Netflix (NAS: NFLX) plans to pay 25 times estimated 2026 EBITDA for Warner Bros.’ streaming and studios business, which strikes us as exorbitantly high, even with the premier, unique assets Netflix will acquire. Regulatory approval is highly uncertain.

Why it matters: Warner Bros. Discovery shareholders win big if the deal is approved. In addition to $27.75 per share in cash and Netflix shares, they will still hold the remaining Discovery Global business, worth about $3 per share at the $27 billion enterprise value we think is reasonable.

  • It will be difficult for Netflix to realize the full value of its $83 billion investment, especially considering the overlap of HBO Max and Netflix subscribers. Netflix doesn’t need to tap HBO Max’s scale or content, so this price seems like a reach.
  • Netflix anticipates cost savings will bring the acquisition multiple to 14 times 2026 EBITDA, which is still leaps and bounds ahead of what Warner’s unaffected share price implied. We also expect revenue dyssynergies from overlapping subscribers.

The bottom line: We think regulatory approval is a toss-up. We anticipate raising our fair value estimate for Warner Bros. Discovery to around $25 from $20 to reflect a 50/50 chance of approval. Those odds should lead us to modestly reduce our $77 Netflix fair value estimate, leaving the shares substantially overvalued, in our view.

  • CNBC reported that the White House is very skeptical of the deal. Since the deal only needs Federal Trade Commission approval, the administration cannot unilaterally block it.
  • However, the administration can have a heavy influence. A lawsuit to block the merger could reasonably have bipartisan support. An antitrust case could be strong, centering on the common ownership of the top and fourth-biggest streaming platforms in the US.

Coming up: Paramount could still be lurking. It has grumbled about the auction process and could take another bid directly to shareholders. However, its path is now more complicated and expensive.

Netflix’s business is nearly flawless, but keeping its sales growth rates targets looks difficult

Netflix is the leading streaming television platform globally and enjoys the economic benefits of market-leading scale. We expect this position will persist.

Netflix has had a different strategy than its peers. It has avoided the temptation to bid for a regular slate of major live sports programming, which has been wise, considering our view that it would’ve had to overpay to attract major sports leagues. It has also chosen to grow organically from the ground up, building its business with no head start in terms of content ownership or foothold in the traditional media business. These decisions now give Netflix the advantage of not having to manage a declining legacy business, and it isn’t burdened with expensive sports contracts or a subscriber base that is dependent on retaining sports rights.

Netflix does face threats. Notably, it faces a much more robust streaming market than it did when it was establishing its dominance while charging relatively low prices. With many subscription streaming platforms offering popular content, we don’t believe consumers will have the financial willingness or ability to subscribe to all, meaning Netflix will need to continue offering a robust amount of attractive programming to maintain its position. This will require significant investment and careful consideration of pricing changes. Despite our view that Netflix will remain at the top, it will have to compete to a greater extent than it did historically.

We still expect an impressive growth trajectory. Assuming no huge misfires that result in a lack of attractive programming over an extended period, we expect Netflix’s subscriber base to be sticky, and we think the cash it generates will allow it the capacity to produce many new series and movies each year, giving ample opportunity for customers to find something they like. We see further penetration opportunity in international markets, and we believe the introduction of an ad-supported subscription in the US will provide opportunities to reach new subscribers and a substantial source of revenue.

Bulls say

  • Netflix has already attracted a massive customer base and level of profitability. This advantage versus competitors makes it more likely a virtuous cycle can continue, with Netflix securing more content that attracts and holds more subscribers.
  • Advertising-supported subscriptions will open Netflix to a new base of subscribers and a major new source of revenue.
  • Netflix has significant room to grow in international markets where it has already shown promise with local content.

Bears say

  • Netflix faces competition that it has not had to deal with in the past. As consumers have more options for quality streaming services, it’s more likely that Netflix could get cut out of some consumer budgets.
  • Netflix’s US business is mature, with very high penetration of total households, meaning price increases may need to be a bigger component of future growth.
  • Netflix will need to spend more on content—through sports rights and local international investment—to increase membership and prices at rates it has historically, when it worked from a lower base and with less competition.

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company’s future cash flows, resulting from our analysts’ independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.