Will Amazon Buy Netflix? Potential Bullish and Bearish Trades

What some thought was impossible just a few months ago now looks more likely than ever.

There was a report out this morning by noted Netflix (NFLX) bear Wedbush that the company could actually be acquired by, gasp, of all companies, Amazon (AMZN).

In the note, Wedbush wrote:

"Upon reflection, it appears to us that the driver for the separation of Netflix into two businesses—Netflix.com (for streaming) and Qwikster.com (for DVD rentals)—was to position the streaming business for sale to Amazon.com... In our view, Amazon has always wanted to be in the streaming business, and has been constrained from buying Netflix due to tax considerations."

Wedbush went on to say:

"We arrive at our $155 price target through a sum-of-the-parts valuation analysis that values the Netflix streaming business at $130/share, and the Qwikster physical DVD rental business at $25/share. For Netflix streaming, we have assigned a 24x P/E multiple to our 2012 diluted EPS estimate of $3.63, plus an additional 50% premium should Amazon acquire it. For Qwikster, we have assigned a 14x P/E multiple to our 2012 diluted EPS estimate of $1.75. This multiple is roughly in-line with its primary DVD rental competitor, Coinstar (CSTR)."

After seeing the company's stock price drop from around $300 per share in July to the low $120s recently, Wedbush's theory certainly does make sense. Amazon is aggressively entering the online streaming space, and seems intent on killing Netflix.

Amazon recently signed up with CBS (CBS) and NBCUniversal, while Netflix lost a major content provider in Starz (LSTZA). A combination of this news, along with the recent price hikes at Netflix and now the split between the streaming business and the DVD rental business make a potential acquisition that much more likely.

Amazon has almost enough cash on the books now to purchase Netflix as a whole ($6.78 billion market cap). Amazon could offer a 50% premium right now, acquiring Netflix's 20,000 pieces of content to go along with its approximate 9,000 pieces of content. That would make Amazon the ultimate player in streaming, which it clearly sees as a huge business. As Amazon brings its tablet to market, it is going to need something to differentiate it from the Apple (AAPL) iPad besides price. Access to all that content under one roof is incredibly appealing. Especially when you couple it with free shipping for $79 per year.

When you're the gorilla in the space, there will always be competitors gunning for you, and Reed Hastings and company know this. Now that Netflix's market cap has been chopped in half since July, it is even more vulnerable.

Like Apple, everything Amazon touches turns to gold: the Kindle, online ordering, digital downloads, warehouse distribution, customer service. Amazon does it all and does it well.

Jeff Bezos, in my opinion, is a genius, and if he wants Hastings to come aboard, he will get it. Or he might just crush the company into nothing.

Action Items

Bullish: Traders who believe that Netflix will get bought by Amazon might want to consider the following trades:

• Amazon can afford to pay a 50% premium for Netflix, with cash on hand and taking out debt. Traders could consider options or common shares of Netflix.

Bearish: Traders who believe that Netflix does not get bought by Amazon may consider alternate positions:

• Netflix has suffered a lot of PR blows recently, and Amazon is poised to take advantage of this. If Amazon decides it is cheaper to go at it by itself rather than buy Netflix, then Netflix could see further sharp declines.

Editor's Note: This content was originally published on Benzinga.com by Jonathan Chen.

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