Michael Milken and his fellow junk bond brethren would be salivating at the markets current appetite for high yield bonds. The roaring 80’s are back led again by the big names like Uber and Netflix. The lack of supply has big investment banks jumping at the chance to bring these issues to market. Let’s look at the details of what Netflix is doing.
The streaming content company intends to offer, subject to market and other considerations, approximately $2.0 billion aggregate principal amount of U.S. dollar denominated and euro denominated senior unsecured notes in two series through an offering to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933. Those qualified buyers would be Goldman Sachs, Morgan Stanley, et al.
The timing is right on schedule with the whopping increase in subscriber base and the cash burn for new content. The balance sheet is once again changing. The bonds would push the cash-burning company’s debt load above $10 billion for the first time. Netflix’s market value has soared almost 70 percent this year to about $140 billion.
The boilerplate language in the letter to shareholders suggests Netflix intends to use the net proceeds from this offering for general corporate purposes, which may include content acquisitions, production and development, capital expenditures, investments, working capital and potential acquisitions and strategic transactions. In actuality, the company will use the offering to fund new programming as the streaming-video giant seeks to maintain its torrid subscriber growth.
The stock market pursuant to the news has been gentle on the equity side, with NFLX trading down slightly Monday. While Netflix’s long-term debt has a credit rating at Moody’s of Ba3, which is considered speculative or “junk,” due to the senior subordination of the notes, the company is obligated to repay these notes even if it files for bankruptcy. The bond bears have been on the short side of the table for a while now. Bearish bets against Netflix’s existing $8.4 billion of junk-rated bonds have more than tripled this year to an all-time high of $347 million, Reuters reported last week. “The short balance in the actual bonds reflects a view that they will decline in value if or when they issue more debt,” said Samuel Pierson, analyst at IHS Markit.
One can understand this bearish sentiment when taking a look at the statement of cash flows. Netflix itself is not shy in coming forth with information. The company is anticipating free cash flow (FCF) in a range of negative $3 billion to $4 billion for 2018. It has also long said it expects to remain FCF negative “for many years.” One has to remember that it took Amazon 14 years from its original IPO to turn a profit. Netflix may be incorporating a similar strategy. As also stated in the letter to shareholders, “We are increasing operating margins and expect that in the future, a combination of rising operating profits and slowing growth in original content spend will turn our business FCF positive.” Slowing the cash burn is a step in the right direction. I’m sure their bondholders, other than the shorts, or hoping the burn will slow too.