Netflix Buys Warner Bros: The $83 Billion Mistake?

Netflix just announced that it's acquiring Warner Bros. in one of the more interesting media transactions of modern history. The number one streaming company is buying one of the largest media companies in the world, consolidating a large chunk of the streaming market. Following the news, Netflix stock sold off 2.9% on the day, and Warner Bros. discovery stock went up 6.19%. This is a company that was doing terrible in terms of market valuation, but is up 144% over the past year, thanks to the past few months of acquisition speculation. So it's been a great year for Warner Bros. discovery shareholders. So today I'm going to give you a full breakdown of the deal, what it means for investors, how this will change the long-term valuation and competitive dynamics around Netflix, and ultimately whether I think this transaction was actually a good move for Netflix shareholders. And right now it certainly seems like a mixed bag, and I'll be giving you this take as a complete outsider who does not own either of the stocks, I've just been following the industry for a number of years, and I find this to be incredibly interesting. My name is Zach, this is Dividend Data, and you should leave a like and subscribe to the channel if you enjoyed the video. So first let's break down the deal. So it's valued at $72 billion in equity, with a total enterprise value of $82.7 billion because Netflix will be absorbing some of Warner Bros. debt. The deal is in both cash and stock. So each Warner Bros. discovery shareholder will receive $23.25 in cash, and about $4.50 in Netflix stock per share. In combination, that values Warner at $27.75. So that's a big premium for Warner Bros. shareholders, especially when you consider the stock was trading at $10 or $11 a year ago. But that's not it, because Netflix is not buying the entirety of Warner Bros. discovery. They don't want the terrible cable television assets. So that's being separated out into a new publicly traded company. That will include things like the Discovery Networks and CNN. Netflix is acquiring the film and television studios. They are also acquiring the video game studios, which I'm not seeing talked about often. So that means Netflix will now own many iconic franchises, whether it's Harry Potter, Friends, Game of Thrones, the entire DC Comics franchise with Batman, Superman. And most importantly, they can consolidate HBO Max over time, which should bring them some more subscribers and really change the competitive dynamics of the streaming landscape. But the crown jewel in this deal really is HBO. Some of the best scripted television series of all time. Shows like The Sopranos, The Wire, and my personal favorite, Succession. Big fan of that show. But they continue to just generate quality show after quality show after quality show. So there's going to be a lot of great content coming to Netflix. And I'll be talking a lot about whether or not this is actually a good deal financially for Netflix and how it changes the competitive dynamics of the market. But one of the more annoying parts of this deal is that for the next year and a half, at least, we are going to be hearing constantly in the news about whether this deal will actually end up being approved. And it already is seeing steep pushback. Most notably in Hollywood, they do not like the consolidation. You have all the big unions and actors guilds and directors guilds coming out against the deal. And this large of an acquisition in the media space really would not have been tried a few years ago. The only reason this is remotely possible is because of perceptions around the Trump administration being pro-merger and acquisition. And now we are getting a very interesting case study of how that's going to play out. And we're already seeing reports that the Trump administration may be more skeptical towards this deal than you would have thought. And we could go down the whole politics side of it, where you have the whole Ellison family, David Ellison, who's now running Paramount Skydance. He was trying to acquire Warner Bros, but ultimately they chose the Netflix bid over the Paramount Skydance bid. And you know, there's personal relationships, but also in terms of making a competitive media market, Warner Bros going with Paramount Skydance would have created another large player that would have competed with Disney and Netflix in that streaming space. Instead, Netflix is now just becoming an even more dominant player. And we'll talk about that later when we get to Netflix's strategy around this acquisition. But ultimately, whether or not this gets approved depends on how the regulators actually think about the streaming space and the media market. Netflix is going to make the case around screen time and TV viewing percentage. And they're going to argue that they're competing with social media, all these digital platforms, all the other streamers and services like YouTube, which are starting to dominate even in TV time. And I actually think in the big picture, that really is the actual argument. But if the regulators decide to specifically focus on the streaming space and the media market, and they hyper-focus just on that, then there's actually a pretty strong case for blocking this transaction, because it really would impact the competitive landscape. This is going to be a big story for a while though. And we'll know a lot more about it once Trump and the actual administration start to make comments on it. They love to talk about