Netflix-Warner Bros deal to close in 12-18 months

Key Concepts

• Acquisition: Netflix's purchase of Warner Brothers Discovery's TV and film studios and streaming division.
• Intellectual Property (IP): The core strategic asset Netflix is interested in from Warner Brothers.
• Subscale Streaming Apps: Smaller streaming services like Paramount+, Max, and Peacock, which were expected to merge with Warner Brothers.
• Accretive Deal: A deal that is expected to increase earnings per share.
• Earnings Dilution: A temporary decrease in earnings per share due to an acquisition.
• Market Share Concentration Metrics: Regulatory tools used to assess if a merger creates a monopoly.
• Linear Cable Channels: Traditional television channels like TBS, TNT, and CNN, tied to the pay TV ecosystem.
• Cord-Cutting: The trend of consumers canceling traditional cable subscriptions in favor of streaming services.
• Orphan Asset: An asset that lacks strategic interest from potential buyers.

Netflix Acquires Warner Brothers Discovery's Studios and Streaming Division

Netflix has agreed to acquire Warner Brothers Discovery's TV and film studios and streaming division for $72 billion. The acquisition is anticipated to be finalized within 12 to 18 months.

Deal Rationale and Surprise Outcome

Jason Bazin, senior analyst of internet and media at City Research, expressed that this outcome was "super surprising." The prevailing expectation was that one of the "subscale streaming apps" – specifically Paramount+ or Max (formerly HBO Max) – would merge with Warner Brothers to create a stronger competitor against Netflix. Bazin estimated only a 5% likelihood of Netflix emerging as a bidder, as the Warner Brothers assets were not considered a "must-have" but rather a "nice-to-have" for Netflix.

Netflix's Strategic Interest: Intellectual Property

The primary strategic driver for Netflix in this acquisition is believed to be the "intellectual property that sits inside Warner Brothers." This IP is seen as the "real strategic asset" that Netflix desires.

Valuation and Financial Implications

The purchase price is described as "a very expensive way to get intellectual property." Warner Brothers Discovery has stated that the deal is not expected to be "accretive" (earnings-enhancing) until two years after closing, meaning a potential three to three-and-a-half-year timeframe. This implies that the market will need to "stomach through some level of earnings delusion" in anticipation of the long-term benefits of leveraging Warner Brothers' IP.

Regulatory Approval Prospects

Regarding regulatory approval, Bazin draws a parallel to the previous attempt by AT&T to acquire Warner Brothers. During the Trump administration, regulators raised concerns and attempted to block the deal, despite market share concentration metrics not logically supporting such a blockage. Ultimately, AT&T prevailed. Bazin believes a similar situation will unfold here, stating that "the government's going to have a hard time blocking this deal" even though it involves the largest streamer (Netflix) acquiring a competitor. He argues that when examining the "math either at the studio level or in terms of streaming subs," the government's case for blocking the deal would be weak.

Competitive Landscape and Potential Opposition

Paramount's stock has seen a significant decline following the announcement, as the deal leaves them in a "bad position" without achieving "requisite scale in the streaming business." There are press reports suggesting Paramount has a "plan B," which may involve appealing directly to Warner Brothers shareholders to block the Netflix deal. This raises the possibility of Warner Brothers investors rejecting the Netflix offer in favor of an alternative from Paramount.

Operational Strategy for Warner Brothers Assets Under Netflix

The stated intention from Netflix is to focus on the intellectual property. This presents an "unorthodox situation" because Netflix typically does not license its self-produced content to third parties, whereas Warner Brothers has historically licensed its content to other streamers, including Netflix. If Netflix's word is taken, content produced from the Netflix lot would not be licensed out, while content from the Warner Brothers lot might follow its "normal theatrical window" and potentially be licensed to third parties. For now, it appears Netflix might "just let it sit," but they will eventually need to "figure out what to do with it."

The Split of Warner Brothers Discovery

Warner Brothers Discovery had previously announced a split into two entities. Netflix is acquiring the studio and the streaming app. The other component consists of the "linear cable channels" tied to the pay TV ecosystem, such as TBS, TNT, and CNN. These channels will be "spun out" and are expected to form a separately traded public entity in the third quarter of next year.

Outlook for the Remaining Linear Cable Channels

Bazin notes that the "street doesn't have any interest in linear cable channels." This lack of interest from both strategics and the buy-side is a key reason for Warner Brothers' original decision to split. The remaining linear channels are considered an "orphan asset," and their future trajectory will be dictated by the ongoing trend of "cord-cutting" and migration to streaming services.

Conclusion

The acquisition of Warner Brothers Discovery's studios and streaming division by Netflix is a significant development in the media landscape. While the price is high and the deal's immediate financial impact may be dilutive, Netflix's strategic focus on Warner Brothers' extensive intellectual property is the primary driver. Regulatory hurdles are anticipated to be surmountable, but competition from entities like Paramount could still introduce complexities. The future operational strategy for the acquired assets remains somewhat unclear, particularly regarding content licensing. Meanwhile, the spun-off linear cable channels face an uncertain future as an "orphan asset" in a declining market.