This report will examine the financial pros and cons for Amazon.com, Inc. of acquiring

its instant video competitor Netflix.

SHOULD AMAZON ACQUIRE NETFLIX?

CHLOE FOSTER-JONES, SEAN LENAHAN, MAGDALENA

KAWALKOWSKI, AND DANIEL BRANDMAN.

1

SHOULD AMAZON

ACQUIRE NETFLIX?

CHLOE FOSTER-JONES, SEAN

LENAHAN, MAGDALENA

KAWALKOWSKI, AND DANIEL

BRANDMAN.

WORK LOG

Chloe wrote the introduction, Part I (“About Netflix”), compiled and formatted

the paper, and did extensive copy and style editing of the text.

Maggie wrote sections 2 and 3 (“Netflix in the Industry: Competition”, “What’s

the Gossip?”), formatted and added effects to the PowerPoint, and helped in

organizing everyone’s efforts.

Daniel wrote Section 4 (“Who are the Potential Buyers”).

Sean wrote Section 5 (“What’s the Strategy?”), did the relevant calculations

and graphs, and formatted the citations for his and Maggie’s parts, and did

the group bibliography.

2

TABLE OF CONTENTS

Introduction ........................................................................................................................................................ 3

I. About Netflix ............................................................................................................................................... 4

A. OPERATIONS ........................................................................................................................................ 4

B. AREAS OF COMMONALITY .................................................................................................................. 4

1. Cost factors ......................................................................................................................................... 4

2. Marketing and distribution ................................................................................................................... 5

3. Customer base .................................................................................................................................... 5

C. COSTS ................................................................................................................................................... 6

D. REVENUE .............................................................................................................................................. 6

E. CAPITAL STRUCTURE .......................................................................................................................... 7

F. STRATEGY ............................................................................................................................................ 7

G. MANAGEMENT ...................................................................................................................................... 8

II. Netflix in the industry: competition .............................................................................................................. 9

III. What’s the gossip? ................................................................................................................................ 13

A. WHAT ARE OUTSIDERS SAYING ABOUT NETFLIX? ........................................................................ 13

B. WHAT ARE THE SHAREHOLDERS’ VIEWS? ..................................................................................... 14

IV. Who are the potential buyers? .............................................................................................................. 15

V. What’s the strategy? ................................................................................................................................. 19

VI. Conclusion ............................................................................................................................................ 29

VII. Works Cited .......................................................................................................................................... 30

VIII. APPENDIX I: Spreadsheets and graphs ............................................................................................... 33

3

INTRODUCTION

Fifteen years into the 21st century, the entertainment industry

has come to be dominated by a format which few saw coming.

Higher speeds of broadband internet and wider access have

allowed online streaming of video content, including television

series and movies, to outstrip almost all other ways of accessing

video entertainment. Netflix, Inc. was the first major player in this

market, at least in the US, launching its streaming service in 2007.

Today, it remains a juggernaut, even as domestic growth starts to

slow, looking to expand its customer base internationally and to

continue the production of critically claimed original content which it

began in 2013. Since 2007, many competitors have attempted to

enter the market, and analysts agree that almost any major tech

firm would benefit from acquiring Netflix. However, the high market

capitalization of Netflix and the substantial debt that the company

holds combine to make it a difficult acquisition target for most

investors.1 Moreover, its management does not seem to be courting

buyers at the moment. Despite these facts, in this report, we will

examine the possibility that tech and retail giant Amazon Inc. could

benefit by merging with or acquiring Netflix. Both qualitative

research and quantitative analysis will be employed to determine

the feasibility and profitability of such a deal for all parties involved.

1 Sanghoee, Sanjay. “Who could buy Netflix?” Fortune, November 18, 2014. http://fortune.com/2014/11/18/who-could-

buy-netflix/

4

I. About Netflix

A. OPERATIONS

Netflix is an online-based entertainment company, and according to company literature is the “world’s

leading Internet television network.”2 Founded in 1997, the company began by offering a mail-order

subscription service whereby customers could order TV shows and movies on DVD online to be

delivered to their homes for temporary rental.3 Although they were quite successful with this line of

business, all but eliminating brick and mortar video rental stores, in recent years Netflix’s focus has

shifted. The bulk of its business is now made up by its subscriber-based streaming service. It has

also begun producing its own original content in the form of several TV series, most of which are

prestige-level productions that compete with cable subscription channels such as HBO and

Showtime. Netflix has more than 44 million subscribers in 40 countries. It has three operating

segments: domestic (United States) streaming, international streaming, and domestic DVD.

B. AREAS OF COMMONALITY

There are a number of similarities between Netflix’s model and Amazon’s Prime Video service.

1. Cost factors Given the similarity of the service they provide, there are a number of shared cost factors for Amazon

Prime Video and Netflix. One is the purchase of rights to exclusive content. As the streaming video

market gets more competitive, exclusivity and unique options for consumers become ever more

important. Additionally, even for non-exclusive content, license agreements with copyright holders are

a major cost. In 2013, Netflix spent upwards of $3 billion on streaming content.4 Going forward, Netflix

plans to continue to expand its original content offerings, which will incur significant production costs.

For its part, Amazon Prime Video is also entering the original content arena, most notably with the

recent success of the series Transparent.

2 ———. Annual Report 2013. Form 10-K, 2014. Page 1.

3 “Netflix, Inc. History,” Funding Universe, accessed May 11, 2015, http://www.fundinguniverse.com/company-

histories/netflix-inc-history/. 4 ———. Annual Report 2013. Form 10-K, 2014. Page 45.

5

2. Marketing and distribution Amazon Prime Video and Netflix face similar marketing and distribution challenges. A significant one

is the worry that the US market for streaming video is potentially growing saturated, so that returns on

investment can be expected to decline.5 Thus, it will be necessary to expand the subscriber base

abroad. Unfortunately, international expansion exposes Netflix to copyright issues, so they are unable

to offer the same library of content to subscribers in different countries.6 Additionally, both Amazon

Prime Video and Netflix rely on partnership with the producers of consumer electronics such as smart

TVs, smartphones, and tablets to make sure these devices are compatible with the companies’ apps.

Amazon does have an advantage in this arena since it produces some proprietary consumer

electronics, including the Fire tablet. Both companies also rely on the partnership of internet service

providers such as Comcast, a relationship which at least for Netflix has been fraught in recent years.

Netflix has its own proprietary Open Connect content delivery network which ISPs must agree to

support. 7

3. Customer base The main customer base for Netflix’s streaming video service is customers with access to broadband

internet service. Although revenues from the DVD segment of business are declining, it still has

positive NPV, mostly derived from customers who live in rural areas where broadband is not reliably

available.

