NETFLIX ANALYSIS (NFLX.) - Liabilities and Debt Financing

Leverage Ratios & Comparison with Competitors (Netflix vs. AMC)

Netflix and AMC operate in the entertainment industry, which has undergone massive shifts in recent years as streaming has disrupted traditional media. Both companies have turned to substantial amounts of debt to fund growth initiatives in this rapidly evolving landscape. However, their leverage strategies have differed greatly.

Netflix has taken on over $17 billion in long-term debt to invest in content and expansion into international markets. Yet it has also delivered strong subscriber growth, with over 220 million global paid memberships. Netflix’s revenues topped $30 billion in 2021 as margins stabilized from 2018-2022 in the 11-15% range. This growing profitability and cash flow has provided capacity to service debt obligations despite economic turbulence. Netflix has also maintained healthy liquidity and solvency, with positive working capital and a MV equity/liabilities ratio consistently above 2.0x.

Meanwhile, AMC has pursued high-risk expansion plans such as acquisitions funded predominantly by debt amidst pressures facing the theater industry. AMC’s long-term debt swelled from $4.7 billion in 2018 to over $10 billion in 2022. Yet profits and cash flows have proven volatile, with EBIT margins ranging from 6-14% over 2018-2022. AMC’s liquidity and solvency has been strained as a result, with negative working capital and a MV equity/liabilities ratio that has swung between 5-9x during industry upheavals.

Essentially, Netflix has smartly leveraged debt to fund growth initiatives that have panned out well, while maintaining reasonable risk management. In contrast, AMC has gambled aggressively with debt to pursue questionable expansion despite the broader shifts weighing on theaters. With AMC now facing over $10 billion in debt and fixed obligations, it has very little room for error should revenues and cash flows take a hit. Going forward, AMC’s strained balance sheet could necessitate asset sales, equity issuances, or a debt restructuring to survive.

Altman Z-Score and Analysis of Netflix:

The Altman Z-score is a financial metric that assesses the likelihood of a company facing bankruptcy within the next two years. The Z-score is calculated using a formula that incorporates various financial variables, including profitability, liquidity, leverage, solvency, and activity ratios.

Various Components of the Z-Score:

Netflix’s Working Capital and Liquidity:

Working capital as a percentage of total assets contributes to the “A” factor in Netflix’s Altman Z-score. This liquidity metric was negative or negligible for Netflix over 2018-2022, hovering between 0-6%. Negative working capital can signal risk, as it indicates potential difficulty covering short-term liabilities with available current assets. However, Netflix has sustained high sales growth in recent years, which could justify leaning more on accounts payable and accrued expenses to fund operations. As long as strong revenue and cash flow continues, modest working capital appears a reasonable tradeoff to fuel expansion. Still, investors should continue monitoring this liquidity gauge going forward.

Netflix’s Long Term Profit Trends:

The Altman Z-score factors in long-term profitability sustainability through the ratio of retained earnings to assets, contributing to factor “B”. Netflix has demonstrated steadily rising profitability in recent years, with retained earnings as a percentage of total assets growing from 11% in 2018 to 35% by 2022. This exceptional profit accumulation indicates Netflix’s growth investments like international launches and original content are paying dividends through member gains and climbing margins over time. Still-rising retained profits signal Netflix is on sound enough operational footing to take on additional financial leverage if needed. As long as subscriber trends hold up, Netflix should have leeway to leverage further without necessarily heightening bankruptcy prospects.

Netflix’s Short Term Profit Performance:

In the short run, Netflix’s profitability as measured through EBIT to assets has fluctuated in the 6-14% range from 2018-2022, driving factor “C” in the Z-score. Despite rising sales, Netflix has faced some margin compression recently after years of steady profit maximization. This could raise concerns on leverage if earnings come under more pressure from rising content budgets clashing with subscriber sensitivity over pricing. However, Netflix maintains highly variable cost structures tied directly to revenue, which should help profits rebound if any revenue slowdown proves temporary. Avoiding protracted margin erosion will be key to validating Netflix’s debt load.

Netflix’s Equity Cushion and Access to Financing:

Lastly, Netflix’s book leverage ratio has climbed from 40% of assets funded through debt in 2018 to 35% in 2022. Meanwhile, its market leverage based on equity value sat at 13% in 2022. These liability ratios driving factor “D” do not appear alarming given Netflix’s bullish growth narrative in past years. Still, $17B+ of debt necessitates consistent access to financing should liquidity needs arise. Here Netflix’s strong brand value and intangible assets may provide an edge. As long as investors have confidence in continued subscriber and revenue growth, resulting buoyant equity valuations should keep financing readily accessible if required to refinance debts or raise additional capital for further content investments.

