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The Case Of Netflix Bonds

Netflix has been a prolific high-yield bond issuer with 7 issues outstanding.

The Netflix credit would seem to be a “slam dunk” with its $158 billion market cap and heavy investor interest as a “FANG” stock.

The cash flow statement tells a different story as the company continues to bleed cash.

Are the bonds a good buy?

As a fixed income specialist, with particular focus on high yield bonds, I have taken a close interest in the high-yield bonds issued by Netflix, Inc. (NFLX). Netflix has 7 issues outstanding, with maturity dates ranging from 2021 through 2028. Yields for the 2021 and 2022 issues are in the 3.8% to 4.2% range, while the 2024 through 2028 issues range from 5.1% to 5.7%. As would be expected, the longer dated issues carry higher yields.

Are any of these bonds a buy, in my opinion? This is a difficult question to answer because Netflix presents a very unusual case in credit analysis. On one hand, these bonds would seem like a “slam dunk.” After all, Netflix has a $158 billion market capitalization and is one of the famous “FANG” stocks which has helped power the NASDAQ for the last couple of years. What else does a bond investor needs to know? Does anyone actually believe Netflix could go bankrupt and not service and repay its debt?

On the other hand, basic credit analysis shows that the company is bleeding cash and pumping out new debt year after year to cover the massive shortfalls. From 2015 through 2018, total net cash flow from operations and investing activities was negative $4.1 billion, which was paid for with $5.5 billion of borrowings. 2018 has been the same. Another $845 million of negative cash flows in the first six months paid for by another $1.9 billion in borrowings (the excess borrowings have allowed cash to build up to $3.9 billion). Total debt has soared to $8.3 billion.

Traditional credit metrics fail in the credit evaluation of Netflix, in my opinion. Typical Debt/EBITDA and EBITDA/Interest Expense ratios are not useful, as the calculation of EBITDA appears to be a misleading figure for this particular company. Why? Because the accounting rules state that much of the spending on programming is a capitalized and amortized balance sheet item, not a current expense. This is why the company had $755 million of negative operating cash flow even though net income showed a positive $674 million in the first six months of 2018. Is this spending recurring or can Netflix reduce it one day? I view programming similar to capital expenditures, and investors must distinguish between “maintenance capital expenditures” and “growth capital expenditures.” Is Netflix’s spending on content assets mostly for maintenance or growth?

So, what is the $158 billion valuation based on? I am not here to perform stock analysis, but like many negative cash flow growth companies, I am sure someone out there has a cash flow model showing that sometime in 2028 (just picking a year), Netflix will be generating $XX billion of positive cash flow, growing in perpetuity, and the value of these future cash flows discounted back comes to something like $158 billion. This analysis, however, is not a substitute for credit analysis.

Yes, yes, I know. How could a company like Netflix worth $158 billion not be able to pay back $8 billion in debt? Moody’s rates the company Ba3 and has stable outlook on the Company expecting that, eventually, the “company’s EBITDA growth outpaces the growth content spend and in debt.” This last point is what it all comes down to for this credit. S&P has the company at one notch lower at B+, deeper into “high yield territory.”

So, which is it, a technology and media company of the future that will one day soon show us that it deserves to be worth $158 billion or a business whose credit is no better than your average “junk bond” issuer? Is shopping mall REIT CBL & Associates LP (NYSE:CBL) at a Ba1/BBB- rating a much safer credit with its $900 million market cap? There are no right answers here. One thing I have learned in 25 years of professional fixed income investing is that one does not invest in fixed income based on a “story.” Hard credit metrics must back up the investment, and I am having trouble doing so in this case, especially for the yields offered by these bonds. Many will disagree. The bottom line is that 3.8% to 5.7% yields are simply not enough to entice me to add Netflix bonds to my bond portfolios. To reach above the 5% yield, do I want to lock in my capital here for 6-7 years? My answer is no, despite the very high probability that the issuer will repay all of its debt obligations on schedule.

(High yield bonds are often called “junk bonds,” a term which can mislead investors into believing these bonds are too risky to consider. Since the common equity of an issuer is far riskier than the same issuer’s bonds, would it be correct to call Netflix a “junk stock”?)

Author’s note: Please consider Downtown Investment Advisory’s subscription service through Seeking Alpha, The High Yield Bond Investor. The newsletter offers deep analysis of three recommendations per month, focused on yields in the 6-8% range, with maturities of 4 to 7 years, for the buy-and-hold investor, as well as regular exclusive insights on High Yield Bonds and related investments such as Exchange Traded Debt, Preferred Stock and Closed End Funds. We seek to uncover undervalued, opportunistic, and “off the radar” opportunities. I offer my 24 years of professional expertise in credit and high yield to subscribers. Read subscriber reviews here.

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Updates to our Distressed Debt 1 Hedge Fund



Updates to our Fixed Income 2 (FX2) Segregated accounts

Durig’s FX2 SMA Ranked 1st by Informa