Amazon Prime Video is obviously a direct competitor for Netflix, but something of an open question

remains since competitors have only recently begun entering the market. Do customers want to have

multiple streaming accounts? Some subscribers do hold accounts with Netflix and one or more

competitors (Hulu Plus, HBO Go, Amazon, etc.) However, if customer satisfaction with Netflix

declines, users may decide to continue only one of these subscriptions and stop paying for Netflix.

5 Ibid. Page 8.

6 Ibid. Page 19.

7 Ibid. Page 6.

6

C. COSTS

A unique and challenging aspect of Netflix’s business is that most of its costs are fixed. The long-term

fixed costs of content licenses limit Netflix’s operating flexibility and its liquidity. For example, if Netflix

signs a two-year contract for the rights to a given property, but finds that the view counts are

extremely low, it can’t pull out of that deal and purchase more profitable content immediately. The

production costs and other expenses for original content are rising, and most of those occur up-front,

which runs the risk of their becoming sunk costs if the given property is not successful.8 The rights to

the music used in TV shows and movies must also be maintained separately, which can be

expensive.9 Interestingly enough, Netflix’s servers, another long-term cost, are hosted by Amazon

Web Services.10 Additionally, payment processing fees from subscriptions, which are paid for with

credit and debit cards, and enhancements and modifications to Netflix’s technology (video player,

Android and IOS apps, etc.) are additional sources of costs.11 Finally, Netflix leases all the real estate

it uses, including 4 offices in California, a distribution center in Ohio, and a customer service hub in

Oregon.12

D. REVENUE

All of Netflix’s revenue comes from member subscriptions. According to company reports, demand is

cyclical, with the 1st and 4th quarters representing the most growth in subscribers. The second quarter

is the slowest. In the status quo, domestic revenue growth is slowing, especially in the DVD market.

This trend can be expected to continue, although consolidated revenues continue to rise. In 2013,

consolidated revenues increased by almost $1 billion year over year due to growth in international

and domestic streaming memberships.13

8 Ibid. Page 3.

9 Ibid. Page 5.

10 Ibid. Page 6.

11 Ibid. Page 8.

12 Ibid. Page 13.

13 Ibid. Page 18

7

E. CAPITAL STRUCTURE

Netflix has quite a high debt-to-equity ratio, around 3.84 at the end of the last quarter. It plans to

continue increasing its debt holdings in order to fund its international expansion in Europe and other

parts of the world. Obviously, taking on high levels of debt would make an acquisition more risky. As

a rule, Netflix does not pay dividends on its equity.14

F. STRATEGY

Netflix’s strategy going forward is to keep expanding membership and to focus on developing more

original content, and thereby improve their brand recognition and intangible assets.

“Our core strategy is to grow our streaming subscription business domestically

and internationally. We are continuously improving our members' experience -

expanding our streaming content, with a focus on programming an overall mix of

content that delights our customers, enhancing our user interface and extending

our streaming service to even more Internet-connected devices while staying

within the parameters of our consolidated net income (loss) and operating

segment contribution profit (loss) targets.”

–Netflix Management Overview, 2014 Annual Report (10-K)15

14

Ibid. Page 10. 15

Ibid. Page 1.

8

G. MANAGEMENT

Netflix is run by CEO and co-founder Reed Hastings, as well as CFO David Wells and seven other

officers, and a board of directors. The management structure of the company may present an

obstacle to any potential buyers. In 2000, Netflix was losing money and shopping around for a buyer.

They even offered a 49% stake to Blockbuster, and Hastings was willing to take on the Blockbuster

brand name- but Blockbuster passed on the opportunity.16 Now, Hastings and his fellow officers seem

to oppose any potential buyout.

““We think we can make it in the long term absolutely on our own — we’ve been

doing that for 10 years.”

– Netflix CEO Reed Hastings to the Wall Street Journal, November 16, 2012.17

It was this belief that led the Board of Directors to adopt a so-called “poison pill”- a stockholder rights

plan which would preclude stockholders from launching a hostile takeover- in November 2012.18

16

Bushey, Ryan. “Netflix CEO Confesses He Tried To Sell The Company To Blockbuster ... But Blockbuster Wasn't Interested.” Business Insider, January31, 2014. http://www.businessinsider.com/blockbuster-missed-buying-netflix-2014-1 17

———. “Netflix’s Reed Hastings Says Amazon Is Losing $500M to $1B A Year on Streaming.” Deadline, November 16, 2012. http://deadline.com/2012/11/netflixs-reed-hastings-says-amazon-is-losing-500m-to-1b-a-year-on-streaming-373527/ 18

Villalva, Brittney R. “Netflix Hostile Takeover Bid: Streaming Company Elects 'Poison Pill' to Avoid Buyout.” Christian Post. November 5, 2012. http://m.christianpost.com/news/netflix-hostile-takeover-bid-streaming-company-elects-poison-pill-to-avoid-buyout-84432/

9

II. Netflix in the industry: competition

Long before Netflix entered the home video business, a company called Blockbuster

dominated the market. Blockbuster was founded by David Cook in 1985, and was a household name

in video rentals.19 Every year Blockbuster saw revenues climb, and they were rapidly expanding the

number of locations across the United States. After Viacom acquired Blockbuster in 1994, consumers

were outraged with the new ‘late fee’ policy.20 Nevertheless, the firm generated hundreds of millions

of dollars in revenue from this policy alone.21 Blockbuster was a long-lived phenomenon, providing the

public with VHS, DVD, and video game rentals as demand emerged for those new formats in the late

1990s. Then, in 2002, the usurper who would end Blockbuster’s reign had its initial public offering.

Netflix, Inc. was founded in 1997 by Marc Randolph and Reed Hastings.22 Until 1999, Netflix offered

the usual sales and rentals of DVDs, attempting to compete with Blockbuster and other players like

Hollywood Video. The momentum didn’t really started building until 2001, when a partnership with

Best Buy publicized the unique month-to-month DVD subscription model the young company was

offering.23 By 2003, they had a million subscribers.24 Netflix became a favorite with consumers

because its subscription service lacked a ‘late fee’ policy. Then, in 2007, it blew competitors away

with the introduction of its online video streaming service. This service is ubiquitous today, showing

that today’s consumers really respond to products and services offered on demand, with no extra fee

hassles. Given Netflix’s inexpensive and flat monthly subscription fee, which allowed subscribers to

view thousands of movie and television show titles, it’s no wonder it gained so much ground so

quickly. Another key to Netflix’s success is the breadth of its target audience. Netflix’s subscribers

19

Matt Phillips and Roberto A Ferdman, “A Brief, Illustrated History of Blockbuster, Which Is Closing the Last of Its US Stores,” Quartz, November 7, 2014, http://qz.com/144372/a-brief-illustrated-history-of-blockbuster-which-is-closing-the-last-of-its-us-stores/. The first Blockbuster store opened in Dallas, Texas. 20

Ibid. Viacom bought the firm for roughly $8.4 billion. 21

Ibid. The late fees totaled to about $800 million. It is said that this was around 16% of their total revenue. 22

“Netflix, Inc. History,” Funding Universe, accessed May 11, 2015, http://www.fundinguniverse.com/company-histories/netflix-inc-

history/. The company was established in California. 23

Ibid. Because of its affiliation with Best Buy, Netflix gains more exposure. 24

Six years later, Netflix had over 10 million subscribers because of their streaming services. Retrieved from: http://www.entmerch.org/industry/industry-history.html

10

include everyone from teenagers and young adults to middle aged adults and families. The only

determinants are internet access and a credit card.

