No surprise then that Apple has penned deals with Steven Spielberg and Oprah Winfrey, for example, to create exclusive programming.

But what about taking it a step further? What about buying Netflix, with its stable of programming (both exclusive and licensed from others) to secure a dominant position from which to survey this rapidly expanding space? (Netflix, as we explored in a previous post, faces stiffening competitive pressures and rising cash demands.)

The streaming titan is profitable and growing fast, with earnings of $290 million last quarter on $3.7 billion in revenue, which was up more than 40% from the year prior. Right now, Netflix is singlehandedly responsible for nearly a third of all internet traffic in North America.

Sure, it’d be expensive: Netflix is carrying a market cap of nearly $180 billion. But Apple has cash to spare, sitting on nearly $270 billion as of 2Q 2018. And “Stranger Things” have happened before.

Apple has pivoted to focus on services as a revenue growth area—with a goal of growing this space to $50 billion in sales by 2020—and found success. Revenues are up 31% YoY, picking up pace from the already impressive 18% YoY growth registered through 2017. Leading the way: The strength of iCloud storage and Apple Music, driven by Apple’s staggering 1.3 billion active devices.

As of April, Apple Music had 40 million paying subscribers worldwide, up 84% since the music streaming service was first introduced at Apple’s WWDC 2015. Late last year, Apple moved on Shazam to bolster both Siri and Apple Music, and earlier this year it also purchased Texture, a digital magazine subscription service, for bettering the News app for iOS.

To date, Apple has been content-agnostic, with Netflix integration into Siri and Apple TV devices already on point. The integration of a post-acquisition Netflix would likely become even tighter, with the platform becoming the default streaming video app preinstalled on every device Apple ships and potentially acting as a platform for other content providers. Such as sportscasts, for instance. With monthly subscription revenue flowing in.

Apple would also get an instant foothold in the living room, an area it has struggled to gain traction in, with possible synergies between Apple’s native apps and the Netflix app built into many smart TVs and set-top boxes. Imagine talking to Siri through your iPhone and seeing the results displayed on your television. Or showing off your latest Photo Stream on the big screen.

All of that would serve the interest of bolstering the Apple ecosystem by making the viewing experience more streamlined, on one hand, while raising the cost to users for switching to competing platforms on the other. Thus, helping sell more iPhones.

But are the benefits enough to justify the price of admission?

UBS analysts are bulled up on streaming in general, forecasting streamers to capture 25% of the pay-TV market in the next five years. That works out to 25 million streaming subscribers, up from the 9.2 million forecasted through the end of 2018. So a deal is certainly tempting.

But Morningstar director of TMT research Brian Colello believes a “Build It” rather than a “Buy It” content strategy makes more sense for Apple here given Netflix’s huge price tag. While Netflix has a commanding lead in terms of subscribers and binge-worthy programming, it’s worth noting that much of its programming has been developed with media partners, such as Disney for “Daredevil” and other Marvel-related series. Apple could replicate that. Or partner with creatives directly, as it’s doing now.

For Colello, there are no obvious benefits to be gained from platform exclusivity since it would alienate hardware buyers if Apple blocked competing streaming and video-on-demand apps from its hardware devices. Want to watch Fox Sports on your phone? Better buy an Android.

And besides, when someone signs up for Netflix via the App Store or the Netflix iOS app, Apple gets a cut anyway. So, it’s already getting a piece of the streaming revenue pie without really lifting a finger. Or spending a dime.

In an interview with PitchBook, Colello also deftly pointed out possible culture clashes and brand incompatibilities. Does Apple really want to be associated with shows like Netflix’s “Marco Polo,” a Weinstein Company-produced historical drama filled with nudity and violence that was canceled after two years for a loss of $200 million?

Instead, he posited that Netflix, not Apple, is the one that should be on the acquisition trail as competitors lock up content vertically, tying creators together with telecoms and likely leaving the company out in the cold. Especially with Disney’s streaming service expected to launch in 2019, potentially including the assets of 21st Century Fox, should its $71.3 billion bid be accepted by shareholders later this month.

Apple, Colello warned, would do best to steer clear of what he believes would be a “disastrous deal” for Apple amid an intensifying cash burn and an eye-watering valuation. Given Apple’s hesitance to engage in splashy deals—its $3 billion purchase of Beats is its largest acquisition to date—and the sheer cost involved, the sentiment is well-founded.

And thus, Apple’s hunt for TV glory continues. 
 

Watch for a follow-up post, the third in a three-part series, exploring possible acquisition targets for Netflix as it battles growing competitive pressures and industry consolidation. Read the first post here: Can Netflix fend off big name challengers?

PitchBook is a Morningstar company.

 

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