However, we are positive on the capital infusion, as it strengthens NFLX's balance sheet and improves its financial flexibility.
It's bad enough to advocate a long position in a broken stock floated by a broken company, but it's a-whole-nother mess to tout an act of desperation as a move toward "strength" and "flexibility." I wonder what Credit Suisse will have to say if Netflix moves to raise more cash (or money for a rainy day, as company spokesman Steve Swasey put it) in 2012.
Fellow Seeking Alpha contributor Liqddynamite stated it best when he did the one thing Netflix CEO Reed Hastings has probably come to hate. Dynamite turned management's words on itself, contrasting their shameful and fantastical relay of the "facts" one day with the cold, hard reality of the next:
"By pausing further international expansion and halting buybacks, our current cash on hand is adequate to support the growth of the business."
-Netflix Letter (.pdf) to Shareholders, October 24, 2011
Look again at the quote at the top, that wasn't even four weeks ago and now the company is raising cash. You don't do a very public one-eighty and raise capital if you don't really need it ... So clearly there is a liquidity concern considering the public fallout this move will generate and how it will affect the stock price. It's the right decision, but only because of how bad the situation is.
To quickly recap the deteriorating financials, total debt now exceeds $4.5 billion, revenue only grew 4% from Q2 to Q3, subscriber growth has waned considerably if it even exists at all anymore, and it's worth noting that the total debt of $4.5 billion now exceeds the market cap of $3.8 billion. The debt is rapidly growing and revenues are stagnant. Netflix had no choice but to raise cash here (emphasis added).
Given the dire situation, it makes no sense to dwell on the past. As such, let's look ahead to what we can expect from Netflix come 2012.
Counting the $400 million in financing, Netflix has easy access to about $765.8 million, based on the roughly $159.2 million in cash and cash equivalents and $206.6 million in short-term investments it lists in its 10-Q for the third quarter.
Netflix now concedes that it will lose money throughout all of 2012, after the less-specific mention in the October 24th shareholder letter that "for a few quarters starting in Q1," the company will be "unprofitable on a global basis." (It's amazing what a couple of months can do, isn't it?). As the company fails to turn a profit for all of 2012, it will continue to burn cash. Setting aside the well-publicized billions of dollars worth of off-balance sheet content commitments, just consider the money Netflix spends on expenses that actually find their way to the balance sheet here and now.
Have a look at the numbers yourself, straight from the most recent 10-Q for Q3:
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Netflix burnt about $100 million last quarter alone on two items that do not even count toward its "contribution profit" - Technology and Development and General and Administrative. And then, going to back to what remains, for the moment, off of the balance sheet, we know that, with some level of certainty, about $741 million worth of off-balance sheet expenses come due between Q4 2011 and the end of Q3 2012. Before the end of 2012, some portion of over $2.1 billion in off-balance sheet costs must get paid.
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And do not forget something else Netflix sneaks into Footnote 9, Commitments and Contingencies in its quarterly reports:
The company has entered into certain license agreements that include an unspecified or a maximum number of titles that the company may or may not receive in the future and /or that include pricing contingent upon certain variables, such as theatrical exhibition receipts for the title. As of the reporting date, it is unknown whether the company will receive access to these titles or what the ultimate price per title will be. Accordingly, such amounts are not reflected in the commitments described above. However such amounts, are expected to be significant and the expected timing of payments could range from less than one year to more than five years (emphasis added).
When I review these numbers two things come to mind. One - something Michael Pachter of Wedbush said to me via email a few months back. When I asked him a question about how Netflix's expenses would flesh out, he could not answer with confidence, instead referring to Netflix accounting as a "black box."
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And, two, the numbers at Netflix continue to not add up. Consider the bills that have come due related to streaming content, as of the end of Q3, also from the above-linked 10-Q:
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And then go back and consider close to a billion dollars worth (maybe more) of off-balance sheet obligations coming due over the next year (which help to drastically increase the numbers called out above), $100 million a quarter in T&D and G&A, not to mention marketing, DVD-associated costs and international expansion-related expenses against a model that no longer generates profits to plow back into the business and a relative pittance of $765 million or so in cash. I won't insult your cognitive abilities or your math skills.
So, as Netflix kills the business segment - DVD - that actually makes money and has been subsidizing streaming, how in the world will it make its way through 2012?
In Q4, at the high-end of its guidance, the company expects total revenue of $875 million (so much for that $1 billion Q4 that Hastings suggested just a few short months ago). Nobody really knows what the revenue numbers will look like in 2012 - and Netflix isn't saying anything beyond expectations of a losing year - but let's consider Pachter's recent revised estimate of $3.57 billion for all of 2012. That breaks down to a pretty optimistic $892.5 million per quarter.
Talk about a cash crunch.
If expenses stay the same as they were in Q3 throughout 2012 (but, of course, they'll likely continue to increase exponentially), Netflix will dish out $400 million in T&D and G&A and another $356 million in marketing costs alone. Cost of revenues in Q3 alone totaled $537 million. Again, do the math using a generous revenue allocation of $892.5 million per quarter and cash, cash equivalents and short-term investments of about $766 million, as of the moment. And don't forget about accounts payable and non-current liabilities, taking into account how rapidly they grow quarter-to-quarter, thanks, primarily, to those pesky off-balance sheet obligations. As the most persistent bears have argued long before this past summer, it would be those costs that would come back to haunt Netflix.
Simply put, Netflix moves forward in 2012 operating like a senior citizen on a fixed income. It has little room to breath even when you factor in the $400 million in financing. Back of the envelope math shows a tight 2012 and possibly even a shortfall in terms of liquidity. Go ahead and run the numbers yourself.
Taking all of that into account, I predict that Netflix will do one of the following two things in 2012, or both. It will give Credit Suisse something to wax bullish about again by going to Wall Street or Silicon Valley for more cash. (It's always such a positive sign when a company goes from predicting a $1 billion quarter to issuing stock to fund operations!). And/or it will conduct another 180 by selling off its DVD unit to raise cash to keep its streaming business alive. Of course, Netflix - I think in response to my work on Seeking Alpha-- noted in its Q2 letter to shareholders that it has no intention of selling its DVD unit. I've said all along that selling off the DVD unit would be the ultimate outcome in an effort to stem the bleeding. Given the company's dire situation, I am more confident about that than ever.
Netflix has proven that its DVD segment can turn serious profits. It's what brought the company to the dance. Despite this, Reed Hastings is convinced that streaming is the future. And he refuses - I think stubbornly - to seriously consider alternative scenarios. If I were him, I would go back to the future, focus on DVDs, make that business hum and return to the drawing board on streaming. Everything else, including finding a buyer for the DVD unit in 2012, amounts to little more than a continuation of Netflix's nightmarish status quo of hanging on by a thread and grasping at straws.
Sadly, Hastings is probably in too deep to reverse course now. Plus, he would never be able to save face if he revamped his company's business model for, what would it be, a third time? With that in mind, he will have no choice in 2012 but to ask - and at that stage, the more appropriate word might be beg - for a bailout.
Disclosure: I am short NFLX.