- Netflix has a unique opportunity to buy a high-growth advertising business to complement its global video service.
- Netflix has identified TikTok as a potential existential threat to its company's subscription service success.
- Netflix's culture and leadership may be a more natural fit for TikTok than Microsoft.
- Netflix has international aspirations, so buying all of TikTok makes far more sense for Netflix than just its U.S., Canadian, Australian and New Zealand operations.
Brace yourself. Here comes the fire take.
Netflix should buy TikTok.
OK, at least hear me out.
Let's start with the caveats. Netflix has exactly zero experience doing a large acquisition. Netflix has intensely focused on produced video to build its business globally. TikTok is mostly raw user-generated video. TikTok is a totally different business from Netflix that relies on advertising, and Netflix has no experience selling ads. There are no back-end synergies. Netflix doesn't have a cloud computing arm that can safely house TikTok data. TikTok will almost certainly bring headaches about content decisions regarding misinformation and censorship that Netflix has been able to largely avoid. Microsoft is already a month or so down the road on a complicated deal to buy TikTok's U.S. operations and has the government's blessing. Netflix already borrows billions of dollars for content. Buying TikTok in cash would mean billions more in debt.
Now that we've got that out of the way, let's talk about why it makes sense.
Someone has to buy TikTok's U.S. operations from its Chinese parent company ByteDance. The Trump administration signed an executive order this week stating it will shut down the app in 45 days. It's possible ByteDance could just accept the ban and try its luck with the Biden administration, but that's a huge risk, given that Biden has also told his campaign employees to remove TikTok from their phones. In the meantime, TikTok's creators and stars would decamp and find new outlets -- possibly on Facebook's copycat product Reels, which just happened to debut this week.
ByteDance does not want to sell. TikTok's advertising growth potential is immense. The Wall Street Journal reported internal forecasts indicate ByteDance is projecting $1 billion this year and $6 billion next year in revenue.
So, to quickly wrap up: ByteDance is being forced to sell an asset with enormous growth potential whose closest comparisons — YouTube and Instagram — are worth well over $100 billion. And TikTok arguably has a better advertising model for younger people than both companies, since it pushes brands to develop their own creative TikTok ads. Commercials feel more modern and less intrusive, so people may not skip them as often.
In other words, TikTok is a jewel asset that a buyer might be able to get to a bargain price. Yes, there are some major risks that could destroy the company's value. The main risk is sorting out TikTok's intertwined relationship with ByteDance if only four countries are sold instead of the entire company. But the majority of TikTok's value is in the U.S. Almost all of TikTok's most followed creators are American. CNBC reported Microsoft could pay up to $30 billion for the American, Canadian, Australian and New Zealand businesses.
As Morgan Stanley Vice Chairman Robert Kindler said, if you buy an asset on the cheap, it doesn't matter if the deal has synergies. Whoever buys TikTok could be buying a winning lottery ticket. If so, purchasing TikTok becomes a matter of risk tolerance. Microsoft, with a market valuation of $1.6 trillion, has a built in cushion. Netflix isn't quite as large. But at $221 billion, the company can afford TikTok for $30 billion while taking a chance on building Netflix and TikTok into complementary behemoths. Netflix can always invite outside investors to buy minority stakes to lower the price tag while keeping control of the company.
Unlike Apple, Amazon, Google and Facebook, Netflix wasn't just called in to testify in front of a Congressional antitrust committee that grilled those companies about having too much market power. There are few realistic alternatives to Microsoft as a buyer.
And hey, if you agree with Netflix perma-bear analyst Michael Pachter and think Netflix is — pun intended — a "House of Cards" built on borrowed money, what better time to use some of Wall Street's currency to make a big acquisition!
Netflix co-Chief Executive Officer Reed Hastings once said his company's biggest competition is sleep. But more recently, and less glibly, he's focused in on two threats: video games and self-made short-form video. Hastings even specifically called out TikTok as a new competitor in the company's latest quarterly earnings shareholder note.
"TikTok's growth is astounding, showing the fluidity of internet entertainment," Netflix wrote on July 16.
Hastings isn't hiding his fears about what could derail Netflix. It isn't Disney+ or HBO Max or one of the new U.S.-based subscription services. It's what he calls "substitution threats."
