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Netflix — investors shouldn't chill

Netflix

Netflix is issuing its first bond in euros. It's a high yield bond, but not as we know it. It is single-B rated but the covenants are investment grade — though Netflix's leverage is racy. To buy it, you need to be a fan.

Like many of the great and the good running Silicon Valley’s biggest and best-known companies, Reed Hastings, co-founder and CEO of Netflix, is not short of ambition.

In the firm’s first quarter shareholder letter, Hastings called Netflix's achievement of reaching 100m members, or subscribers, "a good start".

There is serious ambition in Netflix’s spending plans this year, too. Not satisfied with making the US version of House of Cards, The Crown and Narcos for its own screens, it expects to shell out a further $6bn on content this year. 

The growth of its original content platform alone is forecast to burn $2bn of free cash flow. Making pictures is an expensive business.

This, alongside its international expansion, is where Netflix’s €1bn debut bond offering in euros enters stage left. Netflix openly says it does not plan on having positive cash flow for "many years", and will plug that hole with debt.

It is comfortable doing this, it says, as its debt is less than 10% of its total enterprise value, compared with 30%-70% for most its peers, giving bondholders a very large equity cushion to sit on.

No self-respecting investor would take this figure at face value.

Netflix’s shares hit an all time high of $148.29 on March 30, giving it an enterprise value of over $66bn.

The firm’s adjusted Ebitda, meanwhile, stood at $822m for the year to March 31, giving an EV/Ebitda multiple of an eye-watering 80 times. It’s worth remembering that private equity firms in Europe have demurred from multiples near 15 times for some time now.

What’s more, Moody’s forecasts Netflix’s pro forma leverage for the deal at 7.1 times adjusted Ebitda, which, to put it lightly, is high for a B1/B+ rated credit.

For this, investors in the 10 year bond can get a coupon of 3.625%. In October it issued a $1bn 10 year bond at a 4.375% coupon.

Hastings’ ambitious streak also extends to the bond’s covenants. Like on the company's US bonds, these are investment grade in nature, with no limitations on debt incurrence or restricted payments, and therefore weak in protection.

One should, however, like a good film critic, give credit where credit is due. Netflix has experienced exceptional growth. It added nearly 5m subscribers in the first three months of this year, and is expected to continue at this breakneck speed for some time as it expands its global footprint.

Indeed Moody's forecasts that Netflix will reduce leverage back toward six times by next year largely thanks to subscription growth.

The deal also offers leveraged finance investors in Europe the rare opportunity to dramatically diversify their technology, media and telecoms exposure, which, unlike in the US, is dominated by traditional telecoms and cable companies.

But ultimately, the deal’s appeal must be linked to faith in Netflix’s skills behind the camera.

It says it wants to “win more of our members' moments of truth", when they choose what to watch.

A potential problem is that, as it itself admits, “the member could choose Netflix, or a multitude of other options”.

Other outfits including Amazon, HBO and even the BBC, from which Netflix also buys content, also make good shows. It would be a bold investor who shares in Hastings’ ambition, at least at this stage, that Netflix alone will scale the streaming summit.

If it fails to do so, that much-touted equity cushion could be revealed to be full of hot air.

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