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Why Facebook Should 'Like' Netflix

Tuesday - 12/11/2012, 1:44pm  ET

´╗┐Netflix and Facebook are two stocks that tend to foster heated debate among passionate investors.  Historically, characterizations about these companies have ranged from over-hyped fads to new, durable paradigms in their respective markets. 

As a current shareholder in both companies, I obviously skew toward those that see long-term value, but I have often been a critic of the uber-bulls who have overlooked the issues both face.  While the two companies share challenges, they also enjoy synergies.  There is a great opportunity for Facebook to buy Netflix and create significant value as a combined global social media and entertainment company.

I owned Netflix during its meteoric rise but I sold at $220/share, missing out on the subsequent rise to $300/share, but I also avoided the plunge.  The forward valuation of an 80 PE suggested that they would continue to grow subscribers in perpetuity without accounting for content costs, competition, or the increasing incremental expense for each subscriber, especially considering its international expansion.  

Reed Hastings telegraphed some of these issues when he discussed a path to strengthening the brand and competitive advantage through proprietary content.  I applauded that strategy but was cognizant that it would be a significant expense. However, many talking heads maintained that content costs were not an issue. Contrarily, when Netflix began to show some traction in international expansion, successful content generation, and the stock was at a fairer valuation (although not cheap) at $80/share, many people suggested the company was a broken model.

Waiting for a suitor?

I believe there is long-term value in Netflix, albeit not like the heady days of yore, but I also think it is an attractive takeover candidate for a deep-pocketed company that wants to expand their reach.  Many names have been suggested including Apple, Amazon, and Google, among others.  An argument can be made for why Netflix might be attractive to each of those companies, especially Google which has had a lot of success with YouTube, mobile, and integrating social media with entertainment.

Apple is a less likely candidate, as management could expand its iTunes product offering (if so desired) organically, especially when a proprietary TV comes to fruition. Facebook should be among those names bandied about, especially because it might be the one able to extract the most value.

The Facebook IPO was an unmitigated disaster.  Underwriters, media, and Facebook itself were placing far too much value on a company that had yet to show how it would monetize its incredible global mindshare.  However, as the stock plummeted, many in the media that hyped the company were then deriding its prospects as a legitimate investment.

Facebook has shown progress in mobile monetization, but the company was concerned enough about the stickiness of its platform that Facebook purchased the popular photo sharing application, Instagram for a billions dollars even though it never made a dime.  While I would argue Facebook grossly overpaid, the more important point is the company was attempting to maximize their mobile footprint and product offering.  Netflix represents a powerful opportunity to expand their product offering for both platforms with the added benefit of being accretive to earnings. 

Global and mobile

Facebook’s strength is in their global reach, as well as the amount of time the average member spends on the site.  The secret sauce for Facebook is to monetize those members without an over preponderance of advertisements that will lessen the brand. 

At the same time, Netflix is trying to expand their brand internationally, spending large amounts to increase their reach and recognition as a global entertainment hub.  If Facebook purchased Netflix, Facebook could leverage their built-in global client base and acquire customers for less money per subscriber, while Netflix content will help Facebook maintain the amount of quality time that each subscriber spends on the site.

Movies are inherently social, foster discussion, and lend themselves to likes and dislikes.  Moreover, Netflix has a powerful mobile application, which would integrate well with Facebook.  While Facebook can make money off of advertisement as a significant revenue stream, especially with creative integration like the “want” button, the value remains in its identity as social network that people feel is a necessary part of their lives. 

The best opportunity for Facebook to monetize its customer mindshare, beyond just advertising, is in continuing to create a dynamic suite of products. Netflix can help Facebook extend their ecosystem while maximizing Netflix’s international reach. The challenge is in the economics of the deal. 

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