Netflix Buying Warner Bros: Terrible Mistake or Best Deal Ever?

While Netflix (NASDAQ: NFLX) investors were still mulling over their thoughts about the company's proposed acquisition of Warner Bros. Discovery's streaming assets and film studios, Paramount Skydance has already added the drama of a potential hostile takeover.

The market initially reacted with a thumbs-down to the Netflix announcement. While the three companies sort this out with the relevant regulatory agencies, let's evaluate whether or not the acquisition is as bad as the market anticipates or Netflix management actually has a clear plan for why this is going to be great for the company and its shareholders.

Image source: Netflix.

Why doesn't the market like this deal?

The market is wary that this is going to be a money pit for Netflix, which is planning to take on debt to finance the deal. Netflix is offering $72 billion for the assets, mostly in cash, and it has less than $9 billion in free cash flow over the trailing 12 months.

But there is a whole bunch of other reasons why investors are souring on the deal. Netflix has never made such a large acquisition before, and investors are concerned that it may be out of its element here. There's a long history of Hollywood mergers that cost a lot of money and don't result in profitable payoffs.

Specifically for Netflix, it's unlike most media companies, which has always been a benefit. It has a strong and growing bottom line, with premium subscription fees covering expenses, and recently, it launched a new advertising tier that adds another layer of high-margin revenue. Buying a traditional film studio, with the old-style model of high-cost box office hits that could also produce duds, completely changes the Netflix operating model. Even if it keeps the new assets essentially separate, their results will still impact the company's financial statements.

Finally, to finance the deal and help pay off the debt, Netflix may need to raise prices on subscriptions again. That could lead to some subscriber losses.

In other words, there are many ways this deal could impact Netflix's financials negatively and over a long time.

What is the market missing?

Management wouldn't be going through this deal if it hadn't already thought of all of the above and still decided this was a good deal. There's clearly more to the story.

Management described the deal as a win for viewers, who will have more content to choose from and "greater value." That could imply that even if prices go up, it's as if subscribers are getting access to more than one streaming company -- Netflix and HBO -- at a better price point than paying for two subscriptions separately. It remains to be seen whether or not subscribers, who may feel like they want enough content from one subscription, see that as a benefit.

Netflix views the acquisition as a way to bring together Warner Bros.' franchises and assets with its groundbreaking model, further disrupting the traditional Hollywood framework. While from the outside it could look like another media merger money pit, Netflix has been able to revamp the traditional model, and it envisions bringing that efficiency and approach to the old-style mega studios. There isn't really a blueprint for that, and Netflix has been successful in the past at creating its own blueprint and successfully shaking up traditional media.

Management also sees this as a positive development for shareholders, whom it imagines will benefit as more members sign onto the improved streaming offering, boosting revenue. It also thinks that combining the two companies, each with its own fixed costs, will result in cost efficiencies.

The Netflix story is still unfolding

There have been plenty of times over the past few years when the investing community became pessimistic about Netflix and its future, and was proven wrong. It was only recently that it fielded intense, new competition from just about every movie studio, plus other companies that all launched their own streaming networks when the pandemic started. Netflix looked like it might be in danger from these established studios which have full content libraries. The company started looking into other money makers, like an advertising tier, as well as new offerings to attract subscribers, like gaming. After a few years of this, Netflix is still king of the streamers while other networks are being taken over.

This acquisition could prove to be a misstep, but it could also end up creating a much-needed shift in film and media. Netflix could come out on top, again, with shareholders benefiting in a big way.

Jennifer Saibil has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Netflix and Warner Bros. Discovery. The Motley Fool has a disclosure policy.