Is There a Consolidation in Play for Netflix?

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There has been some investor frustrations with Netflix’s (NASDAQ: NFLX) lackluster stock performance, even since the stock’s near-$300 days about a year ago. The recent investment in Netflix by activist investor Carl Icahn seems to have provided a temporary lift for the stock, alleviating some investor disappointment for now. Mr. Icahn is best known for his use of investor activism to maximize shareholder value. He usually invests in undervalued companies by purchasing substantial stakes, and then pushes for business reorganization, often through selling off unproductive operations, to uncover hidden value for shareholders. As successful as Mr. Icahn has been, his other recent media holdings, Lions Gate and MGM, didn’t seem to have produced his intended results. So what can be expected from Mr. Icahn’s latest undertaking in Netflix?

Based on Netflix’s price-to-equity ratio, currently at more than eight times the company’s book value, Netflix doesn’t seem to be really undervalued. Such a multiple between price and shareholders’ equity actually compares fairly close to that of Apple, whereas Apple is everything but undervalued. Of course, Netflix’s stock price may rise further when the company’s business performs better over time with more earnings accumulated into equity. But will Netflix’s future business improvement likely come from industry consolidation, as predicted by Mr. Icahn, or independent growth?

According to Mr. Icahn, Netflix may be a desirable acquisition target for larger rivals. But by all measures, Netflix is currently the biggest player in the market for DVD rental and video streaming. If there is any consolidation, wouldn’t it be Netflix that might want to acquire other smaller companies in the sector? Well, Mr. Icahn was referring to deep-pocket companies like Amazon (NASDAQ: AMZN) or Google (NASDAQ: GOOG) as potential buyers. Surely, Amazon and Google are larger companies, but they seem to have only a tiny portion of their diversified business in the area of video streaming, making them smaller challengers to Netflix at the moment.

Based on their relative competitive positions in the video-streaming business, it’s a bit counterintuitive to think that Amazon or Google, each with a much smaller market share, could gobble up Netflix, which has a far more imposing market presence. The normal rationale for industry consolidation seems to prescribe that a larger company take over a smaller company struggling for survival amid competition. Thus, we may not see someone acquiring Netflix anytime soon. On the other hand, Netflix’s other smaller rivals, such as Blockbuster and Redbox, all seem to be holding up ok within their respective market niche, also preempting any potential takeover by Netflix.

But Mr. Icahn has his own consolidation theory in suggesting Amazon and Google as potential buyers of Netflix. His premise for a Netflix consolidation is that companies entering the video-streaming market would prefer buying over building. It sounds like a clever idea, but in a consumer market like video streaming, such a business maneuver might constitute anti-competition and stir up concerns from consumer advocacy. Though still limited, the video-streaming services from Amazon and Google do provide a different choice for consumers, as both companies offer individual video streaming without the need of a monthly subscription, something required by Netflix. For customers who don’t watch movies or shows on a regular basis, such a choice is available and makes more sense to them. But we all know that consumer choices can quickly disappear if there aren’t as many companies out there as a result of industry consolidation.

Even if Amazon or Google were to buy Netflix, the overriding reason would most likely be to eliminate the competition. There aren’t really any barriers to market entry and building a video-straming business, especially for Amazon and Google, both of which already have their own digital distribution platforms -- the Kindle and the various Android-supported devices. All they really need is to negotiate streaming rights with movie studios and other networks. It makes little sense for a so-called larger rival to buy Netflix, as the business model of online video streaming can be easily duplicated once access to the same viewing content has been secured. Admittedly, Netflix has started producing its own original content aimed at attracting more subscribers. But programming is a totally different pursuit than simply setting up computer servers for online content delivery. Absent highly-rated and widely-popular shows, having original content in and of itself may not really make Netflix any more desirable in a potential consolidation.

While investors may feel encouraged by Mr. Icahn’s Netflix investment, they don’t want to be disillusioned about getting a quick consolidation deal. The future market for online video streaming will probably first see a lot of competition, and as the sector cycles through, consolidations may come along. As for now, the way Netflix can realize its business potential and uncover any hidden value for shareholders is probably to perfect its service offerings and content delivery mechanism, which warrants separate discussions.

JJtheArdent has no positions in the stocks mentioned above. The Motley Fool owns shares of, Google, and Netflix. Motley Fool newsletter services recommend, Google, 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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