Netflix (NFLX): If You Can’t Beat ’em, Join ’em…Some Think AMZN Should be Lurking

by Dan September 26, 2011 1:55 pm • Commentary

NFLX has been one of those stocks that unless you had balls of steel and grown them in the last 2 months, it has almost been impossible to make money on the short side….I have tried desperately to short this name, through Put Spreads, Put Flys and Put Trees, I am hard pressed to think that I have broken-even over the last year or so paying lots of bid/ask and expensive premium.

The stocks recent sell-off, since making all time highs at ~$304 in July, is eye popping at about 57%.

Bank of America Merrill Lynch in a note to clients this morning spoke about NFLX’s attractiveness as a takeout candidate:  

Buy-out becoming more likely
We have written on the media’s on-going speculation about potential Netflix
acquirers before and had concluded earlier that the most likely buyers who have
the financial wherewithal to buy Netflix, namely the large Internet and tech
players, would not be interested in Netflix’s physical distribution business.
Now,that has changed with Netflix effectively spinning their DVD business off into a
completely separate operating entity that could be spun off or sold to private
equity by a potential acquirer.
Amazon, the most likely acquirer
The most often cited buyer, and in our view the most likely, is Amazon.  Articles
such as “Amazon may again be mulling Netflix buy” from the WSJ and “Amazon
Buys Netflix? Microsoft Is a Much Better Guess as a Potential Acquirer” from
AllThingsDigital have suggested Amazon could purchase Netflix.  We believe
Amazon likely couldn’t buy Netflix in the past because Netflix’s DVD distribution
centers in virtually every state would have given Amazon “nexus” in those states
for sales tax purposes, forcing them to collect sales taxes on every item sold in
the US.  Now, Amazon who has already shown a commitment to building a
streaming service, faces the choice of spending hundreds of millions to more than
a billion a year building out a content library to compete with Netflix and thus
significantly diluting earnings for the near term, or of buying Netflix with stock and
jumpstarting their efforts with what should be a very accretive transaction even at
much higher levels.

I have fielded many questions from readers on this topic and frankly haven’t had a strong view on the matter…..Merrill’s note doesn’t particularly have a strong view but just making the subtle case why it could be a good deal for AMZN. While a deal in the $10bil range is doable for AMZN, probably a combination of cash and stock….the largest deals they have done in e-commerce was the 2009 acquisition of Zappos for $1.2bil. Now that NFLX intends to split up Streaming vs DVD, maybe as stated above AMZN would get more aggressive to move on the Streaming portion to avoid the tax collection issues.

MY TAKE: This all makes a lot of sense, especially when you consider AMZN’s business momentum in so many categories and that a deal of this size would make them a serious player in streaming content and make them a formidable competitor to iTunes. If I were Jeff Bezo’s I would try to get this deal done for the streaming portion, especially as they are looking to compete with AAPL in the tablet space more and more outside of bookreaders…..

If you want to play for a take out I would be careful selling puts to finance the purchase of calls….the company has made a series of bonehead moves in the last 2 months and they have given no indication that they are done with that strategy. Even-though implied volatility is through the roof, I think the only way to play is long premium with eye towards defining your risk.


NFLX ($127) Buy Jan12 175/200/225 Call ButterFly for 1.50

-buy 1 Jan12 175 Call for 8.00

-Sell 2 Jan12 200 Call for a total of 9.00 (4.50 each)

-Buy 1 Jan12 225 Call for 2.50

Break-Even on Jan12 Expiration:

Profits: btwn 176.50 and 200 make up to 23.50, at 200 make 23.50, payout trails off btwn 200 and 223.50…..

Loses: btwn 175 and 176.50 lose up to 1.50, btwn 223.50 and 225 lose up to 1.50, below 175 lose all 1.50 and above 225 lose all 1.50

** As always in multi leg orders use limits, there is a ton of bid/ask and the spreads are wide…..

TRADE RATIONALE: this is a low probability play, the Jan12 175 call that you would be long has about a 30 delta, basically the options market is telling you that there is only a 30% chance that the call will be in the money on Jan12 expiration. But if you think there is a greater probability that AMZN takes advantage of NFLX’s recent misfortune than time is not likely on their side and they should probably move and soon…..So you have to get a lot of things right, timing, price and a deal for this to make money…..but you are risking less than 1% of the underlying and if you get it right you could easily make 10x your money with a deal close to $9-10billion which gets you back to $200.


This is not a fundamental call on their existing business, this is about the replacement value of the asset to a potential acquirer, this current quarter is likely to be very bad given all of the customer defections.


Stock broke down at $200 and now that seems to be a fairly interesting resistance level. $200 seems like a very healthy premium to current levels and technically deal or no deal a level that the stock would likely pause at on any sustained rally.

[caption id="attachment_4984" align="aligncenter" width="300" caption="1 YR NFLX chart from Bloomberg"][/caption]