- Reuters report looks plausible at first glance

- Netflix’s valuation has halved in 2022

- Cost of a deal could soar on AWS-to-Azure switch

Reuters has suggested that Netflix (NFLX:NASDAQ) might be on Microsoft’s (MSFT:NASDAQ) shopping list in 2023.

At first glance, a deal seems plausible and would make strategic sense. Both companies share a desire to become more meaningful players in the gaming space.

Netflix has this year moved into games publishing and has made more than 20 mobile games available for free to subscribers. Microsoft already runs the Game Pass, which is often called the ‘Netflix of gaming’, with a similar subscription model and à la carte presentation.

MICROSOFT WANTS MORE CONSUMER CUSTOMERS

Microsoft has been looking for a way back into the consumer space for a long time, beyond gaming console Xbox, and Netflix would provide exactly that, with its vast film and TV library. Put TV and gaming together and Microsoft would have a compelling entertainment suite to offer consumers.

Even if a bundled subscription only featured some of Netflix’s content combined with some of Game Pass’s library for a single monthly subscription, with the ability to stream it all straight to your phone or tablet through the cloud, it could still be an attractive offer at a competitive price for millions of people.

Throw in Netflix’s discounted equity valuation - its stock has more than halved this year - and Microsoft’s cash muscle, you can see why the idea might work.

Microsoft had about a fifth of Netflix’s $128 billion valuation in net cash at the end of September 2022 and has churned out about $43 billion of free cash flow in the first three quarters of 2022.

Microsoft president Brad Smith also sits on the Netflix board.

ACTIVISION DEAL IN WATCHDOG FIRING LINE

But a deal would face a number of stumbling blocks. Most obviously, Activision Blizzard (ATVI:NASDAQ), the gaming giant that Microsoft is desperately trying to buy in a $68 billion deal which had already encountered problems.

US and EU regulators have already raised concerns about market dominance were they to rubber stamp the Call of Duty creator to sit under the same roof Xbox.

Sony, the world’s biggest games publisher and owner of the PlayStation consoles, has claimed that letting the deal pass would be disastrous for the gaming industry.

‘It would have major negative implications for gamers and the future of the gaming industry,’ even after Microsoft offered a multi-year licencing deal to Sony that would allow Call of Duty on PlayStations. If the Microsoft/Activision deal is blocked it would certainly make Netflix a more likely target, but one that would still come with a big headache.

AWS-POWERED NETFLIX

Netflix’ streaming service is powered by Amazon’s (AMZN:NASDAQ) AWS cloud business, a direct rival to Microsoft’s own Azure cloud arm. That might stand in the short-term but it’s seems less likely in the long run, which would mean a massive IT transition project from AWS to Azure that could take many months and cost a fortune, driving up the overall cost of a Netflix deal.

Lastly, Netflix recently picked Microsoft as its technology and sales partner for its advertising-backed streaming service. If Netflix’s ad-supported tier builds any kind of audience, Microsoft stands to benefit enormously from this partnership.

That suggests Netflix is currently valuable to Microsoft as an independent partner since it’s enabling expansion into a new area for the company.

Find out how to deal online from £1.50 in a SIPP, ISA or Dealing account. AJBell logo

Issue Date: 21 Dec 2022