Why Netflix’s Mega-Merger Could Crush Your Portfolio

Netflix (NASDAQ:NFLX) has officially clinched the blockbuster bidding war for Warner Bros. Discovery’s (NASDAQ:WBD) premium assets — the Warner Bros. film and TV studios and HBO Max streaming service — in an $82.7 billion cash-and-stock megadeal announced this morning, valued at $27.75 per share. 

This caps weeks of jockeying for supremacy between Netflix, Paramount Skydance (NASDAQ:PSKY) and Comcast (NASDAQ:CMCSA), where Paramount sought to acquire  the entire company including its cable channels like CNN and TNT, while Comcast followed Netflix in zeroing in on the studios. With its own vast cable offerings, it would invite antitrust scrutiny if Comcast tried to acquire those assets too. 

Netflix’s winning bid, however, blends $23.25 per share in cash and $4.50 per share in Netflix stock, paving the way for Warner Bros to spin off its cable assets in Discovery Global, while also paying off most of its $40 billion in debt. While Netflix gains ownership over premium assets, it also introduces a level of risk investors may not be used to with the streamer, potentially dealing a crushing blow to portfolios holding the stock. 

A Perfect Fit — on Paper

Netflix was clear from the beginning that it had zero interest in owning a declining asset like cable TV channels. By acquiring only the studio and HBO Max, the streamer grabs the creative engine behind the most valuable aspects of the business: Harry Potter, Game of Thrones, DC Comics, and HBO’s prestige library. In exchange, Warner Bros is able to spin off a clean, focused, linear TV company.

For Netflix, the prize is enormous: instant ownership of some of the world’s most bankable IP, plus HBO Max’s 100 million subscribers. There is undoubtedly some overlap, but many don’t, and when combined with Netflix’s 300+ million global accounts, the merger creates a substantial competitive moat.

It also happens at an opportune time for Netflix. Its ad-tier subscription and password-sharing crackdowns are supercharging monetization. In May, Netflix disclosed 94 million monthly active users on the ad tier  — up from 70 million six months prior — representing over half of new sign-ups in regions it was available.

The Elephant in the Room

The upside potential is significant, but the hefty price tag brings you up short. The near-$83 billion cost will siphon off Netflix’s $13 billion cash, equivalents, and other assets on its balance sheet while requiring it to raise tens of billions in new debt or equity. Long-term debt has widened this year for Netflix, ending Q3 at almost $14.5 billion. This deal will cause it to balloon to over $90 billion at the close, while its debt-to-equity ratio will go from a healthy 0.56 to something north of 2.5, assuming no aggressive equity dilution. Interest payments could consume 10% to 15% of projected 2025 free cash flow.

Integration will also be nightmarish. Merging Netflix’s data-driven focus with Warner Bros.’ traditional Hollywood culture is a prescription for a clash. Moreover, mega-mergers like this have a poor track record of success. 

Data from Harvard Business Review puts the failure rate at 70% to 90%, citing integration breakdowns where 80% of issues stem from cultural mismatches and poor communication. ResearchGate says overpaying for an acquisition and human factors tank 44% to 45% of deals, resulting in $1 billion in promised synergies turning into $500 million losses.

Both the AOL-Time Warner deal and the AT&T-Time Warner tie up are notable examples. That both had Warner Bros units attached to them is not encouraging.

Key Takeaway

The market doesn’t like the deal, sending Netflix stock 4% lower at the open. With shares trading at 43x forward earnings, Netflix is about to become a vastly different company with balance sheet risk that investors didn’t sign up for.

Now is not the time to buy Netflix stock. Mega-mergers rarely work, debt loads this large are unforgiving when mistakes are made, and the streamer just transformed into a highly leveraged legacy studio overnight.

Should you sell? While Warner Bros marquee names have potential, there is no mistaking the sheer number of flops the studio made, more than offsetting any wins. This deal’s risks outweigh any potential rewards for at least the next 12 to 18 months.