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Oct 23, 2017

Netflix plans to sell US$1.6 billion of bonds to expand programming

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Netflix Inc. (NFLX.O) plans to sell US$1.6 billion of bonds, its largest-ever dollar-denominated sale, as it expands programming and attracts new subscribers.

The proceeds will go to acquire more content and for production and development, among other general corporate purposes, Netflix said in a statement. The 10.5-year junk-rated notes can’t be bought back and are expected to price Monday, according to a person with knowledge of the matter, who asked not to be identified because the details are private.

Investors have clamored for debt from the world’s largest online TV service in recent years as extremely low interest rates on government bonds prompt them to buy riskier and higher-yielding assets. That allowed the creator of “Master of None” and “House of Cards” to boost the size of a euro-denominated offering in April, as it burns through cash to invest in content and fuel subscriber growth.

It seems to be working. Netflix added nearly 5.3 million customers in the three month period through September — its best third quarter ever. The Los Gatos, California-based company has doubled its debt to almost US$5 billion over the past 18 months, and may sell another US$3 billion of bonds by this time next year, according to a Bloomberg Intelligence report. It plans to spend as much as US$8 billion next year.

Moody’s Investors Service assigned the debt a rating of B1, four steps below investment grade, with a stable outlook. However, Netflix’s outstanding 4.375 per cent bonds due 2026 trade closer to a higher-quality ratings group. They were yielding about 4.3 per cent Monday morning, compared with four per cent on BB rated bonds and a 5.2 per cent yield on debt issued by B rated companies — the lowest level in three years, Bloomberg Barclays index data show.

The combination of negative cash flow and rising debt also enticed investors to buy into Tesla Inc’s (TSLA.O) debut bond sale in August, which was upsized to meet demand. John McClain, a portfolio manager who helps oversee US$21 billion of assets at Diamond Hill Investment Group, said he prefers Netflix to Tesla because it’s a more proven concept with a better balance sheet, but won’t buy this issue as Netflix’s debt doesn’t sufficiently compensate for interest rate risk.

“It’s not a great idea to lend to a company that burns cash for 10-plus years at five per cent or below,” McClain said, noting that he’d consider getting involved if the yield was closer to six per cent. “There will be a better entry point driven by higher rates or a deterioration in company fundamentals down the road.”

While Netflix’s debt binge continues to push up leverage, it should drop to around six times earnings before interest, tax, depreciation and amortization by the end of next year, Moody’s analyst Neil Begley said in a report Monday. Earnings growth should outpace that of debt as Netflix makes the transition from licensed to original content and newer international markets improve profitability, he said.

Morgan Stanley, Goldman Sachs Group Inc., JPMorgan Chase & Co., Deutsche Bank AG and Wells Fargo & Co. are managing the bond sale, the person with knowledge of the matter said.