Enough Waiting — It's Time for Amazon to Buy Netflix

Like an old sports injury, the rumor of Amazon buying Netflix seems to flare up once every few months. It happened again this week when a Reuters reporter tweeted about its impact on stock-options trading, and the meme gained traction when other blogs ran with it.

The recurring rumors have always proven false. Because if anyone isn’t taking them seriously, it’s Amazon. The online retailer’s chronic allergy to sales taxes has kept it from a deal that makes sense in many other ways. But things are changing, and it may well be that now is the best time for Amazon to buy Netflix. In short, Amazon may be forced to collect sales taxes in a year or two, and by that time the chance to buy Netflix may have passed.AMZN vs NFLX in 2009

The benefits of a merger are clear. The companies are simpatico: Earnings and revenue growth rates are comparable; and corporate cultures are similar — innovative and centered on a positive consumer experience. Amazon finally gets an online-video business that consumers flock to. As Netflix moves from DVDs by mail to video over IP, it can tap into Amazon’s vast computing platform. And integrating Netflix recommendations with IMDB’s inelegant but indispensable movie database could produce the premier search-and-discovery engine for film lovers.

There are a few reasons why Amazon may not be interested in buying Netflix. It’s not in the habit of making big acquisitions. Its higher-profile purchases in recent years — Zappos, Abebooks, Audible.com — have tended to be priced below $1 billion. Netflix’s market cap is more than $3.1 billion (driven higher this week thanks to those rumors). Netflix is also highly valued, trading at 31 times its recent earnings. So while Amazon would be unlikely to pay cash, it could use its own overvalued stock (81 times recent earnings) as currency.

But the big factor keeping Amazon from moving toward a Netflix deal is the question of sales taxes. Amazon has skillfully dodged sales taxes in most states by arguing that it’s the consumer’s responsibility to report them, not Amazon’s (of course, few consumers do). Netflix charges a sales tax for an odd reason. Businesses must collect a use in any state they have a physical presence, and every state has decided that the very DVDs that Netflix rents out constitute a “physical presence.”

So buying Netflix would expose Amazon to charging sales taxes in all states, eliminating a cost-advantage that has helped it grow market share. But the days of sidestepping sales taxes may be numbered for Amazon. New York passed a law requiring the company to collect sales taxes from its residents, a move that Amazon is fighting in courts. Other states, famished for new revenue, may follow. Congress may even take up the issue; if so, brick-and-mortar retailers losing share to Amazon would be smart to lobby for its passage.

As the online video industry evolves, Netflix can help Amazon in new ways. First, it can offer it a proven subscription-based model, which many consumers prefer to Amazon’s standard pay-per-view model. (Why pay Amazon for a movie when it’s in your Netflix queue?) And if reports that Apple is considering a subscription-based video service prove to be true, Amazon will be much better positioned with Netflix in its fold.

And while the Kindle remains popular, it’s inevitable that some company will start selling an e-reader of similar quality that also offers streaming video. A future-generation Kindle that can not only seamlessly download books but also stream Netflix’s 17,000 Watch Instantly films and TV programs could offer Amazon an edge that others would find hard to match for a while.

Meanwhile, the clock is ticking. The last time the Amazon-Netflix rumors surfaced in July, Netflix was valued at $2.4 billion. And there’s always the chance that another cash-rich company could make a play for Netflix first: Microsoft to integrate it further with the Xbox, Apple to empower iTunes in streaming video, Comcast to build a stronghold on the web.

Buying Netflix would hurt Amazon in the short term because of the sales-tax issue. But by waiting too long, Amazon stands to be hurt in the long term.

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