Netflix’s Dirty Secret

Netflix's Debt Mountain

JANUARY 30, 2019

Netflix has 139 million paying subscribers after adding 29 million subscribers last year versus 22 million in 2017. The most impressive growth came from non-US markets; that storyline has and will dominate the press for now.

However, Netflix’s greatest innovation is in its past. Netflix doesn’t have a competitive advantage in content creation; it’s just willing to spend more than anyone else to acquire content, employees, and talent.

Debt Mountain

Before the recent fanfare about Netflix’s subscriber additions and its selective ratings deception, the streamer quietly 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. 

Netflix’s mounting debt is getting more expensive. The latest offering received a junk rating and a higher interest rate of 6.375% vs. 5.875% for its previous raise.

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

This is Netflix’s sixth debt raise 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 hole that is approaching $30 billion. 

Netflix’s Dirty Secret

The greatest innovation that Netflix is capable of producing is already in the company’s past, according to most technology experts. And since Netflix doesn’t have a competitive advantage in content creation; it’s left 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. [READ MORE]

Netflix’s content funding strategy through 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.

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Go inside Netflix's licensing agreement with Relativity Media. Discover values for Relativity's slate of 40+ films released from 2010 to 2016.

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. 

FilmTake Away

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 will have systemic effects on all levels of production.