Netflix split to set up Amazon streaming merger?

Netflix CEO Reed Hastings may have a trick up his sleeve as he separates the streaming and DVD-by-mail businesses: A sale to Amazon.

That's the theory floated by Wedbush Securities Michael Pachter on Thursday and the idea makes sense.

Pachter upgraded Netflix shares to an outperform from underperform. The analyst argued that Netflix formed Qwikster so it can be spun off eventually. From there, Amazon can easily buy Netflix, which would be a streaming business.

In a research note, Pachter said:

In our view, Amazon has always wanted to be in the streaming business, and has been constrained from buying Netflix due to tax considerations. The split up of Netflix’s business addresses the state sales tax issues raised for Amazon in having a “nexus”. If Amazon were to acquire only Netflix’s streaming business, it could triple the size of its content library, and gain traction as an industry leader. Netflix streaming has current content deals that provide it with access to movie content during the premium cable TV window, and Amazon has the financial resources to secure additional streaming rights, including Starz content. Netflix’s financial flexibility is quite limited, while Amazon’s is virtually unlimited.

The tax issue is that an acquisition of Netflix's DVD business would give Amazon more sales taxes to collect.

Pachter explained:

One of the impediments to Amazon’s purchase of Netflix outright is the state sales tax rules. Under the rules in most states, any company with a physical presence in that particular state (a “nexus”) is required to collect sales taxes for all retail transactions in that state. Amazon has carefully avoided nexus with virtually every state that collects sales tax, providing it with a significant pricing advantage over its brick-and-mortar competitors. Should Amazon have purchased Netflix’s business outright (including the DVD-by-mail business), the company would have found itself subject to sales taxes in virtually every state that imposes sales tax, due to Netflix’s extensive network of distribution centers. Accordingly, we never thought that Amazon would seriously consider purchasing Netflix, as such a purchase would severely (and negatively) impact Amazon’s core retail Internet sales.

If Pachter's theory pans out, Netflix's separation of its DVD business makes more sense. Initially, Netflix looked like it was botching the customer user experience and annoying users. All true to date. But if Netflix, which will be the streaming business, becomes a takeout for Amazon, the separation and angst would be worth the trouble.

Related:

• Netflix's mea culpa disaster: 'Seems like a panic move'
• With service split, Netflix overlooks customer experience
• Netflix wrestles with innovator's dilemma; Customers pan 'Qwikstupid' idea