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Apple Should Buy Netflix

Posted on Wednesday, Jul 27th 2016

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Apple (NASDAQ: AAPL) was expected to report a bleak quarter due to the continuing slump in iPhone sales. It was not just iPhones, though. iPad and Mac sales have also declined. It is time Apple made a big move.

Apple’s Financials

Apple’s third quarter revenues dropped 15% over the year to $42.4 billion. Net income declined to $7.8 billion or $1.42 per share from $10.7 billion or $1.85 per share. But the declining revenues and profits were slightly better than what analysts feared: earnings of $1.39 on revenues of $42.1 billion.

The decline in revenues was driven by a 15% drop in iPhone sales to 40.4 million, slightly better than analyst estimates of 40 million. iPhone revenue plunged 23% to $24 billion. But the declining numbers were not just limited to iPhones. Sales of Macs declined 11% and iPads declined 9%. Mac revenue declined 13% to $5.23 billion. It had the best iPad sales compare in 10 quarters, with revenue growing 7% to $4.8 billion, thanks to the rollout of the 9.7-inch iPad Pro.

Services business now accounts for 11% of revenue from 8% last year and is the second largest revenue generator. Services revenue grew 19% to a June quarter record of $6 billion driven by 37% growth in App Store revenue as well as strong increases in Music, iCloud, and AppleCare. Its installed base related purchases accelerated 29% over the year to $10.3 billion.

By region, Apple’s revenues from the Americas fell 11% over the year $18 billion, Europe fell 7% to $9.6 billion, Greater China dropped 33% to $8.5 billion, and Rest of Asia Pacific fell 20% to $2.4 billion. Japan was the only market that reported growth as revenues improved 23% to $3.5 billion.

For the fourth quarter of the year, Apple forecast revenues of $45.5 billion-$47.5 billion with a gross margin of 37.5%-38%. The market was looking for revenues of $47.4 billion.

Apple ended the quarter with $231.5 billion in cash plus marketable securities, a sequential decrease of $1.4 billion. $214.8 billion of this cash, or 93% of the total, was outside the United States. It has issued a total $2.4 billion of debt in Taiwan and in Australia, while retiring $2.5 billion in US debt, ending up with $72 billion in term debt at the end of the quarter, essentially unchanged from last quarter. It has returned $13 billion to investors in the June quarter through share repurchases and dividends. Its board of directors has declared a cash dividend of $.57 per share of common stock.

Apple Should Buy Netflix

Apple also announced yesterday that it has entered into an agreement with CBS to make Apple Music the exclusive home for the new TV series Carpool Karoake.

But with a cash pile of $231.5 billion, I believe Apple needs to do something radical to turn its fortunes around. It should buy Netflix, which is currently facing market saturation. I have said earlier that Netflix is a good match for Apple, and it still is.

With the iPhone, iPad, and even Mac revenue streams drying out, Apple needs to relook its strategy. Apple TV is a product line that has huge potential, but without its own content Apple will see declining revenues here as well. With a Netflix acquisition, Apple can provide a proprietary content service integrated into the Apple TV. And by offering proprietary content integrated into iTunes and Apple TV, Apple can leverage its user base and invigorate its Apple TV offering.

My main observation is that Netflix has developed good expertise in developing original content that is generating hit after hit. If Apple buys Netflix and really develops this angle, and integrated Netflix with a superior user interface on Apple TV (currently the interface sucks), this combination would inject energy into both hardware sales and content-driven subscriptions. Amazon, for example, doesn’t have the kind of margin that Apple does, still. Apple has the cash and the margin to invest in a formidable content strategy that bolsters its hardware and subscription sales. (One could argue, similar logic applies to the Music industry, where Apple could also play a much larger role in producing original content by working with talented musicians.)

Netflix will also benefit from iTunes base of 800 million registered users. Besides losing some older customers due to a price hike, Netflix is also finding it difficult to attract new customers in a market fraught with competition from Amazon, Hulu, and Google’s YouTube and from traditional media players like Time Warner and HBO. In the recent quarter, it added just 160,000 subscribers compared to 900,000 a year ago. Netflix ended the quarter with 83.18 million streaming video subscribers worldwide, including 47.13 million in the US. Its market cap is around $42 billion.

Apple is known to make small, tuck-in acquisitions and its largest acquisition was that of Beats Music for $3 billion. Following the Beats acquisition, Apple launched a subscription music service that already has 13 million paying subscribers. Apple currently charges $9.99 per month for the service. But this is a strategy that it should look at replicating for Apple TV after acquiring Netflix.

According to a Financial Times article, Apple was considering acquiring Time Warner last year. Apple has been in talks with several media companies to stream content, but has been unsuccessful. The article suggests they could be worried that a deal with Apple would undermine their own pay TV revenues. This adds more fuel to my suggestion for a Netflix acquisition.

Its stock is currently trading around $96.63 with a market cap of $529.28 billion. Its 52-week range is $89.47 – $123.91. BGC Partners downgraded Apple earlier this week to an unprecedented sell rating and lowered the price target to $85 from $110.

Time to do something, rather than just coast along.

Photo Credit: bizmac / Flickr.com

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