Analyst Omar Sheikh of Credit Suisse says it is getting more difficult to justify the acquisition of Netflix by the Walt Disney Co., an idea that has been floated in both entertainment industry and Wall Street circles for the last few weeks.
Sheikh argues that trends in TV are improving, making it increasingly difficult to justify what would be a $70 billion purchase. Paying that price for Netflix would dilute earnings per share and cash flow he says.
He adds that the growth of virtual broadband distributors should slow the pace of subscriber losses at Disney’s ESPN.
Disney faces risks continuing on the path it’s on, Sheikh said.
Some sports rights will be up in 2021-22. And right now, ESPN’s agreement with Altice, which acquired Cablevision, is up this quarter, and Altice will look to drive a hard bargain.
“Competition for sports rights from vertically integrated competitors and limited scope for an organic strategy to achieve scale quickly are two reasons why we think Disney may have to consider either accelerating its organic investment or acquiring a downstream distribution business,” Sheikh says.
And buying Netflix does offer some strategic advantages. The purchase would give Disney 90 million direct customer relationships in 190 countries to whom sports and other content packages could be sold. Scale could be achieved years ahead of any organic strategy. Netflix’s deep dataset of consumers' interactions with video content could be used by Disney upstream content businesses to more closely tailor content to consumers' desires and for targeted advertising.
So while he doesn’t see buying Netflix as a good financial decision now, he expects the topic to continue to be debated.
Sheikh also downgraded his ranking of Discovery Communications to underperform from neutral.
He says rating trends have put pressure on ad revenue and that viewers will continue to go to news networks in the early days of the Trump Administration, cutting into Discovery’s audience.
Sheikh also says that the move from niche programming to premium sports presents high costs and an uncertain return.
Sheikh’s favorite stock in the media/cable segment remains 21st Century Fox.
Fox’s agreement to purchase the remainder of Sky appears to close the door to other risky acquisitions, Sheikh says. Meanwhile, Sky will boost earnings, causing investors to reevaluate Fox’s stock.
He also like Fox’s stake in Hulu.
“The launch of ‘virtual’ MVPDs will be constructive for industry subscriber trends, in our view. As a 30% shareholder in Hulu – potentially the most attractive of this distributor category – Fox stands to benefit more than peers, and is in a strong position to drive the current wave of innovation in the industry,” Sheikh said.
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