2 Stocks That Could Soar On Potential Acquisition

Netflix.com rocks! (Photo credit: luxuryluke)

San Diego, Oct.31, swing trading .-  A rumor that Microsoft (MSFT) is interested in acquiring Netflix (NFLX)drove the video streaming company up 13% in the latter half of the trading day on Friday. The rumor seems largely unfounded; nonetheless, the market loved the idea. I believe a buyout is a good idea, but is still rather unlikely for the time being.

Earlier this month, Netflix CEO Reed Hastings announced that he would resign from Microsoft's board. Many saw this as a precursor to a potential Microsoft acquisition. Hastings does not officially leave the board until the end of November, when Microsoft conducts its annual shareholders meeting. A buyout will have to wait until then.

So why should Microsoft consider buying Netflix? I believe the market severely undervalues Netflix, even with its recent price hike. Additionally, Netflix would allow Microsoft to compete in the huge market for online video. Finally, Netflix will improve Microsoft's internet business segment.

Netflix is the market leader in internet video streaming. Just 15 months ago, the stock was flying high priced at levels near $300. The fall back down was quick and painful as bad news and earnings convinced more and more investors to sell. Rising costs have depressed earnings significantly in the last year.

Two significant costs affected Netflix's expenses over the past two years. First, content costs rose significantly last year. While bad for Netflix's bottom line, increased content prices create a higher barrier of entry and affect competitors similarly.

Second, Netflix spent significant amounts on expanding abroad. Netflix is now available in all of North America, all of South America, the UK, Ireland, and most recently all of Scandinavia. Spending money to grow the company abroad cut into earnings, but sets up the company for much higher future profits and revenues.

Certainly, Netflix has shot itself in the foot once or twice (a la Qwikster), but it is still ubiquitous with streaming video online. Its most recent earnings report showed better than expected profits and revenue, but the stock fell because of slow subscriber growth. Global expansion will improve growth and earnings, which is why I believe the market is still undervaluing Netflix at $69 per share and presents Microsoft with a good price, even with a premium, to buy a controlling portion. ... Continue to read.

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