Netflix Financing: Performance is Deteriorating

Netflix (NASDAQ:NFLX) announced a $400-million concurrent common stock and convertible notes financing. The company raised $200 million (2.86 million shares at $70/share) through the registered sale of common stock to T. Rowe Price Associates, and $200 million through a private placement of convertible notes to Technology Crossover Ventures (“TCV”). The convertible notes do not bear interest, will mature on 12/1/2018, and have an initial conversion price of $85.80/share (11.6553 shares of common stock per $1,000 principal amount of notes). Both deals are expected to close on or about November 28, 2011.

It appears to us that today’s transactions were the result of Netflix’s deteriorating performance and the corresponding impact on its liquidity. Netflix ended Q3:11 with $366 million of cash and short-term investments. The company’s balance sheet showed amounts owed for streaming rights (accounts payable of $654 million and non-current liabilities of $348 million), with another $3.46 billion in commitments and contingencies. These liabilities total roughly 12x the company’s cash and short-term investments at the end of Q3, and recent domestic subscriber attrition and planned increased spending on streaming rights appear to have resulted in rapidly declining liquidity in Q4, forcing the company to raise capital at less-than-optimal terms.

Net loss expected in FY:12. In a Form S-3, Netflix (NASDAQ:NFLX) disclosed that it expected to incur consolidated net losses for FY:12 (compared to consensus estimates for EPS of $1.11)  due to relatively flat consolidated revenues and increased international investment. The company had previously disclosed only that it expected to be unprofitable on a global basis for a few quarters starting in Q1:12.

Lowering our FY:12 estimates to reflect updated guidance. We are lowering our estimates for revenue to $3.57 billion from $3.64 billion and for EPS to ($0.35) from $0.45 to reflect guidance and dilution. Our revised estimates are based upon lower subscriber growth and increased estimates for cost of subscription revenues. Also, lowering our Q4:11 EPS estimate to $0.61 from $0.62 to reflect dilution.

Maintaining our NEUTRAL rating, but lowering our 12-month price target to $45 from $82.50. Our lower price target reflects 15x our revised FY:13 EPS estimate of $3, a multiple in-line with the company’s long-term growth rate.

Michael Pachter is an analyst at Wedbush Morgan.

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