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Netflix: Icahn-ic Brand or Unopened Pandora’s Box?

Douglas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Ever since activist investor Carl Icahn jumped into the breach, Netflix (NASDAQ: NFLX) has shown some signs of life. After establishing a 10% ownership interest in the company, Mr. Icahn has been actively hinting at a hostile takeover while pushing an acquisition play by another tech giant. While the turmoil has suddenly made the company interesting again, opinions as to its viability for acquisition are very mixed. With 30 million subscribers, Netflix is not without value; trading at a P/E north of 100, however, and not free of plenty of other issues, it remains uncertain if any potential suitors will bite.

Suitors and Competition

Depending on the day, Microsoft (NASDAQ: MSFT) and Amazon (NASDAQ: AMZN) are usually counted as the two most likely buyers of Netflix. Microsoft makes an interesting play because as the company strives to enter a renewed renaissance, it is pressing hard on product offerings across the board. Between its enterprise business, Windows 8, the new Surface tablet and other divisions, the company has shown that it wants to compete at every level. The recently announced Xbox Music service might give some indication of how a Microsoft bid would play out – the company decided to tie its music business to its popular Xbox brand. As many users already use their Xbox as a conduit to receive the Netflix service, it would be a relatively easy add-on.

Amazon, on the other hand, makes a far less obvious buyer in my opinion. With the launch of its enhanced Amazon Prime service, the company is taking a direct shot at Netflix. While content continues to favor Netflix, Amazon has negotiated several critical contracts that should position its offering for success. Amazon is likely to gage its own traction before opening its balance sheet to the high premium a Netflix purchase would require.

Beyond the above two companies, the competition in the streaming video space has become intense. Apple (NASDAQ: AAPL) continues to push forward with Apple TV; Google has begun advertising its own take on enhanced streaming video in additional to what it offers through YouTube; Hulu is solidly in the mix; Comcast has released its own version of the service called Stream Pix; and Verizon and Coinstar’s Redbox are testing a pilot program to combine DVD rentals and a streaming option that is expected to be fully released by Christmas. This is becoming a crowded industry accompanied by all of the pitfalls of extreme competition.

The Pandora Problem

Much like online radio provider Pandora (NYSE: P), Netflix does not want to be acquired. While many industry commentators have long seen Pandora as an obvious add-on for one of the mammoth tech providers, the company has pushed to remain independent. One of the offshoots of this stance is that the big players are finding it easier to enter the market independently. Apple, for example, recently announced its own music service that will directly compete with Pandora. Rather than pay a significant premium for Pandora, and its very loyal base of users, Apple believes it can do fine head-to-head. Microsoft’s Xbox Music can also be seen as a direct Pandora competitor.

If Pandora, which has arguably some of the most loyal users in the world, is easier to compete with than purchase, it is hard to imagine Netflix makes a reasonable acquisition. The first-mover advantage that the company once enjoyed was squandered when the company so thoroughly mishandled its pricing increase and division of its streaming and DVD businesses. While I see the appeal of Netflix being absorbed by a larger corporate parent, it remains unclear if the company brings enough to the table.

Overview

As Mr. Icahn works with, and sometimes against, management in an effort to revive what was one of the fastest growing companies around a few years ago, shares look overpriced to me at current levels. While I would be hesitant to be on the short side of Netflix, should an acquisition actually occur, I think there are far better options elsewhere. Even as a speculative play, other stocks have a better risk-reward profile. As much as I like the service, I would avoid the stock.


Mr. Ehrman has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple, Amazon.com, Microsoft, and Netflix. Motley Fool newsletter services recommend Apple, Amazon.com, Microsoft, and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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