Netflix Inc.’s stock was not the only security to be hammered after the company posted second-quarter earnings that missed subscriber numbers by more than a million net additions.
The streaming giant’s high-yield, or “junk” bonds, also took a battering as investors reacted to the disappointing numbers and soft guidance for the current quarter.
Spreads on the streaming giant’s 5.875% notes that mature in November of 2028 widened by 14 basis points late Monday to 295 basis points over Treasurys, according to trading platform MarketAxess. That sent yields up 17.4 basis points on the day.
Netflix NFLX, -6.97% issued that series in a single $1.9 billion tranche in April to help finance its plan to spend between $7.5 billion and $8.0 billion in 2018. The company said it expects to continue to finance its cash needs in the junk bond market. While rising interest rates and lower corporate tax rates make debt financing less attractive, the company said its after-tax cost of debt is still lower than the cost of equity.
CreditSights analysts reiterated their market perform recommendation on the bonds on Tuesday and said they would be buyers on any weakness.
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While the subscriber miss was disappointing, “we do not believe that one quarter of soft subscriber results indicates a meaningful softening in the Netflix story,” analysts Lindsay Gibbons and Jay Mayers wrote in commentary.
However, “our positive outlook for the name is balanced by the expectation for continued debt-finance free cash flow burn over the near-to intermediate-term,” they said.
CreditSights is expecting Netflix to tap the junk bond market again in 2018, to finance part of a cash shortfall that they estimate will total about $2.7 billion.
The company said its free cash flow was a negative $559 million in the second quarter, after a negative $287 million in the first quarter. Management said it still expects free cash flow burn of $3 billion to $4 billion for 2018. With negative free cash flow of $846 million for the first half, the midpoint of that range would imply negative free cash flow of $2.7 billion in the second half, said the analysts.
Netflix had $8.4 billion of debt outstanding at quarter end, dwarfing its cash on hand of $3.9 billion. CreditSights calculated the company’s gross and net leverage was 5.0 times and 2.7 times at quarter end, based on the $1.68 billion of adjusted EBITDA generated in the last 12 months.
“Assuming the company chooses to use 50% of its cash on hand to finance the free cash flow burn, we estimate that Netflix would need to raise approximately $700 million of new debt to fund the remaining free cash flow deficit,” they said.
That would push gross leverage to about 5.4 times, although EBITDA growth could de-lever the balance sheet on a quarterly basis.
Netflix has another $500 million available in an undrawn unsecured revolver, said the analysts. The company has no meaningful debt obligations that mature until 2021, when $500 million of 5.375% senior notes come due.
Still, the company has a sizable equity cushion in its market cap of $174.1 billion. Shares have gained 92% in 2018, while the S&P 500 SPX, +0.26% has gained 4.9%.