this stuff. So we'll know more about it soon. Now the other big thing about that is that Netflix has also offered a $5.8 billion breakup fee. So if they break the deal off, then they have to pay money. And interestingly, Warner Bros Discovery would pay Netflix a $2.8 billion breakup fee if the deal collapses. As an example, if they choose to go with the Paramount bid because they think it might have a higher certainty of regulatory approval. So this is a pretty firm agreement and there are negative incentives on both sides to break it up. And if you're newer to following mergers and acquisitions, these breakup fees are common because there is a time value associated with clogging up these businesses in transactions that may or may not happen. And you could waste a company's time for a year or two. And that time is quite valuable. Alright, so now let's get into the stock analysis. I'll start with Warner Bros, but then I'll spend a lot of time deep diving into Netflix. My main comment here with Warner Bros is just congratulations to the shareholders. Congrats to David Zaslav. I'm sure he is very happy right now that he turned this thing that looked very negative for quite a while into a gigantic win. Now let's get to Netflix. As you notice, the stock sold off today. Really you can't read that much into it. A 3% drop. That often happens with a lot of large acquisitions and a 3% drop is pretty minor. If the market really hated the deal, the stock could have dropped 10, 15, 20%. So I wouldn't read too much into that. So let's get into analyzing this. But then in a somewhat related, but actually slightly different question, whether or not this was good for Netflix shareholders right now. And then I'll also cover the multi-decade view of investing in Netflix. So first, let's just explain what Netflix got. They got a truly incredible content library. I'm talking a century of content. And that includes the high-end scripted series like HBO, and then just very popular shows, whether it was Big Bang Theory or Friends. Things that people just binge watch, which is perfect for Netflix. Then you have the prestige shows like Sopranos, Game of Thrones, Succession. The other thing, Netflix gets to, over time, take out one of the competitive streaming services, HBO Max. They get to absorb those subscribers. So that cleans up part of the competitive landscape and makes Netflix even stronger. But there are a lot of logistic questions around the move. Right now, Netflix expects to maintain Warner Bros. current operations, including theatrical releases, which is something Netflix has started to dabble in, but they really just like the straight-to-streaming service release. So that will be a very interesting nugget to see what happens with that five to ten years from now. Will they continue releasing in theaters or just go straight to Netflix? Or will more Netflix-produced films go to a theatrical release first before coming to the service? This is something that both Warner Bros. and Disney decided were the best strategies because you get to monetize it first. It's a little bit of free advertising. And then you get a second boost when it comes to the streaming service. And I think purely in terms of value creation, that's the best move because you get to monetize the assets multiple times. So personally, this is my speculation, I think Netflix will actually start to put more movies in theaters as well. So this move could end up being an actual good thing for the theaters. Then we have that massive library of content that will be coming to Netflix. And I think that could be a huge boost, especially if they strategically lay it out in a way where they kind of act like that's a release. And then they can invest even more in some bigger projects in the future. You could end up with a really killer content pipeline for a few years, plus a lot more subscribers coming in from HBO Max. Netflix also said that they expect to realize 2 to 3 billion dollars of cost savings per year when the companies combine. But one thing I'm really not seeing mentioned much, but I think strategically is a little bit of the background thought here as well. Warner Bros. Discovery actually owns quite a few video game studios. And video games has long been something that Netflix says they want to get into. They're dipping their toes. Warner Bros. releases some big hits. They had Hogwarts Legacy a few years ago, which crushed it in the market. So I think this could stand to actually accelerate Netflix's move into gaming as well. But now let's pivot to the actual business of Netflix, how it's valued as a stock, and how this move will impact them over the next few years and long term. So first let's just talk about where Netflix is currently at. 424 billion dollars of market cap, and they are valued at a very high multiple in the media space. And the reason is that they were a pure play streaming company. They didn't have those terrible legacy media assets that were declining. The market hated those. They assigned very low multiples to those assets. That's why you saw Warner Bros. Discovery, Paramount, Disney, Comcast, all of these companies trade at very low multiples. Netflix is trading at 40 times earnings. And the reason is that they just have the growth streaming business. So as you can see, Netflix's earnings per share continue to grow reliably at a high rate. They are already operating at scale and highly profitable. And prior to this transaction, analysts were expecting more than 20% earnings per share growth every single