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Netflix bondholders shrug off soft top line as company eyes free cash flow floor


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Netflix bondholders shrug off soft top line as company eyes free cash flow floor

Bonds backing Netflix Inc. held recent gains in the immediate aftermath of the company's fourth-quarter 2018 earnings results, which indicated stronger-than-expected EBITDA, but a miss on the top line for the trailing results and in its first-quarter outlook. However, the company also expects no further slippage for free cash flow after a high-cost year for content acquisitions.

Issues across the company’s debt stack were 0.125–0.25 points higher on the day ahead of the results, and first-blush trades on the release of earnings were in that context. Netflix liquid 5.875% notes due 2028 bracketed 100.25 ahead of the results and traded at 100.375 after the news hit the tape, per MarketAxess. That is up from the late-December low of 95.75 and rivals the highest prices since bonds dove lower from 102 in July on its report of disappointing subscriber growth in the second quarter last year.

The streaming-content concern today posted fourth-quarter EBITDA of $318 million, which compares with the S&P Global Market Intelligence consensus forecast for approximately $313.5 million. But the $4.19 billion revenue outcome was a bit below the $4.21 billion Street view and the company guided first-quarter revenues to $4.49 billion, or more substantially below the $4.61 billion S&P Global Market Intelligence consensus.

The company positioned the results in the context of revenues rising 35% for the full year to about $16 billion, and a near-doubling of its operating profits, to $1.6 billion. "Fueling this growth was our high member satisfaction, which propelled us to finish 2018 with 139 million paying memberships, up 9 million from quarter-start and up 29 million from the beginning of the year," the company stated.

Netflix shares tumbled in after-hours trading on the initial revenue headlines, after the company's announcement earlier this week of significant subscriber price hikes to support its efforts to control content in a pitched competitive environment buoyed its shares.

Moody's characterized the price increases as a "credit positive" event, though without immediate impact on its Ba3 grade and stable outlook. S&P Global Ratings has a BB– rating on Netflix, also with a stable outlook. The company was lifted to the double-B ratings tier on the strength of an upgrade in April 2018 by Moody's and by S&P Global Ratings in October to reflect higher-than-expected revenue growth and EBITDA margin expansion.

Netflix, which in October completed an approximately $2.06 billion-equivalent cross-border bond offering, is showing no signs of shying away from the debt capital markets. "As long as we judge our marginal after-tax cost of debt to be lower than our marginal cost of equity, we'll continue to finance our working capital needs through the high yield market," the company said in today's letter to shareholders. It reported liquidity including $3.8 billion of year-end cash and an undrawn, $500 million unsecured credit facility.

Free cash flow for the year was at the low end of the company's initial guidance range for approximately $3 billion–$4 billion. But the company today said it expected a similar total in 2019 and improvements in each subsequent year as operating margins expand, which Netflix today said "will allow us to fund more of our investment needs internally."

Showcasing the costly nature of its turf war with competitors for content, Netflix's operating margin in the fourth quarter of 2018 tumbled to 5.2% from 7.5% a year earlier, as the company launched a host of high-profile titles ahead of the holiday period and awards season.