Is There a Netflix-Amazon Merger Coming? (NFLX, AMZN)

Shares in Netflix, Inc. (NASDAQ: NFLX) are up slightly today while the rest of the market is down about -440 points. It seems that a number of analysts don’t think that Netflix has suffered as much as the recent dive in its share price would indicate. One analyst even thinks that Netflix is teeing up a takeover by Amazon.com.

You can’t make this stuff up. Wedbush Securities analyst Michael Pachter has raised his rating on Netflix to ‘outperform’ on what he believes is an attempt by Netflix make its video-streaming business attractive enough to Amazon to spawn a buyout offer.  [http://www.marketwatch.com/story/netflix-lining-up-sale-to-amazon-analyst-says-2011-09-22] The reasoning turns on sales taxes.

Pachter thinks that Netflix split itself into two businesses so that the video-streaming business — which is not subject to sales tax in any state — in order to sell that business to Amazon, which has been fighting off efforts by states to impose sales tax collections on the company. Because Netflix has warehouse and mailing operations in several states to handle its DVD-mailing business, that part of its operations were too ugly for Amazon.

Further, Netflix currently offers more than twice the number of streaming videos offered by Amazon. An acquisition of Netflix puts Amazon in the driver’s seat in the streaming video business.

Such a marriage doesn’t seem like one that would have been made in heaven. Amazon’s market cap of about $101 billion is about 14x larger than Netflix’s currently depressed market cap of around $7 billion. Amazon has about $2 billion in cash and no long-term debt. That all looks pretty good for a buyout of Netflix.

But how does anyone put a value on Netflix’s streaming business? In its most recent quarter, Netflix paid out nearly $500 million in streaming license fees. The company’s total obligations for streaming content were $2.44 billion. That’s nearly equal to Netflix’s total revenue for all of 2010, including essentially nothing for streaming because it was included free with the DVD service.

The cost of streaming content is what drove Netflix to introduce its split business model in the first place. There is no reason for Amazon to believe it can negotiate a better deal. In fact the movie and TV producers will probably try to wring more out of Amazon.

Amazon may be interested in boosting its streaming video business and saving itself from having to pay sales tax in several states, but the company is not about to do that by buying the pig-in-a-poke that is Netflix’s streaming business.

Paul Ausick