Netflix's Sales and Asset Efficiency:

The Altman Z-score also factors in asset turnover through the ratio of sales to total assets. Netflix has maintained a high asset turnover of 60-67% over 2018-2022. This top-line efficiency complements Netflix's streaming platform business model. By driving membership gains globally, Netflix efficiently monetizes its content investments and intangible assets. Still near peak historical turnover levels, sustained revenue from existing assets validates the balance sheet leverage taken on to fund expansions. As long as Netflix can deliver steady subscriber growth, strong sales efficiency provides operating leverage to service rising debt levels.

Quantitative Analysis:

The Z-score is primarily used to evaluate the financial health and risk of a company. It categorizes companies into different zones:

1. Z-score above 2.99: This indicates a safe zone where the company is considered financially stable and is not likely to face bankruptcy in the near future.

2. Z-score between 1.81 and 2.99:This suggests a gray area. Companies falling in this range are considered to be in a borderline situation, indicating moderate financial distress and the possibility of bankruptcy. Further analysis is typically needed for companies in this range.

3. Z-score below 1.81: This indicates a distress zone. Companies with a Z-score below 1.81 are at a high risk of bankruptcy. Investors, creditors, and analysts often view companies in this range as financially unstable and facing significant financial distress.

When it comes to Netflix's overall financial risk it is currently in the safe zone because Altman Z-scores are above 2.99, represented mathematically as (Z > 2.99).

Calculation Source/Excel: Post 6.xlsx

Netflix scored solidly in the "safe" zone in 2018 through 2021, with Z-scores ranging from 4.27 to 7.12. This indicates Netflix faced very low bankruptcy risk during those years, thanks to strong profitability, solid working capital liquidity, and reasonable leverage. However, Netflix's Z-score dropped back to 4.36 in 2022. While still in the safe zone, this highlights an increase in financial risk as margins dipped and market equity value declined.

The key takeaway is that Netflix remains financially stable currently based on its latest 2022 Z-score of 4.36. This suggests investors and creditors should feel low distress about Netflix's risk of bankruptcy or financial turmoil in the next two years under current conditions.

However, the tightening Z-score also signals Netflix has less cushion than it did during the pandemic peak years. Its position in the "safe" zone appears more tenuous. If market sentiment turned against Netflix, potentially from subscriber losses or margin declines, its Z-score could dip towards the "grey area" of uncertainty quicker now than previously.

In summary, I view Netflix as financially healthy in the near-term with its current Altman Z-score. But trends bear close monitoring. Sustaining strong subscriber growth and profitability will be crucial to validate Netflix's balance sheet leverage and risk profile moving forward. The Z-score provides a quantitative warning sign if operating conditions deteriorate materially for the streaming giant.

Debts and Maturities:

Netflix carries $14.4 billion of senior unsecured notes as of end of 2022, issued publicly or privately at fixed coupon rates. These bonds represent Netflix’s largest debt component, funding content investments and international launches. Public issuances maturity between 2024-2030, coupons ranging 3-6%.

Additionally, Netflix has a $1 billion undrawn revolving credit facility maturing June 2026 that allows flexible working capital borrowing. The revolver bears interest tied to Fed benchmark rates, currently SOFR plus a 75bps margin. This backstop liquidity combined with laddered bonds reduces refinancing/liquidity risk.

In total, 84% of Netflix’s $16.9 billion debt portfolio carries fixed rates between 3-6%, consisting mostly of staggered semi-annual public bonds. Principal amounts range $400 million - $1.9 billion across 9 total issuances through 2030. Remaining obligations are floating-rate credit lines allowing borrowing flexibility.

This structure provides committed capital aligned to long-term growth plans, while balancing interest rate and refinancing risk via rate locks and maturity diversification. The heaviest maturities of $3.5 billion come due 2028-2030, preventing near-term cliffs.

Moreover, by utilizing unsecured bonds, Netflix avoids restrictive lending covenants that could hinder growth. Required coupon payments rise with larger principal but remain range-bound in the 3-6% area. And the revolver remains untapped for now. Netflix has assembled a sizeable yet tailored debt portfolio geared toward funding ambitious content goals over a 5-10 year horizon while moderating risk. Bonds totaling $14.4 billion across 2024-2030 drive capacity at committed rates, while the revolver adds liquidity optionality if needed. This structure matches Netflix's strategic position as a high-growth firm with long-term investment plans and a relatively strong balance sheet. Execution of the streaming platform and subscriber addition now remain imperative to service debts moving forward.

But the constructs allow strategic flexibility to continue leveraging further if required while avoiding excessive refinancing or interest rate uncertainty. Netflix has effectively balanced capital costs and risk tolerance given growth targets and investment timelines.

Sources:

Calculation Source/Excel: Post 6.xlsx