Emily Flippin (5:46)

Yeah, it's a critical question. And to your point about Netflix being such a disciplined operator, I think that's why it surprised so many investors when they saw that Netflix even made a bid because it seemed like something that lacked, you could argue, a bit of financial discipline. But to your point, Jason, I mean, I saw this and I wasn't surprised at all because to me, this is Netflix saying, we don't need this content library, but we know if we get this content library, we are absolutely crushing the competition. When you compare to other bids like Paramount, which we're going to talk about in a second, they need that content library just to stay competitive. So it's a position of, of strength versus a position of. Of weakness. And Dan, I know there was a lot of interest from other streaming and entertainment companies and of course we have to talk about Paramount, who is coming from that position of weakness. They actually launched their own tender offer to Warner Brothers shareholders for $30 a share, all cash. Now, if more than 51% of shareholders choose to sell these shares to Paramount in the next 20 days, Paramount would of course effectively control Warner Brothers. As of right now, Netflix and Warner Brothers have reiterated that they're committed to the initial deer deal despite Paramount's offer. And the math behind this offer isn't exactly clear. It's not cut and dry. What Netflix is offering is a combination of stock and cash, and then also the potential value of the cable assets when they've been spun off versus Paramount's flat $30 cash rates. But I want to ask you, Dan, I mean, do you. Why do you think ultimately Warner Brothers decided to go with Netflix bid and what, if anything, do you think comes out of this deal?

Dan Kaplinger (7:16)

Yeah, it's easy to get confused with the timeline. Now because with the hostile bid coming after Netflix and Warner Brothers had come to an agreement, if you're just looking at it from the outside, you might be wondering, well, you know, why don't they take the new deal? Why aren't they? It's more money. Why don't we take it? But in practical terms, it's always a little bit more difficult once you have a signed agreement at the end of what has already been sort of this auction bidding war process. Always harder to undo whatever that decision was, even if a better deal comes in later. And so I think that's kind of where we are at this point. Just bear in mind, I think as you point out, the terms of the two offers were not directly comparable. But there's certainly an argument to make that when Warner Brothers finalized an agreement with Netflix, there was a credible argument that Netflix's offer was the higher price deal. And so I think that it's interesting, as Jason pointed out, the way that Paramount has decided to do this hostile tender offer, it really puts the question directly in the hands of the shareholders in both directions. Shareholders were already going to have the ability to vote yes or no on accepting the Netflix acquisition. Tendering your shares is another way of doing it, but basically is the same calculus. If you tender your shares to Paramount, you want the Paramount deal to go through. If you don't tender your shares to Paramount, you're waiting to send those shares to Netflix, assuming that the deal gets approved and, and all of that. But you ask where does, where does Warner Brothers see the value in the Netflix bid? And I think if you go beyond price, what to me is the most intriguing thing about this is that key difference between the Paramount offer and the Netflix offer. Paramount wants the whole thing, every piece of Warner Brothers operations. Netflix, on the other hand, singled out certain operations. They want the studio, they want some of the cable business, but not all of the cable business. And that is something that I think is kind of an intriguing thing. And I think that some Warner Brothers executives may have been intrigued by the idea of really getting almost to turn back the clock and recreate that old independent Discovery Communications looking cable business. Is that shell that is going to be not acquired by Netflix? I know that there's some members out there of the Motley fool stock Advisor service. You may remember, it is that Discovery Communications business that got a recommendation from Motley fool co founder David Gardner on the rule breaker side of the stock Advisor scorecard. That happened way back in 2010. It was before Warner Brothers was even involved. And it's interesting that content that you find under the Discovery Communications platform. Yeah, a lot of people are looking at cnn, the news networks and basically saying, yeah, this stuff is worthless. It's no surprise that Netflix doesn't want it. But there's a lot of kind of fan favorite content out there, whether you're a foodie, you've got Food Network, you've got HGTV for homeowners. I'm a big fan of the show Gold Rush on, you know, on the Discovery Network. I mean, all kinds of stuff is out there. It's kind of an unpopular opinion. But I think those cable properties actually do have value. And that's one of the benefits of the Netflix offer, is that if you're a Warner Brothers Discovery shareholder, you're going to get some cash, you're going to get a lot of cash, you're going to get some Netflix shares, but you also get this kind of Discovery Communications, Discovery Cable. I can't remember exactly what they're calling it, but you get this shell of the cable business that a lot of people think is worthless. I'm not convinced it's going to be, it's going to have a lot of debt, that's for sure. But I'm not convinced that it doesn't have value in the long run.

Emily Flippin (11:24)

And that's exactly where the difference is between the two bids. It'll be interesting to see where individual shareholders, the people who own the majority of Warner Brothers shares, ultimately decide because that's a decision that every shareholder needs to make for themselves whether or not they take the cash or they hold out for the potential change in value of these cable assets. But one thing for me that is very clear from this deal is that regardless of whether or to move forward, Netflix balance sheet is about to look very different than it does today. Either they are making a massive acquisition and taking on a lot of debt in the process or they have to pay a breakup fee that would be north of $5 billion, which would eat into their existing cash. So for Netflix, this is a big change. Up next, we'll be discussing what this means for consumers and whether or not this move puts Netflix on a smarter path or on a collision course with some of the failed mega mergers of the past. Stick with us.