year moving into the future, and then slowing down in future years to around 15 to 20% growth. If we take a look at the revenue per share for Netflix, you can see that's been a consistent grower in the market, and they actually re-accelerated after a brief dip in 2022. And that was due to a lot of factors. You had accelerated growth in the pandemic, and then a slight dip afterwards. You had Netflix cracking down on password sharing and starting a habit of price increases. That's really part of the transition all these streaming companies had. When they turned focus into profitability, Netflix revenue per share has grown at a 10-year compounding growth rate of 21%, three-year CAGR of 10.66%. And over the past year, revenue per share grew 18.8%. And Netflix is starting to become a free cash flow machine. If we take a look at their free cash flow per share, you can see it's positive every single quarter now. And a lot of more casual viewers, they think very negatively about these companies, but they were burning money for a long time. In the pandemic, Netflix started to become profitable, and a lot of the legacy media companies, whether it was something like Disney, it took a few more years after that to start to become profitable. They're only just starting to grow profits now in the streaming business. Netflix is a few years in, and they have the most profitable streaming business, and this is only set to continue and march upwards. They have a good balance sheet. They had very limited debt, $25 billion of shareholder equity, $9.3 billion of cash and short-term investments, $7.2 billion of net debt. This is going to get a lot worse as they're absorbing a lot of the debt from Warner Bros. Discovery. Now, luckily, they have a lot of cash generation that they'll be able to pay that off with, but this move definitely hurts the balance sheet of Netflix. They're absorbing a lot of debt. Warner Bros. Discovery has $33.7 billion of debt. I'm not sure which percentage of that is going to Netflix and what's going to that new remain spin-out company, and that debt was actually a lot higher. Luckily, Warner Bros. Discovery generates a lot of cash, so they were paying off all of that debt. It went from $49.9 billion of net debt to $29.4 billion of net debt. The other big thing with this Netflix transaction, it will be dilutive to shareholders. Netflix will be absorbing more debt, and they will be issuing more shares. That's part of the cash. I'm assuming Netflix will also be using debt to purchase Warner Bros. Discovery because they don't have all that cash available. So this deal really is a combination of debt and dilution. And the hope from Netflix's perspective is they'll be able to absorb a lot more subscribers from HBO Max. Now, how much I think that actually is, I'm not sure, because I imagine a lot of those people subscribe to both services. I'm sure they dove into that in their due diligence. The other thing I think Netflix is bound to be doing now is they will be raising prices, and they'll have a better argument to do so because there's going to be a lot more value on the service. So that'll be good financially for Netflix, and that's how they're going to be able to pay off a lot of this transaction. But that will start to create even more negative sentiment that you already see from a lot of these streaming companies. Now, in my opinion, I think people will pay it. They'll complain, but they will pay it. And I really don't even know what you can do in this world about people not complaining. So what do I think about this transaction in terms of Netflix's valuation? I'll give you the bull case and the bear case. I'll start with the bear. I think you can make a very strong argument that this move is going to be worse for Netflix shareholders over the short term. For one, you're going to have a regulatory overhang for the next two years probably. And then two, you're absorbing a lot of legacy media assets that the market hates and does not value highly. You're going to start getting negative headlines when you have movies that bomb in the box office, even if financially speaking it has very little to do with the economics of the business. And I think the perception of Netflix as a pure streaming company, even though financially it still will be, I do think there's a real risk of potential multiple compression at Netflix from the perspective of investors. One of the big reasons why Netflix stock has risen so much in the past few years is because of multiple expansion. Now Netflix used to trade at a very high multiple, that's partly because they didn't have very many profits. But then as soon as they started to become profitable, we had that very negative bearish market and growth slowed down, that was during 2022. And Netflix stock was trading stupid cheap. It was a great buy at that time. You could have bought it at 18 P ratio, but then we saw a lot of growth in fundamentals, but also at that time, the market started to value Netflix stock higher again, around a 40 to 50 P ratio, which in media is unheard of. A lot of these companies trade at 10, 15 times profits. So Netflix investors have benefited from this large premium that the stock trades at. And frankly, that's the only reason Netflix was even in a position to do this acquisition because they're valued at $420 billion. They were in a position of strength. They didn't have to do this deal. And in terms of actual financials, like revenue and free cashflow, Warner Bros and Netflix are much closer than you would think, despite