The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.
After the market close on Tuesday, Netflix (NASDAQ:NFLX) announced the pricing of a $500 million offering of senior notes due in 2021 (the company filed an 8K this morning saying it intended to raise $400 million). The notes bear interest at 5.375%, payable semi-annually beginning on August 1, 2013.
As previously disclosed, Netflix will use ≈ $225 million of the net proceeds to redeem $200 million of outstanding 8.50% senior notes due 2017, so the new issue raises ≈≈≈ $275 million in new capital. Netflix can redeem the notes prior to November 15, 2013 at 100% of the principal amount plus accrued interest and a “make-whole” premium. The remaining proceeds from the new senior notes will be used for general corporate purposes, including capex, investments, working capital, and potential acquisitions and strategic transactions.
Investors should be troubled by the $300 million addition to debt and the unexpected $100 million increase in principal amount. The increase in debt, coupled with the company’s intention to force conversion of its outstanding $200 million convertible issue, indicates to us that free cash flow from the business is quite weak, and far worse than…
we previously envisioned. We believe the company has virtually no chance of generating positive FCF for the year, and we are lowering our FY:13 expectations as a result. In addition, we do not see this as a one-off, but believe that Netflix will continue to generate negative cash flow going forward, driven by the company’s ever-increasing streaming commitments.
We are lowering our EPS expectations to reflect the greater debt burden that Netflix now faces. We now expect FY:13 EPS of $0.94, down from our prior expectation of $1.00, compared to consensus of $1.15.
We are dumbfounded that Netflix shares continue to rise, indicating that investors do not care about increasing leverage. Negative cash flow will likely continue as long as the company pursues its money-losing international expansion.
Most importantly, capital raises in late 2011 and early 2013 indicate that content costs are rising faster than profits. We expect this trend to continue.
Maintaining our UNDERPERFORM rating and 12-month price target of $55, which reflects a sum-of-the-parts that values domestic streaming ($28/share), domestic DVD ($20/share) and international streaming ($7/share).
Michael Pachter is an analyst at Wedbush Securities.
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