Netflix offers a monthly subscription to their consumers to watch movies and television shows

on any device with internet access, including computers, smart TVs and smartphones, tablets, and

more. New subscribers are offered a free month-long subscription to entice them to try the service

out; after the free month is over, users have the option of continuing their access to Netflix by paying

$7.99 a month.25 Netflix’s foremost competitors in the on-demand streaming business are HBO,

Amazon, and Hulu. These enterprises differ from Netflix in terms of price, plans, and content.

HBO NOW is a proprietary online streaming service owned by HBO, a subsidiary of Time

Warner Cable. HBO is known for their bundle of premium television channels. However, due to the

increased popularity of Netflix and products like it, consumer willingness to shell out for select

channel access is on the decline. Beginning in 2015, HBO is partnering with Apple TV to launch a

new internet subscription package, HBO NOW, priced at $14.99 a month. HBO NOW provides online

access to movies and television shows from the HBO network, but unlike its predecessor HBO GO it

does not require consumers to have a cable or satellite TV subscription.26

Hulu is owned by NBC and is popular for its diverse content. It entered the market by offering

new episodes of most network and cable TV shows one day after they aired. Since then, Hulu has

also branched out into producing its own content.27 While Netflix requires a subscription plan to view

any of its content, Hulu does provide a fair amount free content, sponsored by advertisements. In

order to stream everything Hulu has to offer, however, the consumer must pay $7.99 a month to

25

This is the fee for the basic plan. To use Netflix on two or more screens, it is $8.99 a month. Retrieved from: https://www.netflix.com/us/ 26

HBO Now is providing their network movies and shows without the need of cable or satellite. Showtime also plans on providing an online streaming service as well in the near future. Retrieved from: http://variety.com/2015/digital/news/hbo-sets-date-to-cut-pay-tv-bundle-cord-with-over-the-top-internet-service-1201454621/ 27

Users typically subscribe to Hulu Plus to watch the newest television shows, even though Netflix has a longer list of videos to choose from. Retrieved from: http://www.geek.com/mobile/netflix-vs-hulu-plus-video-streaming-1530507/

11

access Hulu Plus- the same price as Netflix. Moreover, even customers who subscribe to Hulu Plus

must watch ads on every video.

Netflix and its competitors incur different costs and profits due to their unique pricing models,

marketing strategies, and financing plans. According to its published 10-K balance sheet, Netflix had

revenues of $5,504,656,000 in 2013. Total assets were $7,056,651,000, and its market value was

$25,313,674,160. Netflix's operating margin was 7.31%, whereas its net profit margin is 48.45%. The

industry's total liabilities amounted to $5,198,943,000, and its debt was $900,000,000. Thus, it would

cost $25,100,066,160 to take over the business. At this time, HBO and Hulu are not required to issue

10-K financial reports, since they are subsidiaries or products of larger companies. Since launching in

April 2015, HBO NOW currently occupies the number one position in iPad revenue.28 Looking at

estimates, HBO Now makes $30 to $50 million a month, though its numbers are predicted to change

over the months. Time Warner Cable, which owns HBO, had revenues of $22,812,000,000 in 2014.

Due to HBO NOW’s launch costs, the firm expended millions of dollars on marketing and increased

spending on programming. However, TWC expects returns in the form of revenue increases by

2016.29 As of 2013, Hulu Plus had over six million subscribers and revenues of at least $1 billion.30

Hulu continues to adjust its strategies to try and improve those statistics. Some of those tactics

include adding more free television shows supported by advertisements, allowing the firm to gain

more subscribers and to collect revenue from various advertisements. Hulu is known for having some

free streaming content available on desktop computers; recently this feature has also become

accessible on mobile devices. Many consumers do opt to pay for the premium content, since Hulu

Plus is the best option for seeing new episodes of network and cable TV shows soon after they air,

28

Natalia Wolfgang, “This Week, HBO Now Claimed the no.1 Spot in Terms of the iPad Revenue, in the List Compiled by App Annie,” Tech News Today.com, May 8, 2015, http://www.technewstoday.com/23510-hbo-tops-ipad-iphone-revenue-lists-with-hbo-now/. HBO Now is number two in iPhone revenue. 29

“Turner, HBO Drive Time Warner Revenue Beat,” Newsmax Finance, April 29, 2015, http://www.newsmax.com/Finance/Companies/Turner-HBO-Time-Warner-Earnings/2015/04/29/id/641434/. There are other factors contributing to the revenue increase. 30

Sarah Perez, “Hulu, Now with 6 Million Subscribers, Will Make Some TV Episodes Free on Mobile,” Tech Crunch, April 30, 2014, http://techcrunch.com/2014/04/30/hulu-now-with-6-million-subscribers-will-make-some-tv-episodes-free-on-mobile/. Hulu Plus offers its services on additional viewing platforms.

12

while competitors like Netflix and Amazon Prime only upload past seasons. To sum up, based on

available information, Netflix has the most subscribers among its competitors and is continuing to

outstrip both HBO Now and Hulu Plus in terms of revenue.

Netflix will likely continue to grow over the next few years and continues to gain ground relative

to its competitors. Its subscriber base continues to expand at significant levels; conventional wisdom

attributes this continued and mounting success to their near-constant additions of original content

since the launch of its first hit show, House of Cards, in 2013.31 Even though Netflix's competitors are

improving their services, it will be difficult to match Netflix’s trajectory. It is projected that Netflix's

international subscriber base will increase by 35% in the next five years, and by 25% in the following

ten years.32 In addition, it is estimated that there will be a 20% increase in domestic subscriptions

during the same time period. Demand for Netflix's DVD services will continue to decrease over the

next few years, and that segment will be phased out once NPV becomes negative, which will likely be

within the next fifteen years.

