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Announcement:

Moody's comments on Netflix's (Ba1 Positive) weaker than expected subscriber performance and guidance

21 Apr 2022

New York, April 21, 2022 -- Moody's Investors Service ("Moody's") said that Netflix, Inc.'s (Netflix) (Ba1, positive outlook) weak first quarter 2022 results showing a net loss of 200,000 subscribers and second quarter guidance for 2 million subscriber losses represents a material departure verses our expectations for subscriber growth and retention, just as the company reached break even free cash flows and continues to achieve revenue and free cash flow targets.

Moody's anticipates that quarterly subscriber growth will remain quite volatile, as it always has been historically. We still anticipate growth in the back half and for the full year as they typically are the company's strongest quarters, however, we believe there is greater uncertainty as we compare the growth to our previous expectations and to the strong 4th quarter in 2021. Moody's anticipates that the company will likely continue to both beat and miss the company's own stated guidance as it has historically but we still believe that the medium and longer-term credit outlook remains favorable for the company despite the cloud over the company from the fall from overheated equity market valuations for Netflix and the headlines that comes with it. As a result, we will likely observe a few more quarters to determine the new trend lines and reset more specific expectations as well as evaluate the company's fresh new levers to grow revenue and free cash flows before considering raising the company's credit ratings to investment grade.

The company's continuing fundamental and financial credit improvements as well as governance considerations remain very important to a transition to investment grade ratings. The company has experienced significant fundamental improvement as indicated by our two-notch upgrade of Netflix's ratings in April 2021 and the positive rating outlook. This has been due to revenue growth, subscriber scale and operating margin expansion to a level which should generate sustained free cash flows. The growth of the business to get where it is today, combined with the company's implementation of a target debt range of $10 to $15 billion has resulted in a material improvement in credit metrics. Strong positive free cash flow of about $1.9 billion in 2020, larger cash balances than anticipated, and no operational need for new debt issuance in 2021 and going forward other than potential refinancing in the future along with the repayment of debt in Q1 2022 puts the company squarely in their target debt range. Up to now, the combination of more subscribers and revenues, less than expected debt, and subscriber fee increases has led to a consistent deleveraging trend such that we expect gross debt-to-EBITDA with Moody's adjustments to drop below 2.5x by year end 2023 assuming the company resumes subscriber growth, which is consistent with the threshold for the Ba1 rating. Moody's believes that management is committed to sustaining an investment-grade credit profile, which should result in greater access to the debt capital markets during times of stress. Our positive outlook also reflects the company's position as the leading direct-to-consumer subscription-video-on-demand (SVOD) single Tier-1 platform. The COVID-19 lock downs around the world have led to greater than pre-crisis expected subscriber growth rates during the pandemic and pricing power to raise rates due to significantly reduced out of home entertainment options and very strong viewer engagement in 2020 and 2021. However, the back side of the subscriber pull forward is apparent in the Q1 2022 numbers and guidance so far. Moody's believes that the weakness in the first half and if the guidance is correct, will most certainly slow the company's growth trajectory, particularly from its ability to raise prices without churn backlash and from aggressively growing subscribers. Moody's believes that there are likely a number of reasons for the potentially sharp net subscriber additions slowdown: 1) price increases, while revenue accretive, have been numerous in recent years; 2) the emergence of a number of competitive options across most of the company's markets; 3) the other side of COVID lockdowns may not just be the void left after pulling forward subscribers, but also, a purposeful move by consumers to take a break after two years of mostly binge watching television and committing discretionary leisure time to out-of-home entertainment options; and 4) clearly the war in Ukraine had a direct impact as Netflix shut down services in Russia and saw ripple effects not only directly in Ukraine but in much of eastern Europe as the geopolitical landscape has caused stress and a likely move away from entertainment towards news information. Moody's plans to observe these conditions and the company's strategies to put the company back on track to capture a material share of the transition from linear television. Moody's still sees the company continuing to build on its significant scale to penetrate the world's 800 million pay TV homes and the global addressable homes of over 1.5 billion (both excluding China), sustaining competitively low cost per viewing hour leadership, growing average revenue for member, and reinvesting in even more content as it benefits from this virtuous cycle.

