Last week, when Netflix said it was signing up way more subscribers than analysts expected, its stock shot up. Since then, Netflix’ stock has given up all of those gains as investors grappled with the high costs of creating Netflix programs.
Netflix said it would raise $2 billion through a new junk bond offering Monday, which will be issued in dollars and euros and take the company’s debt above $10 billion mark for the first time. The proceeds will likely be used for “content acquisitions, production and development, capital expenditures, investments, working capital and potential acquisitions and strategic transactions,” the company said in a statement.
For years, raising money by issuing debt has been a relatively inexpensive offering. But interest rates have been rising—the benchmark 10-year Treasury yield has risen to 3.2% from 1.3% since July 2016—and that can make borrowing costs higher in the long-term.
Before Netflix reported earnings last Tuesday, several Wall Street analysts lowered their price targets on Netflix’s stock, citing growing competition and rising interest rates as key reasons. Of course, once Netflix blew away analyst estimates on its subscriber growth, those concerns were brushed aside. Now that the initial euphoria is subsiding, and with Netflix planning to hold more than $10 billion outstanding debt, they are returning to center stage.
After Netflix posted earnings, its stock surged 15% to $397.20 a share in afterhours trading, but closed official trading Monday at $329.54 a share, a decline of 17% in a little less than a week.
Netflix is the king of so-called over-the-top TV, with 75% of the 49 million homes that stream video over the internet using its service, compared with 33% for Amazon Prime Video and 17% for Hulu. But Disney is pulling its content from Netflix to prepare its own Netflix rival, while AT&T is adding Time Warner content like HBO to create yet another deep-pocketed competitor.
To maintain its edge, Netflix needs more cash to build its own library. With interest rates expected to keep rising for some time, Netflix may be smart to raise more debt now. But the interest rates on that debt are already looking pricey. A $1.9 billion bond Netflix issued last April had a yield of 5.875%, while a $1.5 billion bond issued one year earlier had a 3.625% yield.
Netflix said it’s still negotiating the interest rate on the new $2 billion bonds with potential investors, but some reports indicate the U.S. portion of the 10.5-year bond may yield around 6.375%, the highest yield on any of Netflix’s outstanding bonds.
While worrisome, the growth in Netflix debt in a market with rising interest rates may not prove be a big obstacle for the company. On Monday, Moody’s gave Netflix’s proposed bond offering a Ba3 rating, which classifies it a high-yield or junk bond offering. Still, Moody’s suggested that, with Netflix’s strong growth in subscribers, the bonds may grow less leveraged over time.
“Despite the continuing issuances of debt to fund the company’s negative cash flows,” Moody’s said, “we expect leverage to drop gradually over time as the transition from licensed content to produced original content levels off and newer international markets begin to contribute to profits and overall margins improve.”