Convergence and Competition No. 1: Netflix Raises $1 Billion in Debt to Create New Content

Remember when people in the business of tech used to refer to the specific  field in which they worked as 'this space?'

It implied that there was a well defined market for which products and services provided a 'solution.'

Seems pretty quaint now. Kinda like saying that you're the local greengrocer or bicycle shop.

Because, truth to tell, there is no such thing as a 'space' anymore. There is a vast market for digitally driven and connected enterprises. And anyone with leadership, a strategic vision and access to money is entering as many of them as they can - and as fast as possible.

So Netflix is taking on $1 billion in debt to create new content in order to compete with the movie and television studios from which it sources most of the product it sells to consumers. They are all 'frenemies,' friendly competitors who also rely on each other as suppliers, customers and partners.

It's getting pretty crowded in that 'space.' Maybe a little awkward, too, as everyone is trying to eat each other's lunch but remain polite in case they need a favor or a job or a partnership or access to content or, well, you get the idea.

And just to underscore the seriousness of the effort, Netflix is financing this new competitive vision with debt. That is significant because debt carries with it financial obligations to repay that equity, or stock, does not. Which means that those payments have to come out of future earnings dependent on the studio/channel/platform's ability generate content of value without alienating those competitors who are currently supplying it but who see that Netflix is challenging their main business.

This convergence thing is not without risk. But the alternative is oblivion. JL

Ingrid Lunden reports in TechCrunch:

Netflix’s leading position in the increasingly competitive and rapidly evolving online video service and its large subscriber base remains dependent on movie and TV studios. Expect the company to increase its investments in original programming for which success is unpredictable.
As streaming video competition continues to grow between Netflix, Amazon, Google, Facebook and others, one of the leaders of the pack is planning to invest big in content acquisitions and investments to stay up front. Netflix today said it plans to offer
$1 billion $1.5 billion in senior notes and plans to use the proceeds for “general corporate purposes, which may include content acquisitions, capital expenditures, investments, working capital and potential acquisitions and strategic transactions.”
The company originally said it would raise $1 billion but then later increased the offering to $1.5 billion, with a $700 million tranche of 5.5% senior notes due 2022 and $800 million of 5.875% senior notes due 2025, with the sale expected to close on February 5.
Markets are not entirely thrilled with the move. Netflix’s stock is trading down slightly, and S&P has downgraded the company’s debt rating to B+ from BB-. “We view Netflix’s business risk profile as ‘fair,’ reflecting the company’s leading position in the increasingly competitive and rapidly evolving online video service and its large subscriber base,” its analysts write. “However, Netflix remains dependent on movie and TV studios for content, and we expect the company to increase its investments in original programming for which success is unpredictable.” It also pointed to risks in the company’s international strategy.
This should not come as a surprise. On January 20, at the same time that it published earnings, CEO Reed Hastings and CFO David Wells published a note to shareholders that laid out plans to continue to invest in original content:

“Over the next few years we expect to continue financing our original content expansion with long-term debt,” they wrote. “As long as the maturities are spread out, and the interest cost is built into our content budgets, we think long-term debt is the best way for Netflix to finance the production of content.”

What is interesting to consider also is how Netflix might use some of the proceeds for international and market expansion. Currently the company is live in 50 countries with plans to launch in Australia and New Zealand in late Q1, and has an ambition to expand to 200 in the next two years.

“There are numerous local competitors and a thirst for movies and TV shows from around the world. Later in the year, we’ll launch additional major countries, in keeping with our global strategy,” the pair wrote in the letter. “Our international expansion strategy over the last few years has been to expand as fast as we can while staying profitable on a global basis. Progress has been so strong that we now believe we can complete our global expansion over the next two years, while staying profitable, which is earlier than we expected. We then intend to generate material global profits from 2017 onwards.”

The company says that in the key market of China, “we are still exploring options — all of them modest. We’ll learn a great deal if we can successfully operate a small service in China centered on our original and other globally-licensed content. That is our preference, for the next few years, if we are able to acquire the necessary permissions.”
S&P notes that Netflix already has $9.5 billion streaming content commitment as of December 31, 2014, up from $7.3 billion a year earlier. “We expect that streaming content commitments will continue to increase and that Netflix’s pursuit of more original programming with global rights will increase its cash flow deficits,” it concludes.

Netflix first started producing original programming in 2012. But, as on-demand streaming players build up catalogues of content from the same film and TV studios — making it harder to differentiate one service from another — it’s been picking up the pace with hits like House of Cards and Orange Is the New Black. Netflix has been nominated for a number of Emmy and other awards for but has had mixed results when it has come to winning.

Last month, Amazon scored a coup when it announced that Woody Allen would be making his first foray into TV series with a production for Amazon’s Prime Instant Video