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Here’s Why a Disney Acquisition of Netflix Would Make Sense

Oct 04, 2016

In a sign of just how much upheaval there is in the media and entertainment space, Disney is rumored to be looking at multiple acquisitions, including a potential purchase of Twitter. But it's a much larger deal that has really caught the market's interest—namely, the possible acquisition of Netflix.

Whispers that Disney might be interested in buying the streaming-video giant pushed shares of Netflix (nflx) up by more than 6% on Monday, adding over $2 billion to the company's market capitalization on higher than average volume.

There's a similar rationale behind both a Twitter (twtr) purchase and a Netflix acquisition. Disney is one of the strongest media companies in the world with an enviable track record thanks to CEO Bob Iger and a string of smart acquisitions, including Pixar, Lucasfilm, and Marvel.

Yet despite that, the company still faces a number of significant challenges. One of the main challenges is the future of ESPN, the sports network that accounts for a significant amount of Disney's profit. Streaming services and cord-cutting behavior have eaten into ESPN's subscriber base, and investors are nervous about where that is going to lead.

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Whenever he talks about this problem, Iger exudes confidence about the continued success of ESPN, and says he has no doubt that the network will be able to justify the billions of dollars it has spent to lock up broadcast rights for key sporting events for decades.

Despite all of that brave talk, however, and the rumored launch of a new ESPN streaming service aimed at millennials and cord cutters, Disney's stock (dis) remains under pressure.

When it comes to streaming entertainment, there is one name that stands above all the others, and that name is Netflix. The company that started as a DVD rental service has gradually transformed itself into the kingpin of online media, with dozens of hit shows and a rabidly devoted subscriber base.

Adding those 80 million subscribers and Netflix's global market penetration to Disney would make a huge amount of sense, and would put to rest the whispers about Disney's future in one fell swoop.

The two companies already work together in a number of ways: As a result of a deal that takes effect this year, Netflix is the exclusive pay-TV host for new movies from Disney, as well as for TV shows and movies from Disney's three, aforementioned major franchises: Pixar, Lucasfilm, and Marvel.

For Netflix, a Disney acquisition would solve one significant problem: Namely, the massive amounts of money it is having to come up with to develop new content to fill its digital pipes. This year alone, the company is going to spend more than $6 billion to come up with new TV shows, documentaries, movies, and other programming, and that is putting a strain on its balance sheet.

Concern about how much longer Netflix can keep up that kind of spending, combined with fears about lackluster growth, has kept the company's shares under pressure. And that may have created an opportunity for someone like Disney to make an acquisition bid.

That said, Netflix would still be a gigantic fish to swallow. The company has a current market value of about $45 billion, and Disney would probably have to offer a significant premium in order to get Netflix to agree to a deal. Even for Disney, which has a market cap of $150 billion, an acquisition of that size would still be a massive investment.

And yet, Netflix's size is also one of the things in its favor when it comes to a potential acquisition. One of the criticisms of a potential Disney bid for Twitter is that the latter company is too small for it to make a big impact on Disney's financial picture.

Netflix would certainly be large enough to transform Disney almost overnight, if the company did decide to go forward with a deal. But it would be a massive bet even for Iger, a man who has developed a reputation for making large bets and having them pay off. All of which is to say that it's a long shot—but certainly not out of the realm of possibility.

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