In honor of Netflix’s 20+ Year Anniversary and the fact that my usual early morning coffee read today, 4/23/2018, was awakened by the beauty of yet another inspiring debt financing structure, I decided to write up a quick synopsis about NFLX below broken down into sections [jump to the end for the juiciest financing part of it 🍾]
Acquisition of Future Revenue and Its Dependency on Continuous Cheap Credit
If one’s business ability to acquire ‘future’ revenue is highly dependent, not just slightly, but overwhelming majority of acquisition of future revenue is dependent on access to cheap new credit…though most of the publicly traded companies have been rolling forward their principal payment due date by raise even more debt to pay back their existing principal, which would totally worth when the projected future rate is on a downward trajectory, but if it’s on an upward trajectory, then the amount of ‘financing flexibility’ in the future is due to be compressed.
Default Risks + Inelastic Pricing Demand
But that’s not to say immediate default challenge is on the horizon, instead, the company has and will probably continue to “layer” their debt financing needs strategically in strong parallel with projected capital expenditure and price appreciation in their monthly charges (i.e. Netflix has increased their monthly price fee several times in the past 8 quarters) and as of today, it looks like customers are either and/or insensitive to price movements, which usually indicates relatively inelastic product demand
An example in inelastic price demand is oil and crude oil price in which demand will plateaued or decline substantially slower than the appreciation in price and vice versa – but the challenging with the $70+/barrel oil price right now might put the pressure in consumer discretionary spending ability or deployment of the average American’s average cash reserve after the fixed liabilities (rent/car payment) to spur purchase in other parts of our economy other than the oil sector might be put into questions. Now we might extrapolate the economic reason (ignoring the geopolitics and petrodollar implications side of it for now) behind this tweet three days ago as it might pressure average consumer’s discretionary spending dry power…
Vertical Integration of Content Creation and Content Distribution Channels
This is more from the financing perspective, and it’s not to ignore Netflix’s newly deployed strategy is moving up the supply chain…now looking to buy cinemas. Netflix has considered buying theaters. Moving up the supply chain similar to that of Slack Investment Fund (forcing the companies to only provide value add to Slack and to none that of their competition) and Rockefeller actually did deals with Vanderbilt to secure total dominance on distribution route, not just on the downstream raw material but also upside delivery channel supply chain (and also horizontal by selling the byproducts from crude refining to 3M to create consumer non-cyclical and discretionary products).
FINANCING Part 1!!!!!
Ba3/single-B-plus rated Netflix, Inc., announced an offering of $1.9 billion in 5 7/8% senior notes (upsized from an initial $1.5 billion figure) due in 2028. That follows a $1.6 billion offering of 4 7/8% senior unsecured notes of 2028 in October 2017, only 1-2 quarters before this latest debt offering, currently trading at 96 cents on the dollar for a yield-to-worst of 5.40%, and 1.3 billion in euro-denominated 3 5/8 senior unsecured notes of 2027 offered in April 2017, which, under the loving embrace of Mario Draghi’s ECB, sit just below par for a YTW (yield-to-worst) of 3.70%. One should note these are 10+ years of debt duration
Euro-denominated bond is currently trading on/slightly subpar to 0% rate, thanks in great prat due to the pumping of unlimited liquidity in the market, which as the latest data has shown, does not drive well into the bankruptcy rate, but as a general rule of thumb, bankruptcy process allows the financial system to flush out inefficient deployment and typing up of capital.
While an investment in Netflix common equity has proved extremely lucrative in recent years (the stock is up by 66% in 2018 alone) not to mention the endless content consumption optionalities for us all end users, bondholders are assured of earning nothing more than the return of their principal, and some interest income. If all goes well. If it doesn’t? Netflix, which will celebrate its 20th birthday this summer, has adapted to changing tastes before. Maybe it will again – or maybe it won’t. If not, the stockholders may lose everything, and the noteholders, too, would likely take a haircut. Default-related losses might reach 35% of par value according to S&P.
FINANCING Part 2!!!!!
I have been an avid follower of default risks in the bond market as well as the covenant protection issuers are bestowing upon to the debtors. The content juggernaut, which has seen exponential growth in its revenues, stock price and free cash flow burn in recent years, is leaning harder and harder against a bond market to finance its operations, while credit investors have thus far been all too happy to comply.
Two things to read every other weekend:
(1) US LIBOR rate seems to be functioning independent for the past per months, as other financial instruments and products has yet to catch up to the growth in US LIBOR rate, as media have been attributing the growth to relatively higher future inflation expectations as well as cash repatriation from aboard back into the country, but it does not mean the traditional duration and interest rate risks analysis needs to be thrown out the window, not to mention the ‘small’ cascading effects on other Hong Kong Dollar-based LIBOR and Shanghai-based SHIBOR rate.
(2) Spreads between the short-term and longer-term duration Treasuries and whether yield curve inversion will create downstream cascading effects to other financial debt instruments as its an above-average indicator of the market compensation requirement for risk appetite or more specifically, how much one should be compensation for duration risks.
The gyrations of financial markets can be startling. I am reminded of the following words of wisdom attributed to the great economist John Maynard Keynes, in which his philosophy and study has been the solid basis to a lot the 21th Century central bankers around the world: “The market can remain irrational longer than you can remain solvent” so deploy your capital accordingly.
Cheers,
Jerry
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