NEW YORK, July 15 (Reuters Breakingviews) - Jumping the shark is a TV term for shows past their prime that try gimmicky storylines to keep viewers. The reference, derived from a 1977 episode of Happy Days when Fonzie water-skis in his signature leather jacket, applies equally to the media conglomerates responsible for such productions. Supersized deals are often a telltale sign of CEOs stretching to retain appeal with investors. Netflix
NFLX.O is on the verge of a desperate such measure, but there's time yet for it to write a new growth story using the same creative spark for which it is known instead of following a tired script.
Why Netflix may be better off innovating
Bold deals are risky for even the savviest of operators, but they are also not part of the Netflix DNA. It has grown by finding new markets, developing fresh series, licensing international programs, revising price strategies, adding games, rolling out a cheaper advertising-based option and other moves. Such decisions have boosted the company's revenue by a GDP-stomping 18% annually on average since 2016, to about $45 billion last year, with its operating profit margin expanding to nearly 30% from 5% over the same span.
Even so, Netflix shares have tumbled 40% during the past year, partly as a result of the Warner Bros deal attempt. Viewer retention has been suffering and YouTube snatched the biggest share of TV watching. New sources of revenue are also fledgling. Ads, for example, are on track to generate $3 billion this year, or roughly 6% of the top line, according to forecasts gathered by Visible Alpha.
A big acquisition might bring more earnings, including from cost savings, but the price tag for one is usually too high. Rather, Netflix would be better served by going back to its inventive roots. Instead of paying exorbitantly for soccer rights, it could develop adjacent programming, as it did with the hit Formula 1 series, Drive to Survive. Investing in valuable characters, as Disney did with Marvel and Star Wars, is also an option.
Another way to attract and retain audiences while staying true to its mission would be by embracing episodic one- to two-minute videos. Viewers watch an ad, buy a token or subscribe to see more of a soapy series. Known as micro-dramas, they are already popular in China, where they have generated $9 billion of revenue, surpassing the country's $7 billion in box office ticket sales, according to tech research firm Omdia.
It's a wide open field, after Hollywood tycoon Jeffrey Katzenberg and former tech boss Meg Whitman arrived on the scene too early with their ill-fated short-video service Quibi in 2020. A handful of apps such as DramaBox and ReelShort are gaining popularity now, but no one company controls the market. Younger consumers are flocking to it. Of the estimated 28 million micro-drama watchers, more than half are aged 18 to 34, Activate Consulting reckons.
Done well, it would be a promising area of growth. By 2030, micro-drama revenue will exceed $20 billion, with a third coming from outside China, per Omdia. If Netflix captured, say, $3 billion of the pot, its forecast 42% EBITDA margin would translate into $1.3 billion of extra profit. On the company's two-year average valuation multiple of 30 times, it would reap some $40 billion, or a 13% uplift for the enterprise. Taking creative risks in micro-doses would be a wiser use of capital than jumping the shark with a silly mega-deal.
Warner Bros deal and industry deal history
The $300 billion streaming giant betrayed its own M&A hubris in December by agreeing to buy Warner Bros Discovery’s WBD.O movie studio and HBO service for $72 billion. The decision stunned Netflix stakeholders because it was its first acquisition anywhere near that large. The company has been a builder for its nearly three decades of operation, only sprinkling in smaller transactions to add intellectual property, such as the 2017 purchase of comic book publisher Millarworld. Twice it upended ubiquitous business models, first by sending DVD rentals through the mail, bringing the curtain down on the video-store era, and then by establishing the first major video-streaming provider, which kicked off cable cord-cutting.
By walking away from WBD after Paramount PSKY.O owner David Ellison stepped in with a higher $83 billion offer for all of WBD, cable networks included, Netflix bosses Ted Sarandos and Greg Peters at least exhibited a modicum of financial discipline. The worry is that they will find another way to join a long list of peers haplessly chasing a merger dream.
The industry is littered with failed empire-building. AOL's union with Time Warner in 2000 is only the Hall of Shame headliner, with a then-record $165 billion deal. By the time Discovery CEO David Zaslav came along two decades later, the company was owned by AT&T T.N and its value had more than halved. The Redstone family reunified its $30 billion entertainment kingdom in 2019, but sold Paramount five years later to David Ellison's Skydance Media at an $8 billion valuation. Walt Disney DIS.N is worth about the same as it was seven years ago, before it shelled out $71 billion for a collection of assets held by Rupert Murdoch’s Fox FOXA.O.
Potential targets and strategic alternatives
Further structural changes create new potential takeover targets. Cable operator Comcast CMCSA.O unveiled plans last month to unwind its 15-year foray into media ownership. Chairman Brian Roberts wants to cleave the company, after having spun off networks including CNBC into Versant Media VSNT.O earlier this year. Now he plans to separate NBC Universal, which includes the movie studio behind The Odyssey and the Wizarding World of Harry Potter theme park that he bought from General Electric for $30 billion.
NBC’s Peacock streaming service, home to National Football League games, may seduce Sarandos and Peters. They already have been toying with more live sporting events, such as Major League Baseball's annual Home Run Derby this week. The big U.S. TV audiences that Fox wooed for World Cup soccer this summer could prompt Netflix to make a pricey bid for the next round of broadcast rights. With the Wall Street Journal also reporting that Netflix is interested in adding live TV, it isn't a big jump to buying NBC Universal.
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