BREAKINGVIEWS-Netflix submits to Warner Bros siren song

By Jennifer Saba

NEW YORK, Dec 5 (Reuters Breakingviews) - Netflix NFLX.O has officially entered the Upside Down, the dark alternate dimension of its hit show "Stranger Things." Co-CEO Ted Sarandos abruptly reversed three decades of building instead of buying and agreed to pay $83 billion, including debt, for the Warner Bros film studio and rival HBO. The deal is fraught from political, regulatory and financial perspectives, putting the streaming titan in a curiously defensive light.

The three-way bidding war for the businesses behind everything from "The Wizard of Oz" to "Game of Thrones" featured plenty of drama, and there may yet be more to come. Netflix emerged victorious on Friday over David Ellison's Paramount Skydance PSKY.O and cable operator Comcast CMCSA.O by offering Warner Bros Discovery WBD.O shareholders $23.25 in cash and $4.50 in Netflix stock conditional on fluctuations. Straight-shooting Sarandos uncharacteristically used M&A cliches like "one plus one equals three or four" and the ability to "give audiences more of what they love” to justify the acquisition.

He and co-CEO Greg Peters are promising between $2 billion and $3 billion of annual savings from the deal. Even then, the price tag fails to stack up. Warner Bros and HBO are expected to generate a combined $1.8 billion in operating income next year, according to Visible Alpha estimates. Add the midpoint of the estimated Netflix cost-cutting range, tax the sum at the standard 21% corporate rate, and the implied return on investment is just 4%, according to Breakingviews calculations. It would take more than twice as much of a synergistic uplift to reach a respectable 8% return.

The decision also plunges Netflix into unfamiliar territory. There probably will be tough regulatory reviews around the world, a risk reflected in the $5.8 billion fee, a hefty 7% of the purchase price, Netflix agreed to fork over to WBD if the deal collapses. Politics will be a factor, too. Ellison's father, Larry, the founder of technology supplier Oracle ORCL.N, is cozy with President Donald Trump. Moreover, Paramount wanted all of WBD, including the cable networks now slated to be cleaved into a separate company, and offered $30 a share, CNBC reported. It won't go quietly and neither will potentially aggrieved shareholders.

Since its founding in 1997, Netflix has creatively upended the Hollywood establishment and generated shareholder value without indulging in the same empire-building acquisitions that haunt the industry. Warner Bros alone previously lured, and cursed, internet trailblazer AOL, telecom titan AT&T T.N and TV conglomerate Discovery. Steve Case, Randall Stephenson and David Zaslav, their respective bosses, all hailed opportunities from owning the storied entertainment business, just as Sarandos and Peters are doing now. The wreckage coming soon will hardly be original.

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CONTEXT NEWS

Netflix said on December 5 that it would pay about $83 billion, including debt, to buy HBO and the storied Warner Bros film and television studio behind everything from “The Wizard of Oz” to “Friends" from Warner Bros Discovery.

Under the terms of the deal, WBD shareholders receive $23.25 a share in cash and $4.50 in shares of Netflix common stock for each WBD share for an equity value of $72 billion. The stock component is subject to a collar, which sets a price range on Netflix stock and adjusts the exchange ratio accordingly to protect shareholders from any wild swings before the merger is completed.

WBD will first proceed with its plan to separate its streaming and studios from its cable networks into two different companies.

Netflix said it anticipates the acquisition to generate between $2 billion and $3 billion of annual cost savings by the third year after completion.

Moelis is advising Netflix, as is Wells Fargo, which also is providing committed debt financing with BNP and HSBC. Allen & Co, JPMorgan and Evercore are advising WBD.