M&A binge could steady subscriber growth for Netflix

Shares of Netflix have nearly doubled in value halfway through the year. But after a miss on Monday’s earnings report, the streaming giant’s stock stumbled over a cliff in after-hours trading, falling by some 14%. The losses were trimmed in Tuesday’s cash session, ending with a 5% loss.

What gives? It turns out that Netflix is still vulnerable to the vagaries of subscriber growth. For 2Q, it added some 4.5 million international users, missing its estimate for this figure by half a million, while miscalculating domestic growth by roughly another half-million users.

Not for the first time—nor, presumably, the last—has Netflix failed to see a sag in subscribers coming. For those keeping score, this marks the third time in as many years it has fumbled on guidance. And the company is keeping things modest going forward, advising the markets to expect 5 million new users worldwide this quarter.

That continues the trend of slow but steady growth to about 135 million subscribers since Netflix’s founding in 1997, helping the company establish a dominant position in streaming and forcing the industry to evolve around it. The trouble is, there’s only so much runway in front of it. And legacy competitors are trying their level best to gobble that up for themselves, leaving Netflix isolated and rapidly burning cash as the industry consolidates to compete for original programming and drive engagement.

The company assured investors on Monday that it believes “there is room for multiple parties.”

How might M&A help?

Netflix has yet to deploy M&A, at least in any significant way, as a strategy to secure its position atop the increasingly crowded streaming video space. Since the start of 2007, Netflix has picked up a single company, Millarworld, for an undisclosed sum in a deal that could point the way forward.

With Millarworld, Netflix picked up the rights to titles like “Wanted,” “Kick-Ass” and “Kingsman,” which together grossed nearly $1 billion at cinemas worldwide. Striking a similar deal would help secure the company’s pipeline of non-exclusive content at a time when competitors like Disney—poised to launch its own streaming video service—pull away from Netflix.

The company has, however, doubled down on its commitment to new content, telling investors earlier this week that it still plans on spending about $8 billion this year.

Looking to the private markets

The private markets have created no shortage of potential targets in media, with VC investment alone into the space representing some 465 completed deals just last year, per the PitchBook Platform.

So, where might Netflix look?

Japan’s Crunchyroll could be an appetizing option. It’s an online video streaming platform that offers full-length episodes of popular anime series including “My Hero Academia.” A deal for the company, which was founded in 2006 and has raised nearly $60 million in equity funding, would be consistent with the rationale behind last year’s Millarworld purchase. In 2017, Crunchyroll surpassed 1 million paid subscribers and boasts a catalog of 800 titles. No less a competitor than Amazon had its eye on Crunchyroll in 2015 before talks fell apart. Meanwhile, Otter Media invested $22 million in Crunchyroll later that year.

And just to keep it Hollywood, a deal for Crunchyroll would give Netflix the chance to spoil AT&T‘s hit parade. Fresh off its $85.4 billion purchase of Time Warner, AT&T has reportedly set its sights on picking up Crunchyroll via the outright purchase of its backer Otter Media, which AT&T jointly owns with The Chernin Group.

Netflix has long planned to expand in India as part of its wider push into original, non-English language content. VC-backed Graphic India could make for an appealing buy. Founded in 2011, the company raised $5 million in Series A funding last year with the aim of emulating what the US did for the superhero genre and Japan did for anime by creating a stable of content based on Indian myths geared to its population of 550 million youths under the age of 25. Control of the company is currently split among publisher Liquid Comics, media investment group Start Media and Emerald Media, a joint venture of Chernin’s Asian media investment arm and private equity firm KKR.

Going public instead

Long gone are the palmy days when a share of Sony traded for over $100 apiece. But top-line growth for the Japanese consumer electronics giant has returned to form as of late. Sony booked $77 billion in revenue for the year ended March 31, surpassing $76 billion for the first time since a data breach at Sony Pictures in December 2014 came to light. Meanwhile, its market cap has climbed a staggering 208% to some 6.8 trillion yen (about $61.5 billion) over the same period.

Like Netflix, Sony rarely pulls the trigger on M&A transactions. The company has completed just eight deals since the start of 2007, per PitchBook data, and none since purchasing Israel’s Altair Semiconductor in a $212 million deal that wrapped at the start of 2016. Indeed, Sony has hit the exit button more times since 2007, completing a divestiture on 10 occasions.

Could Sony be motivated to sell its entertainment assets? Remember, the company is one-half hardware and another half entertainment. And the hardware bit is struggling with its TV business, ailing under pressure in the US from upstarts like Vizio despite becoming the sole Japanese supplier after Panasonic pulled out last year.

Moreover, Netflix could get a leg up over Amazon with such a purchase, making the films from Sony Pictures free as part of a subscription rather than available for rent with Prime. The appeal for Netflix of a Sony Pictures purchase on that front lies in the studio’s stable of Hollywood bona fides, including titles from wildly successful franchises like James Bond and Spider-Man alongside critically acclaimed films like “American Hustle” and “The Social Network.”

Whatever path Netflix chooses, though, something likely needs to be done to alter the company’s course going forward since the status quo of falling free cashflow doesn’t look sustainable amid stalled subscriber growth.