More Netflix Junk To Binge On
Streaming media giant Netflix (Nasdaq: NFLX) was set to sell US$1bn worth of high-yield bonds Thursday, despite uncertainties over when coronavirus-induced containment measures will ease, and film production may resume.
Netflix graced the junk bond market with a new ‘BB’-rated, five-year note offering, denominated in U.S. dollars and euros after exiting from earnings season blackouts earlier in the week.
The U.S. dollar portion of the deal was said to carry a 3.75% coupon – the lowest of any of its outstanding bonds in the currency – while the euro tranche held a coupon in the area of 3.25%, according to Bloomberg. The initial price talk on the issuance was in the area of 4.0% to 4.125%.
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Netflix said it intends to use the net proceeds from the private placement sale for general corporate purposes, which may include content acquisitions, production and development, investments, and capital spending, among other strategic purposes.
Bookrunners on the offering comprised Morgan Stanley, Deutsche Bank, Goldman Sachs, J.P. Morgan, and Wells Fargo.
S&P Global Ratings, which assigned a ‘BB-‘ credit rating to the issuance, noted that Netflix’s adjusted leverage was 4.4x at the end of 2019 (pro forma for the debt sale), which they expect will fall to the mid-3x area by the end of 2020.
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S&P added that it also anticipates the firm’s free operating cash flow (FOCF) deficits to improve to about US$1bn in 2020 from US$3.3bn in the prior year due to “stronger subscriber growth and lower spending on content due to production shutdowns stemming from the coronavirus pandemic.”
Netflix reported in its first-quarter of 2020 earnings that it had close to US$5.18bn worth of cash on hand.
Original Risk
Meanwhile, the streaming media company has typically applied the cash it receives from its debt sales towards producing original content, which many in the market think poses a major risk to the company’s business model.
By some counts, the firm has spent around US$15bn on content in 2019, which Dave Novosel, a senior analyst at corporate bond research service firm Gimme Credit, recently pointed out “happens to be drastically higher than its rivals.”
With half of its total spend tied to original programming, Novosel continued that if the company “cannot provide the new appealing content it has traditionally delivered, subscriber growth could stall, as new shows have been the key factor in subscriber additions.”
Netflix has recently received much criticism about its programming, with media outlets such as The Atlantic, for example, calling the highly popular docuseries Tiger King an “ethical train wreck” and a “moral failure,” while Wired has slammed it as ‘cruel and appalling.’
Other publications, including The Washington Post, have highlighted growing concerns about Netflix’s hit crime-related shows such as You, Making a Murderer, and Conversations With a Killer: The Ted Bundy Tapes.
The Post recently cited that “a number of Netflix’s hit shows spotlight gruesome violence, often committed against women, according to viewership statistics and industry experts.”
From an environmental, social, and governance (ESG) standpoint, Netflix has received consistently negative scores on sentiment related to social impact and the COVID-19 pandemic, which may reflect criticism about its content, as well as potential technical disruptions in Europe and resulting in lower streaming quality.
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Signals of negative sentiment have popped-up on ESG-related data, collected and analyzed by Truvalue Labs, on a weekly basis since at least the week ending March 18.
Truvalue Labs applies machine learning and natural language processing in several languages to assess sentiment across thousands of news sources, such as traditional media, blogs, and industry publications. The negative signals have appeared in data fields representing social impact, economy, and response to the COVID-19 outbreak within a framework of categories established by the Sustainability Accounting Standards Board (SASB).
SASB, established by the SASB Foundation, is an independent standard-setting arm, which aims to capture sustainability matters that are likely to have a material impact on financial performance or condition.
Rising Competition
Indeed, quality of content appears paramount, amid the rapid proliferation of over-the-top (OTT), subscription video on demand (SVoD) companies.
Since its introduction in 2007, Netflix now competes with several other players in the space, including Amazon’s (Nasdaq: AMZN) Prime and IMDb TV, Disney (NYSE: DIS)- and Comcast Corp (Nasdaq: CMCSA)-controlled Hulu, Disney+. AT&T-owned (NYSE: T) HBO Now, Lions Gate Entertainment’s (NYSE: LGF-A) Starz Play, and CBS All Access (NYSE: CBS), among others.
Netflix has admitted that the SVoD model has exploded, with the upcoming arrival of services such as HBO Max and NBCUniversal’s Peacock set to create further congestion.
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Earnings / Subscriber Boom
Netflix’s latest quarterly earnings boasted a massive number of new subscribers, as well as a positive free cash flow position.
The global COVID-19 pandemic was largely responsible for helping new Netflix memberships to mushroom, as containment measures such as ‘stay-at-home’ mandates generally spurred a mass wave of sign-ups.
All told, the firm added a whopping 15.77m paid subscriptions globally, far outpacing the same year-ago period’s 9.6m number, while generating revenue of nearly US$5.77bn and free cash flow of almost US$162m.
As domestic and global competition intensifies, Netflix has been focusing on expanding and diversifying its international content.
In Q1 2020, Netflix’s additions in the U.S. and Canada were up 14% from the same year-ago period; rose 2% in Europe, increased 3% in the Middle East and Africa; and notched-up 3% in Latin American countries; while subscribership in the Asia Pacific fell 5% from the same year-ago quarter.
Ed Border, analyst at Ampere Analytics, highlighted that Spanish-produced titles are “proving an international hit for Netflix,” with three most viewed titles on its platform over the week spanning March 23-29 each made in Spain.
Border noted that while “around half of all Netflix Original and Exclusive titles have been internationally produced for the past few years, this proportion has recently started to increase again.”
He added that productions in English-speaking markets such as Canada and the UK “now make up a lower proportion of productions, while the number of productions from Spain, Brazil, Mexico, South Korea, and India is increasing.”
However, although the paid net membership additions exceeded management’s targets, the company’s revenue was about flat with its guidance, which Netflix attributed to foreign currency headwinds from a stronger U.S. dollar.
For its customers in Brazil, for example, the price for the firm’s standard plan is R$33 in local currency, but due to foreign exchange rates, its value fell roughly 25% in U.S. dollar terms – from US$8.50 in 2019 to around US$6.50 as of April 2020.
Moreover, Netflix’s operating margin of 16.6% fell short of its 18.0% plan after incurring US$218m worth of incremental content costs due to paused productions and hardship fund commitments; these costs squeezed its margin by 3.8%.
The iconic online entertainment company earned US$1.57 per share, disappointing market expectations.
Looking Ahead
With filmed entertainment production effectively shut down globally, the firm delayed its typical cash spending on content. Although this delay helped improve its free cash flow, uncertainties persist over when production may again resume.
New memberships may also decline, in line with the global COVID-19 case curve, similar to the likely drop in the production of 2m pounds of Campbell Soup-owned (NYSE: CPB) Pepperidge Farm Goldfish and cookies.
In the meantime, Netflix has enjoyed upward momentum in its stock, and many of its outstanding bonds have risen in value.
In fact, shares of Netflix have risen almost 34.25% year-to-date in 2020, while OAS spreads on its 5.375% notes due November 2029 tightened by 4 basis points to 355bps, and its 5.875% April 2028s were 7bps tighter at 333bps, intraday Thursday.
For more insights, use the global bond scanner in the IBKR Trader Workstation to locate corporate bonds that are available to trade in the secondary market, along with U.S. Treasuries, municipal bonds, non-us sovereign debt and more.
DISCLOSURE: AUTHOR SECURITY HOLDING: NO POSITIONS
The author does not hold any positions in the financial instruments referenced in the materials provided.
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