Why The New Microsoft – Netflix Partnership May Have Bigger Implications (NASDAQ:MSFT)

Over the years we’ve heard a variety of rumors about X company buying Y.

Usually, it involves some combination of Disney (DIS), Apple (AAPL) or Netflix (NASDAQ:NFLX) and in each case they are mostly just gossip. Case in point Roku (ROKU) and Netflix, a scenario which many fell over themselves to praise – despite there being some fairly big problems with the concept. Ultimately now we know the talks were tied to ad sales help and a takeover was never really on the table.

It was more a combination of speculation and wishful thinking from a small handful of people. Remember in this industry, the vocal minority can impact the thinking of the vast majority.

As I mentioned the Roku/Netflix rumors had a lot of flaws.

Overall, the business model of both companies would have prevented any sort of takeover deal from the start, but it sounded good, so that was overlooked.

Now comes word the Netflix has indeed found a dance partner in Microsoft (NASDAQ:MSFT) for its upcoming foray into ad sales and this time rumors of a takeover aren’t as far-fetched.

First as always, some background.

By now, you know the state of affairs for Netflix and how it’s lost so much value in such a short period of time. As a result, they’re going back on a number of “never we will ever” comments including that of adding an ad tier.

It’s not a quick fix.

All of Netflix’s content was designed to be watched with no commercial breaks, so now not only do they have to physically add them in, but they have to go back and get permission from the content providers to do so AND compensate them for it. This also extends to acquired content such as Breaking Bad or Seinfeld which was designed to have ads inserted originally.

And you can bet those in charge of those rights are not going to give them a break on the cost – likely they’ll bill a premium rate.

That aspect aside there’s also the technical side which Netflix needed a partner to come in and operate because they have no knowledge in that space. And again, that where the Roku rumors came from – Roku, Google (GOOG) (GOOGL) and Microsoft were supposedly among the companies in talks to help.

Of those three, Microsoft is the only one that made even a remote bit of sense, especially given Microsoft has no substantial ties to streaming TV and thus was always an ideal teammate.

Now Netflix gets a partner who knows the space and an influx of cash upfront to help both with those new deals they have to make as well as pay off the overall production cost of their content which is still high.

But this actually goes beyond that as for the first time the idea of “X buying Y’ scenario actually makes sense. Some have summarized that it’s not out of the realm that Microsoft could really take a run at acquiring Netflix down the road. Needham Senior Analyst Laura Martin went so far as to say this could be Netflix “looking for exit.”

She may be right.

Remember while Microsoft has no TV ties – it definitely has gaming ones. And as you may remember, Netflix has eyes on gaming as well. What we could, again down the road, be looking at is a marriage of convenience that unites two very different entertainment companies and elevates them to another level.

“Microsoft’s emerging GamePass & Console-less XBox gaming platforms, combined with the largest TV sub product on earth. That’s a damn fine sandwich.” – media expert Evan Shapiro

It potentially creates a package that has an added value you wouldn’t get from a Disney+ or HBO Max and on a higher scale than you would from an Apple or Amazon.

Beyond that it would also give Netflix an “in” with Microsoft to take its gaming IP and convert it into scripted content as well as potentially transfer its back-end storage needs to Microsoft’s Azure.

The main problem I always had with a “Disney buys Netflix” or an “Apple buys Netflix” or the reverse is the “why.” None of the companies have a need to own the other, all it really does is create a logistical headache.

But for the first time in a while, something of this nature makes sense.

This could be a strong team-up that has the potential to send some large shockwaves through the industry. Now to be clear this is all speculation and the only thing we know for a fact is that the two companies are teaming up to launch Netflix’s ad business, but there are some signs here that certainly makes things a little more interesting.

Nothing is imminent – first Microsoft has to close its Activision acquisition and Netflix has to launch the ad tier and begin to regain control of its stock. That last part isn’t going to be a quick fix especially if next week’s earnings call doesn’t produce good news. And we haven’t even gotten into the legal hurdles that could come through Congress who may object to this type of union.

In any case, this is definitely a storyline that’s not done and will play out the rest of the year and into 2023. Investors would be wise to stay aware because in streaming anything can happen.