Netflix’s $2bn high yield bond is a missed opportunity

Netflix has returned to the high yield market once again this week with a $2bn offering to fund its ever-increasing spend on its original films and TV shows. But instead of issuing high coupon debt, the company would have done better to look at a convert.

  • By Aidan Gregory
  • 23 Oct 2018
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The 10.5 year euro and dollar offering by the streaming service behind The Crown and House of Cards is likely to make little sense from a cost of funding perspective. High yield investors, rightly, are sceptical about the firm's rapid cash burn and increasing debt load.

The only way it can be justified is if Netflix’s management genuinely believes that its share price, which has surged by 59% over the past 12 months, still undervalues the company. If they do, then issuing equity-linked debt would mean giving away upside cheaply.

Netflix, which made $0.89 of profits per share in the third quarter and spent $1,000 per new subscriber, is anything but undervalued. The company is currently trading at around 107 times its earnings.

That is an astonishing valuation compared to other long established US companies that are more profitable, and even versus other FAANG stocks. Coca-Cola, which has historically been considered an expensive stock, currently trades at around 83 times its earnings. Google’s parent company Alphabet trades around 48 times earnings.

Alongside its lofty valuation, Netflix has built up a pile of expensive high yield debt. It had long-term debt of $8.3bn as of the end of September, up 71% from $4.9bn at the end of the third quarter of 2017. The new bond announced on Monday will take its debt past $10bn for the first time.

Netflix plans to use the proceeds of the latest bond to fund its original content. It said last week that it expects to burn $3bn of cash this year.

Funding this cash burn through debt alone is unsustainable, particularly at a time when Netflix is about to face much tougher competition from other streaming services such as Amazon Prime, which is already well established, as well as WarnerMedia and Disney, both of which are both planning to launch their own rival streaming services next year.

Instead of adding further to its expensive high yield debt pile, Netflix should issue convertible bonds at a fraction of the cost. It has issued them before, back in 2011, when the company was valued at $4.12bn, and achieved a zero coupon then.

In contrast, Netflix sold a $1.9bn 10.5 year straight debt bond in April this year with a 5.88% coupon.

If Netflix were to come back to the equity-linked market, it could potentially achieve a zero or near zero coupon like dozens of other US tech companies that have utilised the asset class this year, driving issuance volume in the US to its highest level since the financial crisis.

US tax reforms passed last year have made it advantageous for companies to issue debt instruments with lower cash outlays.

Netflix’s share price is now down by around 17% from its post-results high last week, and around 30% down from its all-time high in June, which would have been an ideal time to issue a convertible bond. 

But if it were to issue one now, Netflix could likely still achieve a large enough conversion premium to regain this fall and more, assuming a typical conversion premium of 30% or more.

Another common complaint about equity-linked bonds is that they risk diluting shareholders, but unlike with a normal share sale, the dilution does not happen immediately with a convertible bond. Netflix could also minimise the risk of dillution by purchasing derivative overlays, and still save upfront coupon payments compared with its high yield debt.

Netflix’s addiction to junk bonds should worry its backers, but it is not too late for the company to diversify its funding sources. After all, with a growing stable of successful shows to fund, it really needs the money.

  • By Aidan Gregory
  • 23 Oct 2018

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 JPMorgan 163,028.47 711 8.04%
2 Citi 160,005.15 642 7.90%
3 Bank of America Merrill Lynch 132,268.74 528 6.53%
4 Barclays 127,185.71 494 6.28%
5 HSBC 106,407.22 534 5.25%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Bank of America Merrill Lynch 12,912.95 35 6.60%
2 BNP Paribas 12,334.48 61 6.31%
3 UniCredit 11,196.47 58 5.73%
4 Citi 9,580.75 37 4.90%
5 Deutsche Bank 8,953.95 35 4.58%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Morgan Stanley 5,579.06 26 10.66%
2 JPMorgan 4,866.13 28 9.30%
3 Goldman Sachs 4,405.13 21 8.41%
4 Citi 3,774.81 24 7.21%
5 UBS 3,602.23 16 6.88%