31

Tom Huddleston Jr., “Netflix Shares Soar on Revenue, Subscriber Growth as Stock Split Nears,” Fortune, April 15, 2015, http://fortune.com/2015/04/15/netflix-earnings-subscribers/. More new shows means more subscribers. 32

Michael Neilsen, “Netflix Revenue Forecast 2014 - 2030,” Seeking Alpha, March 5, 2015, http://seekingalpha.com/article/2069893-netflix-revenue-forecast-2014-2030. These are estimates based on Netflix's revenue.

13

III. What’s the gossip?

A. WHAT ARE OUTSIDERS SAYING ABOUT NETFLIX?

Given the rapid rise and ubiquity of Netflix, it’s no wonder that media outlets and investors have a lot

to say about the company, both good and bad. In the positive column, it is noted that Netflix has over

sixty million subscribers worldwide, showing the universal impact that their streaming service has

made since being introduced in the United States less than a decade ago.33 Netflix has more than 20

million subscribers outside of the United States. Moreover, their number is growing exponentially, a

trend which should signal substantial revenue growth in future. On the other hand, Netflix despite a

24% sales gain in Q1 of 2015, profits dipped due to an unforeseen change in exchange rates.34

Nevertheless, Netflix expects to add at least 2.5 million more subscribers in the current quarter.

Based on the company’s own analytics, it is most likely that Netflix's additional DVD subscription

service will soon slow to a halt. This is because lost revenue due to declining DVD subscribers over

the past year.35 However, it is also estimated that there will eventually be over 100 million Netflix

subscribers, at which point Netflix will be able to raise subscription prices without losing much

ground.36

33

Fortune, “Netflix Membership Soars Past 60 Million,” 15 April 2015, Time.com, accessed May 11, 2015,

http://time.com/3824524/netflix-sales-gains-profits-fall/. It is noted that there are precisely 62.3 million Netflix users. 34

Ibid. In the last quarter, Netflix had a 26% sales gain with only 4.3 million subscribers. 35

Lawrence Meyers, “Netflix, Inc.: Profit Declines, NFLX Stock Soars. Go Figure.” Investor Place, April 16, 2015, http://investorplace.com/2015/04/netflix-inc-earnings-nflx-stock-soars/#.VVBMB9NVikp. Netflix lost a million subscribers from its DVD subscription service. In terms of numbers, Netflix lost $10 million from this. 36

This is assuming that there won't be rising competition from other industries. Based on analytics, it is most likely that Netflix's additional DVD subscription service will soon slow to a halt. This is because of lost revenue due to declining DVD subscribers over the past year.

14

B. WHAT ARE THE SHAREHOLDERS’ VIEWS?

Most shareholders support Netflix’s current strategy of adding more popular, high-quality original

content. With that in mind, these shareholders believe that Netflix won't be threatened by their

competitors.37 As a matter of fact, it is believed that Netflix will slowly eliminate the 'pay TV' business

as we know it over the next couple of years. Netflix is competing directly with pay TV channels, which

have traditionally also provided exclusive, original content to viewers. Some notable 'Netflix Originals'

include TV series House of Cards and Orange is the New Black, both of which have received

primetime Emmy nominations. Furthermore, equity holders have a good deal of faith in the concept of

internet TV. Trends indicate that watching shows on a traditional television set is a thing of the past

and that watching shows via the internet will grow continuously more popular for the foreseeable

future.38 Netflix is also planning to increase privacy protections for their subscribers in the next year,

and on updating its user interface design to better accommodate customers’ needs.39 Currently, there

are no credible or widespread rumors predicting major management changes at Netflix. The last time

there was such a change in management was in 2012, when its Chief Marketing Office Leslie Kilgore

joined the Board of Directors.40 Shareholders also opposed a proposed plan to sever the CEO and

chairman positions, with 73% voting against the measure.41 With this vote, Netflix also agreed to put

an end to public accusations of internet providers which it believed were throttling internet speeds for

its customers.

37

Fortune, “Netflix Membership Soars Past 60 Million.” Competitors of Netflix have different streaming content. 38

Joan E. Solsman, “Netflix signs up new members like crazy in record-breaking quarter,” CNet, April 15, 2015,

http://www.cnet.com/news/netflix-1q-2015-earnings/.The co-founder of Netflix, Reed Hastings, trusts that Netflix won't be stomped out by increased competition from pay TV companies such as HBO or Showtime that are now trying to provide similar services like Netflix. 39

Ibid.Netflix plans on inputting HTTPS to provide additional privacy. 40

“Netflix Announces Management Changes,” PR Newswire, January 20, 2012, http://www.prnewswire.com/news-releases/netflix-

announces-management-changes-137787348.html. Individuals were promoted to the roles of Chief Marketing Officer and Chief Communications Officer. 41

Tom Huddleston Jr., “Netflix Shareholders Oppose Plan to Split CEO, Chairman Roles,” Fortune, June 9, 2014, http://fortune.com/2014/06/09/netflix-ceo-chairman/. Both the CEO and the chairman roles are occupied by Hastings.

15

IV. Who are the potential buyers?

Taking into account a variety of factors, we and the financial community at large have come to

the conclusion that it would be advantageous for Amazon to acquire Netflix, for several reasons.

Amazon’s online video streaming service, Amazon Prime Video, is one of the top direct competitors

of Netflix. In order to establish themselves as a direct competitor to Netflix, Amazon has bundled their

instant video streaming with their free shipping services on their huge online retail selection. All

Amazon customers, even those who do not subscribe to Prime, are able to access Amazon’s

streaming library on a pay-per-view or fee basis. In addition, Amazon recently made a deal with EPIX

in order to significantly increase their catalog of titles.42 However, there are still many aspects of

Amazon’s service which are lacking in comparison to Netflix. For instance, the amount of content that

Amazon provides, even after their deal with EPIX, is still dramatically lower than Netflix’s.

Furthermore, probably the most unattractive feature of Amazon Prime’s video streaming service is the

high fees that they charge per movie, a minimum of $2.99 per title. For only $5 more, consumers can

purchase access to Netflix’s entire streaming library for a month.43.

From our findings, there are six primary reasons why it would make sense for Amazon to

acquire Netflix. The first reason is a set of tax implications which would create incentives to acquire

only Netflix’s streaming business. If Amazon avoids purchasing Netflix’s fulfillment centers, which

have, conveniently, been severed from Netflix’s streaming business, Amazon would avoid any

taxable connection in most of the United States. This would allow Amazon to continue to avoid

collecting sales tax in most states. Should such a transaction occur, it is likely that Amazon will move

Netflix headquarters out of California to avoid physical tax nexus there.

The second incentive is that Amazon would drastically increase their content library. Netflix is

estimated to have about 20,000 TV shows and movies, while Amazon only has around 9,000 titles.

