A lot has been said about the equity story and valuation of Netflix (NFLX). In this article today, I will focus on the credit story of Netflix.
According to recent SEC filings, the top holders NFLX stock are T. Rowe Price (12%), Capital Research and Management (11%), Davis Selected Advisors (7.7%), Sand Capital (7%), and The Vanguard Group (5.5%). So now that we have a list of Netflix believers, lets look at the credit and equity story, and then the valuation.
On the credit side, as of June 30th, 2012, the company has $813 million in cash and short-term investments and $400 million in long-term debt. The $400 million in debt consists of $200 million in Zero convertibles due 2018, with limitations on the company's ability to pay cash dividends or to repurchase shares of its common stock.
Also outstanding is $200 million in 8.5% in senior notes due 2017, which consist of covenants such as limitations on the company's ability to create, incur, assume or be liable for indebtedness, create, incur or allow any lien on any of its property or pay dividends. Following is a table for the company's contractual obligations as of June 30th, 2012:
The company has no debt in the form of credit facilities or revolvers. Unfortunately, Netflix has $2 billion in content liabilities in addition to the $3.8 billion in off-balance-sheet content liabilities. With the high demand of content, this number will only get worse for the company.
Fundamental concerns for NFLX:
- Competition of Verizon (VZ)/Redbox is a risk both on the pricing and content. The competitor list goes on with names like Hulu plus, Comcast XFinity Streampix (CMCSA), and Amazon Prime Instant Video (AMZN).
- Highly risky is the decline in the DVD rental business, and with 45% of profits and contribution margins responsible for the funding of global streaming efforts, any decline in the DVD business means overall decline in profits for NFLX. Also, the move from DVD to non-profitable international streaming could slow the international growth.
- Lose piracy laws outside of the U.S. could make it hard for Netflix to convince non-U.S. consumers to be loyal to Netflix,.
- With the demand for content rising, acquisition costs are expected to continue to increase. Expect to see the company's off-balance sheet content liability number to get worse.
On the valuation side, Netflix trades at $66.56 versus its 52-week range of $52.81-$133.43, and its high of $298.73 was reached in July 2011. The stock trades at a P/E multiple of 106x based on a 2012 EPS of $0.62, and a forward P/E of 60x based on the consensus EPS of $0.91. Not a very attractive valuation. Based on the risks mentioned above, I think there is huge downside risk to valuations going forward. Also, I think, sell-side estimates might still be too high for the stock, and might have to be adjusted when we see the fundamental and industry risks priced in the stock.
Conclusion: Overall, I think given the off-balance-sheet debt, growing competition, increase in content acquisition costs, and the domestic growth of revenues stagnated by the investment in international growth, investing in Netflix seems like a very risky proposition right now.