Amazon Buys Netflix? Microsoft Is a Much Better Guess as a Potential Acquirer

From All Things Digital, July 14, 2009:

Yesterday, shares of Netflix got their semi-regular rocket boost–with its stock up more than five percent to close at just over $42–from rumors that Amazon was interested in buying Netflix.

Oh, it’s a seemingly dreamy match–the top online retailer snapping up the upstart U.S. mail-order DVD movie and television show service.

But the speculation completely ignored the giant price needed to buy the Silicon Valley-based Netflix–well above its current $2.43 billion market cap, to be sure – which would be a big chunk of Amazon’s $35 billion valuation.

And it also leaves out the nearly impossible tax problem Amazon would acquire if it ever bought Netflix, given Netflix has many distribution U.S. locations for its subscription rental business. Amazon does not like paying state taxes and avoids them carefully.

Instead, those interested in seeing the independent company in the embrace of a larger one might want to consider a more suitable and very interested candidate: Microsoft.

Neither Microsoft nor Netflix will comment about such a hookup.

But several sources close to Microsoft told BoomTown that that the partnership between Netflix and Xbox Live to allow users to watch movies and TV episodes on the Xbox 360 device–struck exactly one year ago today–is going like gangbusters, with one saying it was “en fuego.”

Very loosely translated: On fire.

So much so, several sources said, that Robbie Bach–who is President of Microsoft’s Entertainment and Devices division, which includes the Xbox business–has been meeting with Netflix CEO and Co-founder Reed Hastings (pictured above) in recent weeks about what else the pair can do together to expand its current partnership.

The deal already in place between them is a hit, according to sources at both companies.

It gave Netflix access to 12 million Xbox members, and handed Microsoft what has turned out to be a very popular application and an unusually successful joint effort.

While an acquisition would be a much bigger move, some at the software giant think it would necessarily be such a bad one for Microsoft, which has long been seeking to forge better ties in the entertainment arena.

Many of Microsoft’s major Hollywood forays over the years have been duds. So, stronger ties with Netflix–even a more robust partnership, at the very least–would give it a more definitive video strategy most think it lacks.

Its archrival Google has been trying–with similarly lackluster impact–to accomplish the same results via its pricey and money-losing YouTube unit.

But Netflix–which has an office in Beverly Hills, as well as Los Gatos, Calif.–has much better relationships with the industry there, mostly because it has become such a big buyer of DVDs, as it has grown its business (see charts below of subscriber and revenue growth; click on them to make them larger).

In addition, it has added more subscribers than ever in the last year and is solidly profitable, mostly due to sending consumers all those DVDs in little red envelopes.

And while a lot of execs at Hollywood studios that Netflix does business with have been wary–and told me so in no uncertain terms on my recent visit to Los Angeles–about its entry into the digital video delivery business, they have also been thrilled with the checks that Netflix has been writing them since it was founded more than a decade ago.

But, it is that main DVD business that Hastings, in a recent interview with The Wall Street Journal recently, has said is “doomed.”

Noted the article:

“As soon as four years from now, [Hastings] predicts, the business that generates most of Netflix’s revenue today will begin to decline, as DVDs delivered by mail steadily lose ground to movies sent straight over the Internet. So Mr. Hastings, who co-founded the company, is quickly trying to shift Netflix’s business–seeking to make more videos available online and cutting deals with electronics makers so consumers can play those movies on television sets.”

With Internet video still in its infancy–and barely in gestation in terms of any viable business models–Netflix might indeed need help, especially since Hollywood has been slow to give it rights to more movies for online distribution.

That will be increasingly troublesome, given that digital delivery is the way consumers are headed. According to the Journal story, over 20 percent of Netflix members now use the streaming service.

But it only has about 12,000 titles–mostly older films–licensed its online service, compared to 100,000 DVD rental titles.

That’s because, for now, much more powerful pay channels usually win out over Netflix in these online video distribution wars, which also include Amazon and Apple (AAPL), along with many others.

Thus, even with a strong and unusually long-term executive bench, the close-knit Netflix will still be facing a major battle in moving in a direction it must head in sooner than later

Such an epic journey could be easier for Netflix with a powerful ally like Microsoft.

One more interesting link would make such a relationship even more smooth: Hastings in also on the board of Microsoft, having joined in 2007.

So, the savvy and innovative entrepreneur–well known for his close-to-the-vest dealmaking and eager to not miss a key turn for his company–might very well decide to keep friends very close.

More from All Things Digital:

• Apple's App Store a Year Later: 65,000 Apps, 1.5 Billion Downloads
• Facebook Stickier Than Google, eBay