Amazon Not a Threat to Netflix, But This Stock Is
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In light of the secular change going on with iPads and tablets, Netflix may be well positioned to capitalize. However, perhaps the company would fare better under a larger parent media company? With Icahn owning 10% of the stock and shareholders upset with Netflix's management (to say nothing about the customers), a proxy contest could--and, in my view, should--be in the works. By replacing the board, Icahn would better be able to hold management accountable to a more shareholder-representative board. Since it is very hard to predict whether the company will ultimately be sold, one would be better off speculating whether Icahn could generate high enough returns through stirring up takeover chatter. Will this takeover chatter hedge against the stock's overvaluation? And are there any better takeover targets?
It seems that everything that should be said about Netflix has already been said. But billionaire activist investor Carl Icahn's decision to exercise his stock options for a 10% stake in the movie supplier brings plenty of speculation. While Icahn has already sent signals that he wants the company sold, management, as is usual in activist targets, appears unwilling to bend. The implementation of a poison pill and the existence of a staggered board are Netflix's major barriers to hostile takeovers. Since Icahn won't be able to gain board control even if he does win the proxy contest, one may naturally conclude that Netflix won't be taken over in the next year or so.
Not so fast. One of Icahn's first activist targets, Tappan, may provide an important lesson. The activist investor gained board representation in Tappan but came nowhere close to retaining board control. By threatening to seek greater representation, management agreed to his demand for a takeover, and Tappan was sold at more than twice the price Icahn originally bought it for. While Netflix may be several times larger, Icahn is also several times wealthier now. In fact, Icahn is worth 3.2x Netflix's market cap, so he certainly has the leverage to aggressively push for consolidation. I expect him to continue to make the demand and profit off of it.
The question then is whether there is enough upside left in the stock for Icahn to communicate value to the market. Some have argued that competitive threats ranging from rampant online piracy to Redbox, Hulu, and Amazon make the paid-for streaming business model inherently stable. But, if Amazon's $500 million - $1 billion loss on Prime Instant Video services (source: Netflix CEO Reed Hastings) is of any indication, Netflix has a leading content advantage. Icahn's argument is that a company, like Amazon, would be better off just acquiring Netflix, with its 27 million subscribers, and then leveraging existing customer populations to drive growth thereafter. I concur. In regard to some analyst claims that Icahn failed to achieve significant appreciation for Lions Gate and Blockbuster, I believe that the general track record is what matters. Icahn is billions of dollars up, and it has come through strategies like this in the past that he has achieved such success. 31.7% of the float is being shorted, so a potential short squeeze could occur if Icahn is able to raise takeover speculation from winning board seats. Either way, I believe Netflix is fundamentally overvalued with little free cash flow relative to market cap.
Amazon Would Also Do Well with Coinstar (NASDAQ: CSTR)
Coinstar, a competitor to Netflix, manages Redbox. As tacky as it sounds, Redbox is a vending machine where DVDs can be picked up and returned. Having used the service several times, I find it a nice supplement to Netflix's services. When Blockbuster was going under, management proposed that customers would have the option to pick videos up at stores in addition to renting directly from warehouses. At a respective 9.4x and 8.9x past and forward earnings, Coinstar is an ideal takeover target that will enable other companies to pursue a similar strategy.
EPS has grown 40.3% annually over the past five years. Analysts expect the rate to be 17.4% over the nest five years. This is more than enough to generate substantial value creation. Assuming expectations are met (and Coinstar has beaten consensus by an average of 20.3% over the last five quarters), 2016 EPS will come out to $8.40. At a multiple of 13x, this translates to a future stock value of $109.20. Discounting backwards by 10% yields a present value of $67.80--a more than 45% premium to the prevailing price. I believe people are thinking of the company as too much of a Netflix. But, with a free cash flow yield of 20% and strong momentum, it's easy to rationalize a takeover bid.
Amazon has $5.3 billion in cash and Coinstar is only worth $1.4 billion. If it ends up buying the business, it can leverage existing content deals to then distribute through Redbox. The synergies alone would pay for the acquisition costs within a few years, if that. Add in growth and a clean balance sheet, and you have a low downside stock.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com and Netflix. Motley Fool newsletter services recommend Amazon.com 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!