Dan Kaplinger (12:10)

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Emily Flippin (12:41)

We're zooming out at mega mergers and evaluating if Netflix is on the road to repeating history with its pending acquisition of Warner Brothers Discovery. Now I know when I think about entertainment mega mergers. My mind does go back to the year 2000, of course, when AOL and Time Warner sought to combine in a deal worth north of $180 billion that was intended to dominate both what they called new and old media. But of course, within just a few years, that merger actually led to nearly 100 billion doll, which at the time was the largest corporate loss ever, driven largely by goodwill write downs tied to the merger. Of course, in 2018, AT&T closed its acquisition of Time Warner's assets for $80 billion that ultimately had to be unwound less than four years later, in no small part due to financial strain. Of course, I'm not trying to say that all mega mergers are ending a disaster. I think Disney's acquisition of 21st Century Fox back in 2019 comes to mind. The stake they acquired in Hulu has been a great investment, but in general M and A is pretty challenging. Research has suggested that anywhere between 70 to 90% of all mergers fail to achieve their stated goals or generate value for the acquirer shareholders, which has naturally made Netflix shareholders concerned here. Dan, when you look across some of these past mega mergers, are there any patterns that jump out to you or things that make you think that Netflix is or is not repeating history here?

Dan Kaplinger (13:58)

Well, maybe the most obvious one is for superstitious folks. Maybe is the Warner name just cursed in mergers and acquisitions? You know, you named a couple of examples there. I think it's kind of too early to tell in this case, largely because it's not entirely clear what Netflix's goals are. I don't think it's a warning sign that Netflix hasn't telegraphed too much about what it plans to do with Warner Brothers if it successfully acquires it before antitrust scrutiny really runs its course. Because you don't want to kind of lock into a business model and and then have regulators kind of pin you down on that and say, well, that's not going to work. I think you want to keep things flexible at this point. One area where I think Netflix has A better opportunity, definitely, than AOL did, is that Netflix and Warner Brothers, even though they've taken kind of different approaches to content distribution, they're essentially in the same business. They're trying to find content, produce content, and deliver content in the entertainment business to viewers. And so I think that it's more likely that a merger is going to produce the kinds of cost savings, the synergies, the more efficient production. That just didn't seem to happen with AOL Time Warner. Where I'm a little bit more questioning, though a little dubious, is I'm not sure if combining Netflix and Warner Brothers, especially the subscription service part of Warner Brothers, I'm not sure how much price elasticity that combined entity is going to have in persuading subscribers to pay more. I've seen some preliminary stuff that suggests Netflix is telling people, hey, don't sweat it. Netflix will stay Netflix Max will stay Max. But at some point, don't you think that those two things combine and people kind of want you, you know, Netflix wants you to pay twice as much and kind of join those subscription bases together? That, I think may be a problem, may not go as well as Netflix hopes. And I also kind of worry a little bit about the culture clash that may exist. Netflix at the time, very disruptive in deciding early on we're going to make our own content. We're not going to acquire a Warner Brothers or another studio earlier on, we're going to forge our own course. Only now that they've established that disruptor model, now they're going out and trying to ramp up and get more studio assets. Maybe some culture clash between the two workforces there.

Emily Flippin (16:34)

And to your point about the pricing here for Netflix consumers and HBO Max consumers, there's still this big question mark about regulatory scrutiny and whether or not regulators would even allow a deal, regardless of whether or not it's Paramount or Netflix, to move forward. And this will be interesting. We haven't had a big litmus test like this for the Trump administration, so it'll be really interesting to see where regulators fall on this. But if I'm Netflix, what I'm doing is arguing that a combined Netflix and HBO Max subscription, all under the Netflix umbrella here, would be cheaper to the consumer than paying for two separate streaming services. Maybe prices go up in general, but I would make the argument that one subscription combining both of these entertainment assets, would be cheaper than two. Of course, we haven't seen Netflix actually signaling this, but I can imagine if regulators start to dig into the deal, this is the argument Netflix is likely to make. But Jason, I mean, given the history we've discussed here, when you think about these industry changing deals, is there any specific warning signs that make you think that Netflix could be the next AOL Time Warner vs. The green flags that say this might be closer to a Disney Fox situation?

