Yahoo Finance Netflix is addicted to debt and investors should be terrified
Netflix is addicted to debt, and the wild-eyed bulls on the stock need to start caring about it.
The streaming content giant said Monday it will issue $2 billion in new debt to fund its voracious appetite for content, among other uses. Once issued, Netflix (NFLX) will have a hearty $10 billion in long-term debt on the books, compared to $8.3 billion at the end of the third quarter.
That yawning debt load could come at the expense of the bottom line, something Netflix can ill afford to have happen in a market obsessed with its profit growth potential.
Understanding Netflix’s ballooning debt means understanding why the company continues to issue it in the first place.
Netflix reported that through the nine months ended Sept. 30 its free cash flow was an astounding $1.7 billion outflow. Free cash flow is defined as cash flow from operations minus capital expenditures.
Wall Street doesn’t see Netflix turning cash flow positive within the next four years, according to Bloomberg data.
Amid the ongoing cash burn, which is leading to more debt issuances, Netflix’s once pristine financials are now changing arguably for the worse. Netflix’s $10 billion-plus in long-term debt will be up from $6.5 billion at the end of 2017. Interest expense so far this year, before this latest debt raise, has swelled to $291 million versus $238 million for all of 2018. That is money that could be flowing to the bottom line, but it’s not.
If Netflix stumbles – which is possible as Disney sets to enter the streaming arena in 2019 and Amazon continues its own original content push – the company may be forced to pay greater interest rates on rising levels of new debt. Even if Netflix manages to thwart the advances of Disney and Amazon, it’s likely to pay higher rates of interest on its debt as Wall Street reassesses the company’s risk profile.
Talk about being in a tough spot.
Unsurprisingly, Netflix CEO Reed Hastings and his executive team continue to downplay that the aggressive use of cash and the addition of more debt are problematic.
“Netflix is approaching a point where the growth in operating profit is going to grow faster than our growth in content cash spend, and that’s really going to drive the free cash flow towards improvement – it will eventually break even,” said Netflix chief financial officer David Wells on the third-quarter earnings call with analysts.
Wells said he expects to see a “material improvement” in cash flow by 2020. Note he didn’t say Netflix would be a cash-creating machine by that point.
Netflix expects to burn through more than $3 billion in cash this year and in 2019.
“My competitors have Netflix turning cash flow positive in two years, that’s just crazy – it’s not going to happen,” Wedbush technology analyst Michael Pachter said on Yahoo Finance’s Midday Movers show last week. Pachter says that because Netflix doesn’t own a good chunk of its content it will be forced to pay out even more to get more content, creating a vicious circle when it comes to cash and new debt.
Netflix bulls would be wise to consider Pachter’s bearish Netflix position. It may save them a pretty penny come earnings season from a Netflix increasingly bloated with debt.
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Brian Sozzi is an editor-at-large at Yahoo Finance. Follow him on Twitter @BrianSozzi
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