the fact that Netflix is valued 4 to 5 times what Warner Bros was. And as we look at Netflix stock over the next few years, the real risk is whether or not they continue to trade a high multiple. And I do think, especially over the next two years, you're going to see compression. But that does not say anything about the actual fundamentals of Netflix. I think they are set to continue growing and this makes them far stronger than ever. They have a wider moat, more dominant market position. But that doesn't mean shareholders are going to see any of that value in the next couple years. Purely speaking from shareholders, I think there is a much stronger case that Netflix could have just continued along its existing path. And I think they organically would have just continued to be the winner, investing in their own content library. And I think you could have used a quarter of that money and just bid it on NFL rights and sports rights. And Netflix arguably would have been in an even more strong position there in terms of shareholder value. And don't get me wrong, I'll get to the bull case. But there's no doubt that Netflix is absorbing a lot of baggage with this transaction. Warner Bros Discovery is a huge company. They have tons of employees and infrastructure. That's a lot to manage. And not to mention how deeply seeded in Hollywood this company is. And no matter what way you crack it, people used to say Netflix was a technology company. And I was with them for a long time. No matter what way you crack the egg, Netflix is a media company now. And if this goes through, Hollywood is going to infest the culture of Netflix. You will have unions throughout this entire company. You will have lawsuits. Netflix should kiss the idea of getting into anything AI related out of the picture. If you think anyone in Hollywood is going to be okay with that, you are crazy. So it's actually kind of like a difficult picture to analyze. Part of me, if I was running Netflix, I wouldn't want anything to do with that. I would be running away from the traditional Hollywood infrastructure. But then on my other side, I put on my John D. Rockefeller hat, and I'm thinking about competitive market dynamics, and this move is genius. And that perspective has 100% to do just with the competitive dynamics of market. By acquiring Warner Bros Discovery, they take that asset off the table from all potential other acquirers, whether it was Paramount Skydance with David Ellison. They were trying to build up an actual sizable competitor to Netflix in the streaming space. And now there's not really anything they can do to get to scale to actually reasonably compete. This move completely cements Netflix in the dominant number one position in media. When we talk about film and scripted TV series, and in terms of the actual media space, the only players that I think are going to be significant are going to be Netflix and Disney. All of these other legacy media companies, it's just getting harder and harder now. And by Netflix buying Warner Bros Discovery, it takes it off the table for those other legacy medias, whether it's Comcast, Paramount, they can't lever up to kind of become bigger players in the space. Also prevents any big tech company from taking those assets and rolling it into their streaming service, whether it's something like Apple, Amazon, those assets are now off the board. So Netflix is now locked in. But on the other side, you also have some big tech companies like the social media platforms. You have the whole video game industry. You have Google with YouTube. I don't think this move actually helps Netflix compete with those companies. I think YouTube is still the king and will continue to eat market share. And I think there really is a question of whether or not Netflix would have been better off with or without this acquisition. Yes, they pretty much locked in a top media streaming service, but you could definitely make the case they would have just been there anyways. And a lot of these other media assets, they might have just fallen off the wayside over time and become less and less valuable the longer and longer you kick the can down the road. Netflix did pay a very high price for this asset. But the bull case for Netflix is that they are going to be the global dominant streaming and entertainment platform. This is a company that eventually will have 400 million, 500 million subscribers, huge reach for something that's a paid service, unprecedented. Like I mentioned earlier, I think the video game production studios that will help accelerate their path into other forms of media, Netflix has signaled they want to get into video games. And I think as cloud streaming starts to enable that even more, we'll see that as part of Netflix's offering. And they should really be thought of as an entertainment subscription service. But this move, it really just locked down script, television, and film as core pillars of what that offering is. So with that said, that's my initial reactions to the Netflix acquisition of Warner Bros. Discovery. It's very interesting. I really do love looking at all this stuff and seeing how the business environment evolves. It's very interesting. And if you enjoyed the content, make sure to leave a like, comment, and subscribe to the channel. And by the way, if you want to use the stock research tool I was showing throughout, it's all available at DividendData.com. Link is in the description and pinned comment of the video. Thanks for watching, and I'll see you in the next one.