The Long and Short

Netflix paid sharing program could spur another upgrade

| January 26, 2024

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Netflix (NFLX) recently posted strong fourth quarter results, highlighting the success of its paid sharing program and recent price changes. The combination led to double-digit top line growth and solid margin expansion, strengthening its already strong credit metrics. And the company’s stock is already up over 14% year-to-date, providing valuable currency for potential acquisitions. NFLX’s balance sheet and credit profile now look stronger than higher rated media peers Comcast (CMCSA: A3/A-/A-) and Disney (DIS: A2/A- (p)/A-). Moody’s is likely to upgrade NFFLX again as leverage remains below the 2.5x threshold required for an upgrade. This would serve as a potential catalyst for further spread tightening relative to peers.

Exhibit 1. NFLX Curve vs. CMCSA and DIS Curves

Source: Company Reports; Bloomberg TRACE; Santander US Capital Markets

Strong quarterly results

Management noted that they achieved the key financial objectives that they set out at the start of the year. Revenues in the quarter were up 12.5% (to $8.8 billion), fueled by membership growth of 12.8% (to 260.3 million subs). For the year, NFLX was able to expand its operating margin 300 bp to 21%, ahead of management’s 18%-20% target that it provided. The outperformance can be chalked up to better than anticipated operating income coupled lower-than-planned spending. Free cash flow in the quarter was a strong $1.6 billion, roughly 5x more than the $332 million generated in the year-ago period. Free cash flow for the year totaled $6.9 billion which compares very favorably to the $1.6 billion generated in 2022. Management noted that free cash flow generation for the year includes $1.0 billion in delayed spending associated with the WGA and SAF-AFTRA strikes.

Room for growth

Given that the pay TV, film, gaming and branded advertising market generates roughly $600 billion+ in revenues, NFLX noted that they have a lot more room to grow. As the largest content streaming service provider in the world, NFLX only accounts for approximately 5% of the addressable market. Furthermore, its share of TV viewing is below 10% in every country (Exhibit 2). NFLX believes it is all about content, which is why management continues to invest in their slate while competitors have cut their content spend. This view underscored management’s recent announcement to move into the live sports arena, with the exclusive rights for WWE’s “Raw”, commencing in January 2025. NFLX will pay $5.0 billion over 10 years for the rights.

Exhibit 2. Global Viewing Share (December 2023)

Source: Company Report; Nielsen

Credit profile indicative of higher ratings

The strong results in the quarter and for the year have only strengthened the company’s balance sheet and credit metrics. NFLX ended the year with cash on hand of $7.1 billion relative to $14.5 billion of total debt. Gross leverage stood at 2.0x while net leverage is roughly 1.0x. This compares favorably to both CMCSA and DIS as net leverage stands at roughly 2.4x and 2.6x, respectively. Additionally, NFLX’s cash flow conversion is much stronger that its peers which bodes well for further credit profile improvement. Management is forecasting at least $6.0 billion in free cash flow in 2024.

Exhibit 3. Credit Profile Snapshot

Source: Company Reports; Bloomberg; Santander US Capital Markets

Management noted on its earnings call that it prefers to hold approximately two months of revenue in the form of cash on the balance sheet. Excess cash is then returned to shareholders over time via buybacks. Importantly, the company remains intentionally under-levered as management believes it provides for financial flexibility. Management’s conservative capital allocation policies are not expected to change any time soon as management believes it has served them well, especially given the ratings improvement witnessed in 2023.

Moody’s upgrades twice in one year

Moody’s upgraded NFLX twice last year, increasing its rating from high yield territory to mid BBB. Each time, the agency left the rating on positive outlook. The current positive outlook reflects the agency’s expectation that NFLX will continue to increase its subscriber base while growing revenues and margins. Furthermore, the agency expects NFLX to be in a position to generate material free cash flow while improving its credit profile. Moody’s expects management to remain committed to its conservative financial profile, and as such, will look to increase the rating if leverage is maintained below 2.5x. While gross leverage is currently 2.0x, Moody’s does adjust leverage for certain factors that puts it higher than 2.0x. However, the agency does expect leverage (inclusive of their adjustments) to be closer to 2.0x by year-end 2024. Given the better-than-expected margin results in the quarter, leverage is likely to be closer to Moody’s adjusted 2.0x level well before year-end, prompting yet another upgrade.

Meredith Contente
meredith.contente@santander.us
1 (646) 776-7753

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