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Netflix Streams More Debt as Investors Wait to See Payoff

Netflix is again going deeper into hock.

In the streaming service’s latest move to cover its massive global content costs, Netflix this week closed $1.4 billion in new debt financing, adding to its $3.37 billion in existing long-term obligations. It’s the third time in a little more than two years that Netflix has raised more than $1 billion in debt financing.

But the company’s mounting debt and content-payment obligations have raised a new question on Wall Street: When will Netflix take its foot off the gas pedal?

“You can’t spend like this on programming forever,” said Michael Nathanson, principal at MoffettNathanson, who expects Netflix to shell out $8 billion in cash for content in 2017. “When do they feel they’ve built the perfect scale and can slow it down?”

The company has reassured investors that it isn’t excessively leveraged, noting in its first-quarter letter to shareholders that it has a debt-to-market-cap ratio of less than 10%, far smaller than that of industry peers.

But that doesn’t account for Netflix’s content obligations — the billions in payments for programming over a period of several years. That figure stood at $15.3 billion at the end of the first quarter, more than double that of the same quarter three years earlier. A whopping $8.4 billion of that $15.3 billion isn’t reflected on Netflix’s balance sheet.

Netflix is betting subscriber growth will keep pace with its growing debt load and content commitments.* Excludes $1.4 billion in new debt expected to close May 2 ** Bulk of payments due within three years
Sources: Company reports, SEC filings

To finance the latest debt offering, a Netflix representative said the company is targeting non-U.S. lenders because European interest rates are attractive. Moreover, the rep said, “Netflix is a global company, and we want to have access to global capital markets.”

The company’s hypothesis: It needs to spend big now to keep the customer-growth engine humming before it can reach cruising speed and live within its means. So far, execs have sold that story to the investment community, and nobody on Wall Street is worried that Netflix is becoming over-leveraged. “The market is surprisingly comfortable with Netflix’s balance sheet,” Nathanson said.

With access to cheap credit, and investors not expecting big profit margins, Netflix has an advantage over traditional media companies that need to worry about the bottom line. To Nathanson, Netflix’s current investment mode is akin to the U.S. cable sector’s heavy capex spending two decades ago when operators built out fiber-optic networks to set the stage for growth.

Netflix shareholders are fans of the debt-fueled strategy for one key reason: “The correlation between content spending and subscriber growth is strong,” said CFRA Research senior analyst Tuna Amobi.

To be sure, Netflix’s long-term debt has not been a huge drag on earnings, as it continues to grow the top line. The company reported $46.7 million in interest expense for the first quarter of 2017, on revenue of $2.67 billion (up 35% year over year). But in addition to the content itself, Netflix will have to promote it, which the company expects will gobble up more than $1 billion.

It all makes sense if Netflix successfully signs up millions more users (and keeps them). If subscriber levels start to taper off, though, in a worst-case scenario Netflix would be forced to raise prices again.

While that would obviously stifle subscriber growth, hiking rates by $1 per month would generate an incremental $1.2 billion in cash per year, giving the company enough money to cover content obligations and pay down debt over a few years, said Wedbush Securities analyst Michael Pachter. The analyst (who has a “sell” rating on the stock) doesn’t see extreme risk in Netflix’s model per se. The danger, he said, is that the pricey content won’t resonate with customers.

“I think they’re spending way too much,” he said, “and have way too little to show for it.”

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