"Many people love video gaming instead of watching movies and TV shows, or they live on YouTube instead of watching movies and TV shows," Hastings said on Vox Media's Land of the Giants podcast. "Our goal is to be the best in the world at movies and series, and the danger for us is these other things become highly more relevant for people. You can think of it as 100 years ago, we might try to be the best in the opera and the novel, and then those turn into very small art forms today because television became so much more compelling. So we have to watch out for those substitution threats."
Buying TikTok would hedge one of those substitution threats in a major way.
Now, M&A experts may argue that you should never buy an asset to diversify or hedge. But TikTok is more than just a hedge for Netflix. For years, Netflix has said its subscription service will not include advertising. But the advertising industry insists the company will have to give.
"They're going to need growth," Tara Walpert Levy, YouTube and Google's VP of Agency and Media Solutions, said last year about Netflix. "Eventually, they're going to need more growth."
TikTok could keep Netflix ad-free even if global subscriber additions begin to fall. Buying an advertising-based company with huge growth potential would give Netflix an outlet to tap in to that market without tampering with its successful subscription product. TikTok is, of course, free. Netflix is a subscription. They're complements, just as NBCUniversal has positioned its streaming service Peacock to be a free alternative to cable TV. In other words, that's not really hedging —both companies can flourish next to each other.
Facebook bought Instagram and WhatsApp to stay ahead of social media trends. It worked. Facebook is a $790 billion behemoth. Netflix could use similar thinking with TikTok.
There would be clear synergies by marketing and mixing talent between Netflix and TikTok. Each service would push the other. TikTok stars would have their own series on Netflix. Netflix stars would create TikTok accounts.
Netflix already uses Amazon Web Services for its storage and data security. AWS could be the secure home for TikTok as well. Netflix's deal with AWS is enormous. The terms it could strike with Amazon for TikTok would almost certainly be as advantageous for Netflix as any company in the world. It may not be as clean as Microsoft, which can offer both cloud services and ownership, but it's a solution.
Netflix has invested billions of dollars into content recommendation and artificial intelligence that understands viewing preferences. While TikTok's algorithm is proprietary, one could imagine there may be some interesting data synergies between the two companies to better perfect video recommendation with both companies.
One of the biggest concerns with Microsoft buying TikTok is its history of screwing up acquisitions, though most of those blemishes happened before CEO Satya Nadella took over. But even Microsoft's biggest deal under Nadella -- the $26 billion purchase of LinkedIn -- has been hindered by slow integration and minimal earnings gains.
New Netflix co-CEO Ted Sarandos knows TikTok CEO Kevin Mayer from his previous job running Disney's streaming video operations.
Netflix has a unique and intense culture. Integrating any company may present big cultural challenges. But TikTok's U.S. operations are relatively small. There are just 1,400 U.S. employees — far fewer than most legacy media companies that would move the needle for Netflix. Netflix's hands-off approach to decision-making, empowering employees to make big decisions on their own, could be an ideal set up for TikTok. Having Hastings and Sarandos as sounding boards on how to build and grow a media company would be ideal.
Netflix has also said it has likely reached peak cash burn, and the company is focused on becoming consistently free cash flow positive. That would help with the long-term absorption of TikTok, even if outside investors cushioned the price tag.
Here's why the deal doesn't make sense to me: TikTok wants to keep the bulk of its global business. Netflix has international aspirations. Buying an asset that only has growth potential in four countries doesn't jive with Netflix's overall mission to take over global entertainment.
But a move to buy TikTok U.S. today could lead to an acquisition of the rest of the TikTok down the road. Netflix should pounce on the opportunity today and figure out the rest later. Splitting TikTok seems complicated. If Netflix gets its foot in the door, perhaps it can figure out a way to buy the rest of TikTok — specifically in India, where Netflix is banking on enormous growth after first struggling — in the months or years to come. This idea of buying the entire business has also reportedly been appealing to Microsoft.
And here's the biggest plus of all: if this happens, I'll ask for a smaller finder's fee than the U.S. government. What's fair? $50 million? That sounds reasonable. Art of the Deal, baby.
Disclosure: Comcast is the owner of NBCUniversal, parent company of CNBC.
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