This would make Amazon an industry leader, which would give large pricing power to Amazon and a

better offering to consumers at an estimated subscription price of $80 per year, which is lower than

the current Netflix price.44 Such a deal may or may not raise antitrust issues due to the increase in

pricing power caused by the reduction of competition in the market. Consolidating the two services

would eliminate overlapping costs in production, distribution, and management, but may or may not

raise red flags with regulators. However, since Amazon Prime and Netflix are related through a

horizontal connection, their reasons for merging are not solely focused on money, but rather to

42

http://www.fierceonlinevideo.com/special-reports/top-three-netflix-competitors-whos-challenging-industry-giant 43

http://www.fierceonlinevideo.com/special-reports/top-three-netflix-competitors-whos-challenging-industry-giant 44

http://finance.yahoo.com/news/6-Reasons-Amazon-Will-Acquire-wscheats-9238272.html

16

acquire a competitor who is in the same line of business.45 Antitrust laws mostly concern cases of

vertical mergers; for example, if Amazon were to acquire Comcast or Time Warner Cable, which are

companies that provide the broadband internet connections which are essential for video streaming

services to function. This would be a huge issue because Amazon would essentially be able to set its

own prices and choose which prices to give to their competitors.

The third reason for Amazon to acquire Netflix also has to do with the limited range of content

that Amazon currently possesses, as mentioned above. Specifically, the exclusive streaming content

rights that Netflix holds, which for the most part Amazon lacks, would be desirable factors in this deal.

Netflix has agreements with Starz, EPIX, Relativity, Nu Image/Millennium, and Miramax. Starz

controls Disney and Sony movie content, which accounts for 30% of all box office movie sales in the

United States. EPIX controls Paramount, Lionsgate, and MGM, which together make up another 20%

of box office sales. Additionally, the independent studios Netflix has contracted with control about

10%, meaning that Netflix has content rights to 60% of all widely released movies in the US once they

are released for home consumption.46

The fourth motive for the acquisition of Netflix would be the possibility of Amazon minimizing

their losses if they were to continue to marginally build their streaming business, which in the status

quo must compete directly with the dominance of Netflix, a challenge which generates several billion

dollars of losses every year. In addition to eliminating a key competitor from the equation, Amazon

could get a head-start on its other competitors, such as Apple, Microsoft, and Google. However, even

though buying Netflix might save Amazon money on content acquisition because of the overlap, but it

could also cannibalize sales of their existing offerings, especially their own online video streaming

service, Amazon Prime, and could possibly interfere with the strategic purpose those offerings serve.

This leads us to our fifth reason, which is Amazon’s superior financial resources, which make it

one of the best candidates to buyout Netflix. Unlike many actors, Amazon would be able to absorb

this substantial and expensive acquisition financially47. For comparison, Netflix’s market capitalization

is $34.08 billion, and their enterprise value is $33.84 Billion48. Amazon’s market capitalization and

enterprise value, on the other hand, are $180.06 billion and $171.73 billion respectively49. This shows

that Amazon is more than capable of absorbing the added debt associated with the acquisition of

Netflix.

45

http://bizfinance.about.com/od/Basic-Financial-Management/f/what-are-horizontal-and-vertical-mergers.htm 46

http://finance.yahoo.com/news/6-Reasons-Amazon-Will-Acquire-wscheats-9238272.html 47

http://finance.yahoo.com/news/6-Reasons-Amazon-Will-Acquire-wscheats-9238272.html 48

http://ycharts.com/companies/NFLX 49

http://ycharts.com/companies/AMZN

17

The final incentive for Amazon would be the enticement for Netflix customers to stay with

Amazon after the deal was finalized. It is likely that the synergy Amazon would be able to provide

through its other products, including discounts on merchandise, its Kindle Library, and the continued

free shipping on nearly all retail products that comes with the subscription, would be enough of a

reason for consumers to continue their subscription with Amazon50. This claim is supported by a

recent study that was done by Strategy Analytics. According to their findings, Americans are more

interested in Amazon Prime’s free two-day shipping benefit than they are in its streaming video

service. They have also quantified that in the status quo, after Amazon Prime consumers have

ordered a physical product from Amazon’s retail department, many of them turn to Netflix to stream

video content that is also available on Amazon. The survey discovered that 63% of Amazon’s

customers had used Netflix at least once in the previous month. According to Leika Kawasaki, digital

media analyst for Strategy Analytics, “Amazon is needlessly losing users to Netflix when, in fact, it

should be eating into their user base.” She continues to comment, “Amazon Prime offers subscribers

multiple benefits, there are more Amazon-

capable devices and the subscription is

slightly cheaper.” The survey showed that

by owners of Amazon’s consumer

electronic products, such as the Kindle e-

reader or the Fire TV, were 10% more

likely to stream video content from Amazon

Prime Video. However, Amazon hasn’t

efficiently integrated the retail line of

business with its video streaming service

on its website or in its apps. For all

Amazon device users and Prime

subscribers, it is required for them to use separate applications or browsers in order to access both

integral parts. Kawasaki states, “Amazon has not had the same level of success as Apple in creating

a unified ecosystem of devices and services.51" Unfortunately for Amazon, this inefficiency

encourages its client base to switch to a more user-friendly video streaming service, such as Netflix.

Even the CFO of Amazon attested to this point when he commented on the company’s fourth quarter

earnings for 2014, saying “what we see is customers who come in through our Prime pipeline for

50

http://finance.yahoo.com/news/6-Reasons-Amazon-Will-Acquire-wscheats-9238272.html 51

http://www.fierceonlinevideo.com/story/amazon-prime-reels-svod-subscribers-netflix-binds-them-study-says/2015-04-08

18

video for a free trial, those customers are converting at higher rates to other channels.”52 Amazon’s

investors will thus look to replace inefficient management of resources by eliminating this

unsuccessful distribution technique. By acquiring Netflix, Amazon would be able to successfully

duplicate the simple and efficient user interface that Netflix prides itself in.

Given these many reasons for why Amazon would benefit from acquiring Netflix, we will now

attempt to present a strategy for how Amazon would go about acquiring or merging with Netflix. We

will show that the numbers, including net present value and discounted cash flow analysis, bear out

our conclusion about the feasibility and desirability of such a deal. We will also look into Netflix’s

comparables and develop our own acquisition plan.