Jason Hall (17:37)

So we didn't even really hit on something important about that. AT&T deal for Time Warner in 2018, you know, paid $85 billion the quarter before WBD was spun out as a standalone company. AT&T took a $25 billion goodwill impairment. Right. It is definitely. It feels like a cursed asset. But I think the difference really is that both of those two prior deals we talked about, these were disparate businesses and assets that were really just empire building. These weren't like integrating things that worked well together like we're talking about with Netflix, where this is obviously part of their core business and it's additive to that instead of empire building. I mean, let's be honest, empire building royalty are the only ones that enjoy the riches. Right. And in businesses, that's the executives and the grand viziers, which you are the M and A bankers. I also, I want to push back just a little bit on the Disney Fox situation either. Frankly, I don't think that's gone great. There's definitely been benefits getting that. The fox Studios, the 21st Century Fox, there's value there. Hulu, that's been really, probably really the greatest value there. But the Fox side of that business, they're making about half as many movies as they were since before the acquisition. And then think about the linear TV challenges. They've eroded a lot of that, that value. So I think this for Netflix is more like what we saw with Activision Blizzard during its most successful period as a standalone company. It included a ton of M and A, acquiring game studios and integrating them into the business. This is a big deal. I think one of the reasons Netflix has decided to do it now versus doing this in the past. Tess Rand has talked about, we've been a builder, not a buyer. They're big enough now that I think they have enough culture that's big enough that they can integrate this and their corporate culture is going to win. And it's one of the few companies that could has the discipline to deliver a happy ending for something like this.

Emily Flippin (19:29)

It's nice to hear a more positive take. Although I will say history does show that mega mergers generally don't live up to the hype. But there are always exceptions to the rules. Up next, we'll be stepping away from Netflix and Warner Brothers specifically to talk about how you can judge big acquisitions anywhere in your portfolio, using this deal as a live case study.

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Emily Flippin (21:04)

Money to wrap up today's show, I want to zoom out and look at mega mergers in general and how investors can think about them within their own portfolios. As we mentioned, and generally, M and A doesn't generally live up to the hype that is cultivated when deals are announced. And I very often consider the reason why mergers fail is just because they don't have a clear why about why they wanted to merge in the first place. Jason When a company in your portfolio announces a deal like this, what's the first question you ask yourself to start evaluating if it's a good decision or not?

Jason Hall (21:29)

The starting point for me is really clear. I have to have confidence that the acquirer is a company whose leadership, that's the board all the way through this C suite can deliver on M and A. There are mostly companies that just can't do it, but there are a few that absolutely can do it and do it really well. So, for example, Chart Industries back in 2017, Jill Ivanko joined the company as CFO. About a year later, she was named CEO. In her time there, the company made 25 transactions. The stock is up more than 5x. That's 21% a year for an industrial manufacturing company and it's now itself being acquired. Most of those deals were small, but a few were big and one was massive and debt funded. If a company has a history of doing M and A, well, then it should be already part of the thesis to invest in that company. If not, I want to see a long history of being really disciplined in operations and managing the balance sheet. And I want it to be a move about playing offense. And I need to be confident the corporate culture of the acquirer is strong enough to not get eroded because of a merger. I see all of those things with Netflix in this case.

Emily Flippin (22:32)

Dan, anything you want to add to Jason's checklist or potentially take off?

Dan Kaplinger (22:36)

I think from an investor standpoint, I generally skip over whether it was a good decision or not. I'm kind of stuck with it. I focus on my own interests and there I'm always looking at tax impacts. When it's an all cash deal or mostly cash deal like the Netflix offer, then I'll have a gain or a loss if I own those shares in a taxable account. If it's an all stock deal, there's usually no gain. If I hold on to the shares I get in exchange, the tax basis comes over and so if there's a stock component and the deal goes through, I'm asking myself, do I want to own the Netflix stock I'm going to get. If there's a spin off, do I want to hold that? That would be the Discovery Communications piece. And if the answer to both of those is no, I don't want either one. It could be the stock price has already gone up before the deal closes enough that I can just sell out and call it good.

Emily Flippin (23:27)

It makes sense to me. I mean, I guess it'll be interesting to see. I mean, time will tell if Netflix bid for Warner ultimately ends up landing shareholders in deepwater of both companies or, you know, But I think having a clear idea to evaluate deals for yourself as opposed to just taking management's word for it, is really key to managing your own portfolio.

Jason Hall (23:45)

Hot take. Netflix is going to get a better deal on these assets in five years when it's able to buy it off the scrap heap because Warner brother Discovery shareholders are going to take the quick cash and Paramount's going to screw it up.

Emily Flippin (23:57)

Wow, I can't wait to have you back on Jason. I'm marking the calendar five years from now. Going to have you back on to reevaluate this. Personally, I still think Netflix gets this deal. I don't think Paramount shareholders or I don't think Warner Brothers shareholders. Go for it either way. Looking forward to finding out the answers to our questions. Dan, Jason, thank you both so much for joining. As always, people in the program may have interest in the stocks they talk about, and the Motley fool may have formal recommendations for or against. So don't buy or sell stocks based solely on what you hear. All personal finance content follows Motley fool editorial standards and is not approved by advertisers. Advertising are sponsored content and provided for informational purposes only. To see our full advertising disclosure, please check out our show notes For Jason Hall, Dan Kaplinger and the entire Moleful Money team, I'm Emily Flippin. We'll see you tomorrow.