Netflix Backs Out of the Warner Bros. Deal. 5 Reasons It's a Smart Move

After months of intrigue, Netflix (NASDAQ: NFLX) finally bowed out of the competition for Warner Bros. Discovery (NASDAQ: WBD). Though its offer to buy the company's streaming and studio assets was originally accepted back in December, Paramount Skydance (NASDAQ: PSKY) persisted and scored a winning bid with an offer of $111 billion, including debt, or $31 a share for the whole company.

Netflix investors breathed a sigh of relief after the news was announced, with the stock up 9% on Friday. Prior to the update, Netflix stock had fallen by as much as 25% after WBD accepted its offer.

Still, the deal always seemed misguided, and it's good news for investors that it's been abandoned. Here are five reasons why.

Image source: Netflix.

1. Netflix doesn't need Warner Bros.

The strategic rationale for buying Warner Bros. never seemed complete. Netflix has the world's dominant streaming business, and Warner Bros. is a melange of struggling streaming and studio businesses. In fact, Netflix's success is a big reason for Warner Bros. struggles.

Netflix management seemed to be smitten with Warner Bros. brands and tentpole franchises like Batman and The Wizard of Oz, but the streaming leader doesn't need to pay close to $100 billion for a content library and intellectual property when it's had more success building its own. Notably, Netflix has made almost no acquisitions in its history, and nothing approaching the size of the WB deal.

Additionally, Netflix seemed unsure of what to do about WB's theatrical business, which conflicts with Netflix's preference of avoiding theaters or having a limited release for awards-seeking films. Finally, the HBOMax streaming service seems like an extra appendage for Netflix, which has always had just one brand.

2. Media mergers have a history of failure

Media mergers have a history of blowing up. The most famous example is probably the combination of Time Warner and AOL, but Time Warner, which evolved into Warner Bros. Discovery, has been a white elephant several times.

AT&T's acquisition of Time Warner was a disaster, and its spin-off/merger with Discovery Communications was also a bust, as the stock foundered until WBD put itself on the auction block.

Elsewhere in the streaming sector, Disney's acquisition of Fox's entertainment assets is generally regarded as a dud, and Disney stock has struggled since.

There's no economic rule that all media mergers fail, but given the lack of strategic rationale and the high price tag, the Netflix-WB combo didn't seem promising.

3. Paramount is overpaying for WBD

Paramount is buying WBD because it needs it to stay relevant, but it's paying much more than it's worth. Prior to talk of a sale, WBD was trading below $13 a share, and it was down as low as $7.52 last April.

In addition to a business that hasn't lived up to expectations and frequently reported slow growth and losses, WBD is also loaded with debt, with $33.5 billion in debt in its most recent report.

Taking on that debt would have hamstrung Netflix and made it less flexible with capital allocations.

Paramount might have "won" the bidding war, but any dealmaker knows that overpaying for an asset isn't a victory. Forcing your competitor to do so, on the other hand, can be its own form of checkmate.

4. A deal benefits Netflix

Consolidation tends to be good for remaining industry players, and that seems to be true for Netflix. With Paramount and WBD combining, that means one less bidder for content to compete with. It also could mean one less streaming service in the market if the new company chooses to combine Paramount+ and HBOMax.

Given the struggles of both WBD and Paramount, Netflix could even find itself in a position to buy the new combined company in a few years for less than it had bid for Warner Bros. originally.

Netflix has all the momentum in the industry, and it's unlikely to face a significant challenge from the Paramount-WBD combo, especially with the debt albatross hanging around Paramount's neck.

5. Getting regulatory approval wasn't guaranteed

Netflix is the dominant streaming player in the world. Warner Bros. is one of the biggest film studios and owns the best-known premium cable network, HBO.

It was clear that combining the two businesses would test antitrust guardrails around the world, and the Trump administration had already expressed skepticism about the deal. Hollywood was also opposed to the merger, believing Netflix had already decimated the traditional theatrical business and that acquiring WB would only hasten its demise. If the deal had been blocked by regulators, Netflix would have been on the hook for $5.8 billion breakup fee.

Now that WBD has backed out, Netflix will collect a $2.8 billion termination fee from Warner Bros. and Paramount. That sounds like a win for the streaming leader.

Jeremy Bowman has positions in Netflix and Walt Disney. The Motley Fool has positions in and recommends Netflix, Walt Disney, and Warner Bros. Discovery. The Motley Fool has a disclosure policy.