52

http://www.fierceonlinevideo.com/story/amazon-prime-reels-svod-subscribers-netflix-binds-them-study-says/2015-04-08

19

V. What’s the strategy?

Netflix is currently the leading video streaming service in the United States, with a market

penetration of about 36%. Amazon Prime streaming services the runner up, with a market penetration

of 13%53. Thus, these two services control about 50% of video streaming in the United States

between them. As of December 31, 2014, Netflix had 37.698 million domestic subscriptions—that’s

nearly twelve percent of the US population. In 2010, Netflix launched streaming services in Canada,

and subsequently began expanding into Latin America and Europe (2014).54 In our opinion, acquiring

Netflix would be beneficial to the shareholders and customers of Amazon Inc. The immediate effect

would be to expand Amazon’s market share and revenue from video streaming services. Amazon

would benefit from the pre-existing licensing agreements and Netflix’s large content libraries, as well

as its critically acclaimed original programming. Given Amazon’s presence in this market, this project

would be of average risk. With Netflix’s commanding lead in the market, and Amazon’s multiple

business lines, there are very few comparable firms (except Hulu, which is privately owned). The

combined market share would allow Netflix to negotiate better licensing costs on content, which

would benefit both the shareholders and consumers of Netflix-Amazon, who would now have access

to an even larger body of content and the combined advantages of Amazon Prime and Netflix. This

would also prevent the content bidding wars which drive up such costs for both shareholders and

consumers.

At their core, Netflix and Amazon Prime Video services provide the same service—video

streaming. Through a merger between Netflix and Amazon Video, technical and administrative costs

could be combined and streamlined, while profitable sections of Netflix could grow with the

53

Taylor Soper, “Netflix Still King of Streaming Video, but Amazon Gaining Market Share,” Geekwire, March 12, 2015, http://www.geekwire.com/2015/netflix-still-king-of-streaming-video-but-amazon-gaining-market-share/. The Amazon subscription includes other services involving Amazon’s other sectors. The data in question is from Nielsen. 54

Netflix Corporation, Annual Report 2013, Form 10-K, (2014), 1.

20

infrastructure and backing of Amazon. Amazon shareholders would benefit considerably, gaining the

experience and content of the firm most associated with video streaming.

At present, Netflix has three separate segments—Domestic Streaming, Domestic DVD, and

International Streaming. Netflix’s most recent segment information, operations statement, income

statement, cash flow statement, and consolidated balance sheet are included as figures 5.8 through

5.12 respectively.55 International streaming, at present, has yet to turn a profit. However, after losing

274.332 million dollars in 2013, it lost only $159.789 million in 2014, a significant decline in losses. As

a percentage of yearly segment revenues, the loss went from 38.5% to 12.2%. Moreover, starting in

2013, revenue from streaming exceeded the cost of revenue; the loss was from increased marketing

expenses. Based on the segment information, this did pay dividends—revenue increased from

$712,390,000 to $1,308,061,000, a growth rate of 83.62%, while cost of revenue increased only

47.53%. Marketing expenditures increased by more than 20%. The DVD streaming service is still

profitable, but has seen steadily declining revenues. The average quarterly revenue decline in 2013

and 2014 was 3.99%, and yearly revenue declined nearly 16% between 2013 and 2014. We believe

this trend will continue, along with the general decline in the renting and/or purchasing of physical

media in general. Nonetheless, for the time being, the declining DVD business is covering the losses

in international streaming. Paid subscriptions increased about 19% from the end of 2013 to the end of

2014, with revenue growth of about 25%.

By acquiring Netflix, Amazon would benefit from Netflix’s existing customer base, its pre-

established marketing and expansion plan, the elimination of redundancies in administration, and

licensing advantage. Netflix’s existing operations can be phased out, and within one to two years

Netflix’s administrative support and expenses— accounting, IT support, human resources, etc. —will

be assumed by the existing infrastructure at Amazon. Moreover, existing subscriber databases,

content storage and the like would be moved to Amazon facilities. Real estate and unnecessary

55

See Appendix I.

21

hardware will be sold. Because Amazon already operates its own streaming service, this process

would be a very simple movement of content and the retention of the best employees from both

services. The Netflix‘s balance sheet will show declining administrative expenses as it essentially

becomes a project within Amazon.

As mentioned, Netflix revenue from domestic streaming grew about 25%, according to the

most recent 10-Qs from Netflix, available on the company website. For our purpose, we will assume

that future revenue growth in the US will be 23%--well in line with past years, but not too optimistic.

Marketing expenses have been approximately 10% of domestic streaming revenue. Yearly

international revenue, as mentioned, grew by over 83%. However, from 2012 to 2013, international

revenue increased by 148%.56

Graph 5.1 shows the increase in revenue from international streaming from 2010 to 2014.

Obviously, exponential growth in the long term is unrealistic to expect. Rather, we expect declining,

but high growth rates to continue for the foreseeable future. Indeed, we would not expect to see 20

percent growth rates for some time, as the potential customer based in Latin America and Europe is

56

Ibid.22

22

simply massive. Moreover, Netflix has already begun expansion, so this would not be an additional

expense for Amazon, but rather the continuation of an already prepared project.

Based on past 10-Ks, the cost of revenue for the DVD streaming segment has remained stable

around 52%. From 2012 to 2013, DVD streaming revenues declined about 20%; Netflix did not begin

recording the difference in segments in 201157. Based on these numbers, we project a yearly decline

in revenues in this segment of 16%. Netflix has not spent any money marketing this service in 2014;

we will continue that policy.

On international streaming, we are projecting revenue to increase at declining rates. As can be

seen in table 5.1, the percent increase in revenue has declined from 2,190% to 83.62%. We are

projecting revenue growth in 2015 in the foreign market to be 75%, and to decline 5% per year after

that. This is conjecture and is likely to be below the actual growth rates, especially in 2015 and 2016.

Indeed, Netflix plans to expand from its current presence in 50 countries to 200 in 201658. However,

these conservative assumptions will allow us to account for any recession or periods of international

expansion where we might underestimate net loss in the early years.

Currently, technology and development expenses stand at around 8.5% of revenue, and

general administrative expenses stand at around 5% of revenue. However, as Amazon already has

their own administrative infrastructure, we expect that after continuing to grow at 5% for 2015, we will

cut these expenses to one half each year beginning in 2016. As Amazon has its own technical

development, we will cut the expenses for this department by 50% per year beginning in 2016. For

fiscal years 2013 and 2014, cost of revenues on a consolidated basis has been between 65 and 73%

of revenue. Assuming that relationship holds, we will use 70% as the consolidated cost of revenue.

Given the international push, we would expect international marketing costs to remain high. Marketing

has been stable as a percentage of revenue between 9 to 12%. With international growth, we will

57

Netflix Corporation, Annual Report 2012, 10-K, (2013). 58

Emily Steel, “Netflix Accelerates Ambitious Global Expansion as U.S. Growth Slows,” New York Times, January 20, 2015, sec. Media, http://www.nytimes.com/2015/01/21/business/media/netflix-earnings.html.

