How does a merger differ from an acquisition and why do companies undertake this comprehensive deal-making process on Wall Street?
Shares of streaming company Roku (NASDAQ: ROKU) rose by 9% on Wednesday on rumors of a potential alliance with Netflix (NASDAQ: NFLX). A report from Business Insider stated that Roku stopped its employees from trading its stock, which then sparked the possibility of an acquisition. Generally, trading restrictions occur when employees can benefit from news that would significantly impact a company’s stock price.
The last six months have been extremely brutal for Roku investors. Initially, the ongoing pandemic acted as a massive tailwind for Roku and several other tech companies, but the relaxation of lockdown rules, coupled with steep multiples surrounding growth stocks as well as challenging macroeconomic conditions, accelerated the sell-off in Roku stock since Q4 of 2021.
Despite the recent uptick in share prices, Roku is trading 79% below all-time highs, valuing the company at a market cap of $13.8 billion.
What are Mergers and Acquisitions?
The terms mergers and acquisitions are often used interchangeably. However, a merger is a collaboration between two companies that combine to form a single entity. Alternatively, an acquisition is when a company completely takes over the majority ownership of another entity.
There may be several reasons for which a company may enter a merger or acquisition agreement. A few of them include:
Several mergers and acquisitions are undertaken to eliminate competition while enabling companies to increase market share. A company may also be eying a particular asset owned by its competitor, which can only be bought via an acquisition.
A merger or acquisition will allow the combined entity to benefit from revenue and cost synergies. In addition, it might enable an enterprise to enter a new market and benefit from economies of scale, lowering the overall cost structure and improving profit margins.
Expansion of capabilities
A merger or acquisition generally expands the company’s capabilities, which may improve its financials and strengthen its balance sheet.
Any merger or acquisition aims to create value for both the companies and their shareholders. It is an exhaustive process, and the deal must be approved by shareholders and regulatory authorities such as the SEC and FTC.
So, why is Netflix looking to acquire Roku?
Netflix reported a decline in its subscriber base for the first time in Q1 of 2022. The streaming war is heating up, which is bound to decelerate Netflix’s top-line growth going forward. During the Q1 earnings call, Netflix stated it might consider advertising opportunities to boost sales and diversify its revenue base.
Roku seems the ideal acquisition for Netflix as the company ended Q1 with 60.1 million accounts, making it the largest connected TV provider in the U.S. Further, Roku derives a significant portion of revenue from advertising and is the leading provider of targeted ads in the streaming vertical.
The possibility of acquiring a market leader at a reasonable valuation might be too enticing for Netflix to ignore.