Netflix borrowed $1.6bn on Monday to fund its investment in original movies and television shows as bankers wrapped up the company’s biggest bond sale.
The deal, following stronger than expected subscriber growth in the third quarter, will help finance a growing $7bn to $8bn budget for original content next year as the streamed entertainment provider behind shows such as Stranger Things and House of Cards expands its movie and TV line-up.
The new 10.5 year bonds, which mature in 2028, priced with a yield of 4.785 per cent, according to two investors following the sale.
That was in line with prices marketed to investors earlier in the day and slightly above the company’s existing dollar-denominated debt that matures in 2026, which changed hands on Monday with a yield of 4.4 per cent. Two investors said bankers had marketed order books for the $1.6bn transaction reaching about $2.5bn.
“The timing is perfect,” said Rahim Shad, a senior analyst with Invesco. “They are coming off of very strong numbers. The market is completely open. It is a great deal for the company and equity investors if they can tap the bond market at these levels but as a creditor you always think about the underlying risk.”
The deal lands in a market that several well-known investors have judged to be frothy, as benchmark stock indices hit new records and risk premiums on low quality debt approach levels rarely seen since the financial crisis.
“We have been concerned about valuations for a while,” Mr Shad added. “Valuation is just one common concern that you’ll hear no matter where you go these days.”
Valuation is just one common concern that you’ll hear no matter where you go these days
Companies have raised more than $1.4tn in the US so far this year, a record pace, according to Dealogic.
But the heady headline figure, boosted by large banks raising capital, belies the lacklustre new issuance in the junk bond market, where companies have raised $215bn in 2017. That is the second-slowest figure since 2011.
While flows into high-yield funds have been volatile, investors have shown a strong preference for fixed-income assets this year. US bond funds have counted $182bn of inflows this year, according to EPFR.
Kapil Singh, a portfolio manager with DoubleLine Capital, added that with redemptions and upgrades of high-yield bonds out of so-called speculative territory, the market for junk debt has shrunk.
“We are underweight high yield for various reasons, valuations being the main one,” Mr Singh said. “As a firm [our] belief is rates are rising. Risk assets could potentially get more volatile.”
Although Netflix’s stock has rallied more than 50 per cent this year, its B1 rating from Moody’s and B-plus opinion from S&P Global put it squarely in junk territory.
Neil Begley, an analyst with Moody’s, warned that measures of Netflix’s indebtedness would continue to rise this year before falling by the end of 2018.
Mr Begley said that he expected earnings growth to outpace the company’s rising debt levels next year as Netflix begins to profit from its expansion outside of the US.
S&P analyst Jawad Hussain, by contrast, said his assessment of the risks of Netflix’s business had “improved due to its strong subscriber growth”.
But he cautioned that the “company’s comfort with growing negative free cash flow from its large original content investments” weighed on its rating.
If subscriber growth slowed or margin improvement stagnated, it would imply that the company’s spending on programming was “outpacing its ability to grow its subscriber base, which could hamper its access to capital markets and pressure liquidity”, Mr Hussain said.
Netflix said last week that it anticipated free cash outflows of up to $2.5bn in 2017. As some media groups that were once partners, such as Walt Disney, stop licensing their content to Netflix, the Silicon Valley-based company must invest in new TV shows and movies to keep subscribers loyal.
The cost of that content is borne before it airs, and amortised based on estimated viewing over time, usually between six months and five years.
That model leaves Netflix with high upfront capital requirements and it has warned investors that it expects to see cash outflows for “many years” to support its growth around the world.
It is presently pushing hard into full-length movies, expecting to release 80 films next year, up from just eight in the most recent quarter and many more than most traditional Hollywood studios, as well as TV shows in new languages, including Italian and German.
Morgan Stanley led the bond sale for Netflix on Monday, alongside Goldman Sachs, JPMorgan, Deutsche Bank, Wells Fargo and Allen & Company.
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