23

project this as 14% of revenue on a consolidated basis. This is modeled in Figure 5.2, the Pro Forma

Income Statement.59

Based on 2013 and 2014 numbers, accounts payable were equal to an average of 3.0704% of

sales, 2.48% in 2013 and 3.66% in 2014. Assuming that there might be some difficulties with

expansion, the model will assume 3.1% of sales. Receivables, both according to its 10K and freely

available financials information, do not exist, probably as Netflix’s customers’ credit cards are charged

automatically, moving receivables onto the balance sheets of the credit card companies.

Between 2013 and 2014, the cost of current content liabilities grew by about 16.12%; non-

current liabilities 14.6%. For projection purposes, we expect those rates to remain the same for 2015.

Beginning in 2016, content costs will decline substantially—to be blunt, content creators simply

cannot refuse to do business with the streaming service that controls half the market—even if

Amazon continues to operate the Netflix label. Therefore, by 2016, we project the current content

liability costs to halve in the short term (8.08%), and for them to decrease more slowly on the long

term liabilities (to 12%, 11%, 10%, 9% and 10% from 2016 to 2020), as these longer term content

contracts have already been set. The greatest cost reductions will likely come in the next 5 to 6 years

as contracts end. As Amazon has its own content library, similar cost savings will likely occur,

although as a conglomerate, it would have a smaller balance sheet impact. For projection purposes,

we will assume those prices remain the same and the cost reduction will be reflected in Netflix’s

Balance Sheet.

Current net content liabilities have averaged approximately 98.9% of current short content

liabilities between 2012 and 2014; we expect this to continue. Non-current content (an asset) has

averaged 1.657% of non-current content liabilities; we expect this to continue. We expect cash to be

about 15% of revenue; a bit lower than the 2013 and 2014 average of 17%, but reflecting the likely

increased usage of cash during expansion. As Netflix will not be adding more short term investments,

59

See Appendix I.

24

and will in fact be selling off much of its property and equipment, we will hold other current assets,

property and equipment, and other non-current assets flat for 2015. In 2016, real estate and

unnecessary capital equipment will be sold (98% of the dollar value, the remaining 2% will be kept on

hand and remain at a constant dollar level. Assuming that the assets, valued at $146.877.50 are sold

for that amount, with a tax rate of 35%, this will be a cash gain of $95,740 in 2016. This will be kept

as cash on the balance sheet until at least 2020 to cover any unforeseen expenses during the merger

process. The remaining $29,650 in property and equipment will be maintained through the expenses

budgeted in the pro-forma income statement. “Other Current Assets,” a highly variable and ill-defined

category, are projected to remain at 3.6% of sales, the average of 2013 and 2014. Accrued expenses

are highly variable, so we will assume a long term yearly average of $80 million from 2015 onward.

The “other noncurrent” liabilities will be 1.45% of sales, again the average of 2013 and 2014

numbers. Deferred revenues will average about 5% of revenue.

Netflix’s current and long term content liabilities will continue to grow, but at a lower rate. Once

the merger occurs, Netflix and Amazon will control 50% of the content streaming business, and thus

have significant price making power with content providers (not unlike the power Amazon has with

book publishers). As a result, depreciation in dollar amount will decline. In 2013, depreciation was

1.11 percent of sales and in 2014, .98%. As a conservative estimate, our model will incorporate

depreciation as 1.044% of sales. This can be seen on the pro-forma income statement and pro forma

Balance sheet, figure 5.3.

On the expenses side, Netflix’s 2013 tax rate was calculated to be just below the 35% mark, at

34.3%. Its 2014 income tax rate was 23.63%. However, Netflix put aside about 38.33% of its Q1 2015

Revenue for tax purposes. As such, given that corporate tax rates in the US are around 35% we will

assume a 35% income tax rate. However, as part of a larger company (which often sees losses), the

actual tax expenses generated by Netflix as part of Amazon would depend on the overall profitability

of the rest of Amazon’s lines of business.

25

In 2015, after a downgrade by Moody’s and S&P, Netflix raised $1.5 Billion in debt, $700

million in notes at 5.50% due in 2022, and $800 million in senior notes at 5.875% due in 2025.60 In

2014, Netflix issued $400 million in senior notes at 5.75%, due 2024.61 According to its 10-K, Netflix’s

outstanding issuance at the close of 2013 was $500 million at a rate of 5.375%.62 Therefore, future

debt issuances would like result in further downgrades and/or increased cost of debt. As of December

31, 2014, Amazon had long term debt of $8.265 billion, other long term liabilities of $7.410 billion, and

current liabilities of $28.089 billion. With an enterprise value of $33.73 billion as of March 2015 and a

market capitalization of $34.76 billion,63 purchasing Netflix with debt alone would be hugely expensive

and would increase interest payments and cost of debt for Amazon significantly. By weighting the

makeup of the debt and their interest rates, we find that in 2015, the average cost of debt is 5.45%,

and from 2016 to 2020, 5.637%. These calculations will be included in the appendices.

For purposes of calculation, 2015 will be the year of acquisition, and 2014 Year 0. With the

most recent 10 Year Treasury notes issued on Friday May 8th, 2015, at 2.12%64 and a YTD return on

the S&P 500 of 12.82%,65 the unlevered cost of capital for Netflix was determined to be 17.72%. See

Figure 5.4, Cost of Capital. Netflix’s EV/EBITDA Margin is approximately 10.7366. Based on present

debt levels, that means the NPV of Netflix in 2015 is $37,468,571,410 with our cost savings. See

Figure 5.5 for the Calculation of Free Cash Flows and 5.6 for the calculation of Net Present Value of

the cash flows of the Acquisition.

60

Rodd Sprangler, “Updated: Netflix Prices $1.5 Billion in Debt to Fund Content, Other Initiatives,” Variety, February 2, 2015, http://variety.com/2015/digital/news/netflix-plans-to-raise-1-billion-more-debt-to-fund-content-1201421246/. 61

Zacks Equity Research, “Netflix to Issue $400M in Debt,” Zacks, February 5, 2014, http://www.zacks.com/stock/news/122088/netflix-to-issue-400m-in-debt. 62

Netflix Corporation, Annual Report 2013, 13. 63

“Netflix, Inc. (NFLX),” Yahoo Finance, May 8, 2015, http://finance.yahoo.com/q/ks?s=NFLX+Key+Statistics. 64

“Daily Treasury Bill Rates Data,” US Department of the Treasury, May 8, 2015, http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=billrates. 65

“S&P 500,” CNN Money, May 8, 2015, http://money.cnn.com/data/markets/sandp/. 66

“Netflix Inc. NFLX (U.S.: NASDAQ),” Wall Street Journal, May 10, 2015, http://quotes.wsj.com/NFLX/financials.

