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Netflix’s View into the Future

February 6, 2019

Netflix now has 139 million paying subscribers after it added 29 million last year … as opposed to adding 22 million in 2017.  The most impressive subscriber growth came from markets outside the US.  

 

However, Netflix’s greatest technical innovation is in its past.  Netflix no longer has a competitive advantage in content creation, yet it’s willing and able to spend more than anyone else to acquire content, employees, and talent.  How does it do this?

 

Debt 

Before the recent news about Netflix’s subscriber additions, and its selective leaking of ratings data, the streamer raised another $2 billion in its latest bond offering. 

Netflix now has over $10.4 billion in long-term debt, compared to $3.4 billion at the end of 2016. And Netflix’s mounting debt is getting more expensive.  The latest offering received a junk rating and carries an interest rate of 6.375% vs. 5.875% for its previous fund raising.

This is Netflix’s sixth debt raising over $1 billion in the last 3 years. With nearly $19 billion in streaming content obligations and its $10.4 billion debt load, Netflix is digging a financial hole that is now approaching $30 billion. 

 

Moody’s Investors Service has assigned a rating of Ba3 to its new notes, three levels into junk territory, which is the same rating the agency has given Netflix overall. 

 

Netflix’s Secret

According to most technology experts Netflix’s chief steps in technical innovation are in the company’s past.  Nowadays its spending greater and greater sums to acquire content, employees, and talent.

 

Netflix spent $9 billion to produce and acquire films and series content in 2018.  The company plans to spend $10 billion on original content in 2019 – more than Amazon, Apple, HBO and other streaming services will spend on a combined basis.  

 

The company recently announced it would produce 90 films a year starting in 2019, with budgets up to $200 million. 

 

Netflix’s Average Monthly Revenue per Paying Member in its domestic segment grew by 6% compounded annually from 2013-2017, but its content spending grew 34% compounded annually over that same time.  

Netflix recently paid over $100 million to Warner Brothers to retain the exclusive streaming rights for one year to the dated, but popular show Friends.  This mind-blowing amount is three times what it previously paid. 

Netflix’s content funding strategy, using cheap debt, has been a relatively inexpensive proposition.  But interest rates are rising.  The benchmark 10-year Treasury yield has risen to 3.2% from 1.3% since July 2016, which is lifting corporate borrowing rates.  

As of October 2018, bearish bets against Netflix’s then $8.4 billion in junk-rated bonds more than tripled to an all-time high of $347 million. 

 

It’s an Expensive Stock

Netflix is likely the most expensive stock for any company that has been publicly trading for fifteen years.  The company trades at a whopping 130 times earnings.  

To put this number is perspective, the S&P 500 and Disney trade at 15 times earnings, and Viacom at only 7 times earnings.  Obviously, Netflix is more dynamic than Viacom, but the companies currently have about the same in revenue.  Viacom (parent of Paramount Pictures) had roughly $13 billion in revenue in 2018 and booked net income of $1.7 billion.  Comparably, Netflix had $15.8 billion in revenue and only managed $1.2 billion.  

The share price of Netflix ($328 as of January 29th) could halve to $170 and it would still be expensive.

 

To believe in Netflix at its astronomical price, you have to believe that the company can drastically increase its prices, reduce the growth in its content spending, and continue to grow its subscriber base at double-digit rates for nearly a decade. 

 

The rising debt headwinds facing content producers and distributors globally will have systemic effects on all levels of production and Netflix assumes this burden as it looks to the future. 

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