Moody's anticipates that leverage will continue to decline over time assuming the company makes no material acquisitions, but at a lower trajectory than we previously expected. In a scenario where the company does make debt-financed acquisitions, we believe that the company will endeavor to reduce leverage to under 3x over a reasonable period of time and return to its target debt range of $10 to $15 billion. Moody's expectations for continuing improvements in fundamentals and credit metrics stems from: 1) our view that subscribers will continue to grow, albeit at a potentially much slower rate than recent years; 2) the company's plans to pursue account sharing fees at scale in 2023 which will be a material high margin and free cash flowing opportunity in our view, though we believe that member sharing accounts likely have lower churn than average which the company could see unintended consequences of a reduction of such accounts over time; and 3) the company's plans to offer a hybrid ad supported option for consumers together with a lower subscription rate which will provide consumers with more choice and affordability which Moody's anticipates will help the company expand in heavily populated lower socio-economical regions and reduce churn during economically challenged climates. Moody's believes some of these potential moves will add considerable high-margin revenue and free cash flow conversion potential given the fact that they do not require additional spend on content, the company's largest expense, so they could materially boost performance and the company's credit profile so long as overall subscribers remain stable or grow. In addition, Moody's believes the company will manage to its 20%-plus long range margin goal, growing content spend to remain competitive, but only to the extent that revenue grows by as much or more. Hypothetically, adding subscribers does not necessarily require spending more and more on content, but remaining the go to option for member subscribers remains dependent upon the popularity and strength of the company's new original release strength and the comfort-food content between such new releases. Moody's believes that if the company can return to subscriber growth, and at this point we do but with caution, it will sustain revenue growth given the number of global pay TV homes (800 million) which will likely transition from linear bundles pay TV to streaming VOD. Moody's believes revenue growth will exceed the growth of content costs which will continue to expand EBITDA margins from the low 20% range upward toward the mid 20% range over the long-term. Moody's anticipates that beginning in 2022, the company will sustain free cash flow generation even with the weakness in the first half. We anticipate that subscription rates will continue to increase, particularly due to the new password sharing fees, subscriptions will grow to near or around 250 million by the end of 2025 or potentially more if the company's strategies and content resonate well with consumers, and churn will remain manageable. Moody's has some concern that aggressive rate hikes beyond the password sharing fees, along with greater SVOD competitive options will raise churn as consumers learn to lower or cap their spending by rotating in and out of SVOD platforms since all Tier 1 and tier 2 platforms are presently spending record amounts on content and new production to attract subscribers. Moody's believes that the company may need to consider offering a lower annual prepaid rate as compared to monthly rate subscribers to deflect such rotation churn or face increasing part-time subscriber headwinds and volatility. The streaming field is becoming vastly more competitive, even though most programing is exclusive unlike traditional bundled pay TV service providers which are heavily substitutable. However, the streaming consumer has much more control of their viewing choices and what they are willing to spend, and with only a click of a mouse can move from one platform to another and back again months later.

Unlike adding new subscribers, Moody's is confident that Netflix has control of its leading levels of spending on content, and increasingly on owned originals, which will not only increase the asset value of its library, but will result in many successful global and regional series and film hits capturing the zeitgeist of our time, as evidenced by the plethora of awards Netflix has earned so far. To remain a top service choice for consumers, the company provides a regular and significant cadence of new original whole series releases that gives consumers greater control over how they consume content. Moody's believes that this release schedule may present an advantage over competitors that release episodic television programs on a single episode weekly basis consistent with how many broadcast and cable companies have released series for decades. As investment in streaming content by Netflix and its competitors will dwarf bundled linear television spending, we anticipate the transition to on demand streaming to continue and favor Tier 1 streamers like Netflix across most of the globe. Moody's believes Netflix will continue to be a leader in streaming despite the competition, and we forecast the subscriber base to grow at a materially slower rate than what the company experienced in recent years, but still to exceed 250 million globally by the end of 2025, which is a materially moderated expectation compared to our previous view in April 2021. Despite this moderation, Moody's anticipates that it can moderate content spend in line with revenue growth and generate sustainable free cash flows even when revenue growth slows. However, we expect the company to grow content spend for the medium-term unless there are more negative surprises beyond Q2.

As stated, Moody's still anticipates that quarterly subscriber growth will remain quite volatile, as indicated by the company's subscriber decline guidance. We anticipate growth in the back half of the year as they typically are the company's strongest quarters. The company will likely continue to both beat and miss the company's stated guidance as it has historically. But we also believe that the medium and longer-term outlook remains favorable for the company as it continues to build on its significant scale to penetrate global addressable homes of over 1.5 billion, sustaining competitively low cost per viewing hour leadership, growing average revenue for member, and reinvesting in even more content as it benefits from this virtuous cycle.

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history.

Neil Begley
Senior Vice President
Corporate Finance Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Lenny J. Ajzenman
Associate Managing Director
Corporate Finance Group
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

No Related Data.
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