26

As of Dec 31, 2014, Amazon has cash (and equivalents) on hand of $14.557 billion67. Net

working capital was $3,238 Billion for 2014 (nearly twice that of 2013).68 In order to ensure that

Amazon has enough to pay its bills and cover any unexpected expenses, Amazon needs to keep

some cash on hand. However, using up to $8 billion in cash to purchase a portion of Netflix shares

would still leave over $6 billion in cash, enough to cover working capital needs (assuming that NWC

requirements do not double and Amazon continues to realize revenue).

With recent downgrades, a high debt strategy would not be ideal for either firm. Therefore, in

order to complete this transaction, we will use a mixture of equity and cash. Netflix shares closed on

Friday May 8th at $574.60,69 and there are 60.5 million shares outstanding.70 3.025 million shares

would represent 5% of shares outstanding, the threshold for reporting to the SEC under Scheduler

13D71. At the current share price, that would represent $1,738,165,000. If the price were to increase

to $600, then the cost of 5% ownership would be $1.815 billion. Due to Amazon’s recent downgrade,

the goal would be to use the $8 billion to purchase a large minority stake in Amazon. Then, Amazon

will swap out Netflix shares at a premium to its current value. By adding this goodwill, the likelihood of

these dealings turning hostile would be lessened. Neither Amazon nor Netflix would be served by a

reenactment of Barbarians at the Gates.

Any aggressive share purchases would likely cause upward pressure on the stock price. A

Cash/Equity strategy breaks even at $618.231/ share (the NPV of 37,093,885,700 /60.5 Million

shares), after the 1% fee collected by the bankers. Amazon should continue quietly purchasing

shares until the price reaches $590 or 5% ownership of Netflix. It’s also highly possible that the price

will decline, even shortly. On May 5th, the stock closed around $565, and reached $556.72 on the 6.th

67

Amazon Corporation, Annual Report 2014, Form 10-k, (2015), 42. 68

Ibid. Networking Capital=Current Assets-Current Liabilities=$31.327B-$28.089B=$3.238B 69

“Netflix Inc. NFLX (U.S.: NASDAQ).” 70

“Netflix, Inc. (NFLX).” 71

Bell B. Jeffrey, “THE ACQUISITION OF CONTROL OF A UNITED STATES PUBLIC COMPANY” (Morrison Foerster, 2014), http://media.mofo.com/files/Uploads/Images/1302-The-Acquisition-of-Control-of-a-United-States-Public-Company.pdf.2

27

Opportunistic trading could allow Amazon to buy small blocks of shares below the current price. A

share price of $557 would mean a difference of approximately $53 Million. Buying shares and

removing them from circulation would lower the number of shares that would need to be exchanged

for Amazon shares. 5% of an EV of $33.73 billion would decrease the number of shares and cut

down on ownership dilution. Once the 5% threshold is met and filings made with the SEC, Amazon

must be very careful to ensure that acquisition rumors do not send the price rallying. If the price

remains below $590, Amazon should continue to buy shares and simultaneously make the official

offer to Netflix. The remaining cash put aside for the acquisition will be used for such opportunistic

share purchases.

Amazon’s current share price is $433.69 with 464.38 Million Shares outstanding.72 Netflix’s

outstanding shares, in number are about 13% of Amazon’s, but trade for over $100 dollars more. To

ensure that the offer is welcomed, Amazon will exchange each Netflix share at above market value.

For each share, Amazon will offer $600 dollars’ worth of Amazon shares, approximately 1.3 shares.

Should the share price already have been pushed near that level, the over will be increased to $610;

1.316 Amazon shares. These calculations are in figure 5.7. The number of shares should be kept as

low as possible to prevent existing Amazon shareholders from worrying about ownership dilution.

However, as the pro-forma Netflix has an NPV of approximately $37 billion, the added value to

Amazon’s valuation will offset the relatively small ownership dilution. As of May 10, 2015, the

enterprise value of Amazon was 200.25 billion73. The combined enterprise values of Netflix and

Amazon, adjusting for the retirement of 5% of the shares and the 1.3 Amazon-for-Netflix shares, even

before the cost savings are taken into account, is $234.23 Billion. The fair market share value would

be $434.49. With the NPV of the acquisition and Amazon’s current EV, that would increase to

$440.73. Obviously, should the share price increase, the benefits of the acquisition would decrease.

$618.23/share would represent the point where the cost of acquisition equals the NPV of the project.

72

“Amazon.com Inc. AMZN (U.S.: NASDAQ),” Wall Street Journal, May 10, 2015, http://quotes.wsj.com/AMZN. 73

“Amazon Inc. (AMZN),” Yahoo Finance, May 8, 2015, http://finance.yahoo.com/q/ks?s=amzn+Key+Statistics.

28

At that point, the NPV of project would equal the share offer. So long as the Netflix share price is

below that, the acquisition is worth undertaking, as our conservative estimates likely underestimated

the upside.

29

VI. CONCLUSION

Both Amazon, Inc. and Netflix, Inc. were products of the late1990s Tech boom. Since then, they have

become incredible valuable companies and cultural icons. Given the growth of video streaming as a

standard form of media consumption and the development of Netflix and Amazon as effectively two

oligopolies surrounded by much smaller competitors, we believe that the consumers and

shareholders of both companies would benefit from a merger. The merger would allow the

consolidation and reduction of administrative, research, and other costs, and allow for significant

decreases in content costs. A significant portion of Netflix’s physical assets and the like could be sold

and could rely upon Amazon’s already impressive infrastructure. The growth of serious contenders for

Netflix’s crown toward the end of the first decade of the 21st century saw content costs for Netflix

increase dramatically. The ability to negotiate operating costs while holding at least half of total

streaming market share, a share that is increasing rapidly abroad, would put downward pressure on

price, benefiting the merged firms, competitors, and thus the consumers, who will not see their

monthly costs increase due to higher content costs.

By relying on cash and equity, as opposed to debt, the cost of the acquisition relative to its

value can be kept very low. Because of Netflix’s and Amazon large debt loads and recent

downgrades, significant debt issuances would lead to further downgrades and increases in the cost of

debt. While medium to long term interest rates are quite low, increases of more than 25 to 50 basis

points would not be unlikely. The ability of either Netflix or Amazon to support billions more in debt is

doubtful, given Amazon’s transients profits and Netflix’s much lower value. Moreover, the equity offer

and share purchases, even at a premium, offer the easiest and lowest cost opportunity for this merger

to occur smoothly. Moreover, shareholders’ slight dilution is ownership is more than covered by the

almost immediate increase in share price.

30

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31

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VIII. APPENDIX I: SPREADSHEETS

AND GRAPHS

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