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Rating Action:

Moody's upgrades Netflix's CFR to Ba1 from Ba3; the outlook is positive

15 Apr 2021

New York, April 15, 2021 -- Moody's Investors Service ("Moody's") upgraded Netflix, Inc.'s (Netflix) corporate family rating (CFR) to Ba1 from Ba3, probability of default rating (PDR) to Ba1-PD from Ba2-PD, and senior unsecured debt ratings to Ba1 from Ba3. Additionally, Netflix's speculative grade liquidity (SGL) rating was maintained at SGL-1. The outlook remains positive.

Upgrades:

..Issuer: Netflix, Inc.

.... Corporate Family Rating, Upgraded to Ba1 from Ba3

.... Probability of Default Rating, Upgraded to Ba1-PD from Ba2-PD

....Senior Unsecured Regular Bond/Debenture, Upgraded to Ba1 (LGD4) from Ba3 (LGD4)

Outlook Actions:

..Issuer: Netflix, Inc.

....Outlook, Remains Positive

RATINGS RATIONALE

The upgrade to Netflix's CFR and positive outlook reflects the company's rapid credit improvement due to continuing strong subscriber growth and operating margin expansion in most of its operating regions around the world. The COVID-19 lock downs around the world have led to greater than pre-crisis expected subscriber additions and pricing power due to significantly reduced out of home entertainment options and very strong viewer engagement in 2020. We expect the stronger momentum to continue to a degree through 2021. The rapid improvement in credit metrics has been helped by the temporary halt of much content production in 2020 which enabled the company to generate strong positive free cash flow of about $1.9 billion in 2020 and larger cash balances than anticipated. The lower than expected working capital spending on content production occurred through a material portion of 2020 as the lock down temporarily halted almost all global studio production except animation and post-production work on previously shot scripted and unscripted programming.

"The performance of Netflix in the second half of 2020 materially exceeded our forecasts at the time we placed a positive outlook on the ratings a year ago," stated Neil Begley, Moody's Senior Vice President. These favorable developments are pulling forward the credit improvement trend by as much as another year and have resulted in a two-notch upgrade and maintaining a positive outlook. These favorable developments include:

1) sustained stronger subscriber growth in the second half of 2020, continuing to pull forward subscriber growth while we previously expected that trend to fall off moderately and stabilize between Q4 2020 and early 2021;

2) improving pricing power in the company's more mature markets as exhibited by the absence of any material increase in churn despite price increases;

3) the combination of stronger sub growth, higher pricing impact on average revenue per member (ARM) and the temporary working capital benefit from the temporary halt in production in 2020, all resulted in higher revenue, EDITDA, margins and cash balances;

4) despite the need to ramp up production spend to restore the content pipeline which was depleted during the lock downs, the materially higher cash balances and improving cash flows the company has generated through 2020 will be sufficient to meet the company's capital needs in 2021 (we previously expected the company to need to issue additional debt in 2021) and beyond excluding potential M&A activities;

5) achievement of low to mid 20% EBITDA margins and expected moderation of growth in content spend will result in sustained free cash flow generation beginning in fiscal 2022 versus our previous view that this would be achieved in 2023; and

6) financial policy shift for target debt levels to between $10 to $15 billion of debt (below the current debt load) from a previous debt target tied to enterprise value which could have lead to significantly higher debt than current levels.

"We still anticipate that quarterly subscriber growth will remain volatile, both beating and missing the company's stated guidance as it has historically," stated Begley. "We believe that the leaner content pipeline going into 2021 could very well influence subscriber growth until the cadence of programming catches up and resumes its normal level," added Begley. But we also believe that the medium and longer-term outlook remains very 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.

Netflix's positive free cash flow, coupled with the company's debt issuance in 2020, bolstered the company's already excellent liquidity and cash balance to about $8.2 billion at the end of 2020. Netflix's leverage fell to about 3.7x at the end of FY 2020 as the company's operating income grew 76% over FY 2019. Moody's expects leverage to continue to improve below 3.00x (including Moody's adjustments) by FY 2021. We expect working capital spending to climb and cash flows to be temporarily volatile quarter over quarter in 2021 and potentially turn negative again for a few quarters as production ramps back up, with strong growth in the subscriber base, and strengthening margins and other credit metrics in 2021. "We forecast the company will achieve low to mid 20% margins in 2022, breakeven cash flows by the end of 2021 or early 2022 (versus our past forecast of achieving breakeven at the end of fiscal year 2022/early 2023), and sustained free cash flow generation for full fiscal year 2022 rather than 2023," added Begley.

Netflix's Ba1 CFR is supported by the company's scale and leadership in the content streaming service industry. Growth remains high in terms of subscriber count, and operating margins are expanding as marketing and development costs are scaling well over a larger base and achieving the industry's lowest cost per viewing hour. Offsetting these positives are the company's historically volatile and high financial leverage-which is now moderating quickly, negative cash flows-though rapidly improving, and risk of rising competition and more crowded streaming landscape from well-funded companies such as The Walt Disney Company (A2, stable), AT&T Inc. (Baa2, stable), Comcast Corporation (A3, stable) and Apple Inc. (Aa1, stable). We believe Netflix will continue to be a global leader in streaming despite the competition and has a path towards sustained profits and free cash flow by 2022, as increases in content moderate relative to growth in revenues, and the subscriber base grows to 250 million globally over the next 18 months.

With regards to our ESG framework, social factors are considered a moderate risk for the media sector. The key risk in the sector lies in evolving demographic and societal trends and potential changes in consumer preferences in particular in the way people choose to consume media. However, the recent spread of the coronavirus and subsequent quarantine and lock down at home of much of the world's population, is creating opportunity for Netflix to grow its subscriber base more quickly over the temporary period. However, like others in the media sector, Netflix's exposure to content creation and production, which were largely temporarily shut down worldwide to limit the exposure and spread of the virus, have left it vulnerable to running out of content to release until production resumes. We regard the coronavirus outbreak as a social risk under our ESG framework, given the substantial implications for public health and safety.

From a governance perspective, we believe the company is committed to improving its credit profile (as demonstrated by its debt level commitment), investing to strengthen its competitive position, and sustaining strong liquidity.

Netflix's SGL-1 speculative grade liquidity rating reflects the company's very good liquidity profile. We expect the company to maintain very good liquidity with high cash balances ($8.2 billion in cash and short-term investments as of 12/31/2020) and an undrawn $750 million revolver. The company generated about $1.9 billion of free cash flow in 2020 as a result of lower working capital spending on content production as lockdowns halted global studio production. Although we anticipate that the company will return to generating negative free cash flow in some quarters in 2021 the company has more than ample cash on hand to fund its capital needs and will generate positive free cash flow in 2022 to meet capital needs beyond 2021. We expect cash flow deficits to decline from pre-COVID-19 levels and that the company's current liquidity sources will be sufficient to fund all working capital and capital expenditures over the next 12 months. We expect that Netflix will not need to raise external financing to fund the company's day-to-day operations over the next 12 months and that the company will generate breakeven free cash flow by early 2022 and sustainable positive free cash flow for 2022 and beyond. Netflix also benefits from the absence of any near-term debt maturities or restrictive financial maintenance covenants. While the company's growing content library could be monetized via sale or licensing, we do not believe that the company will need to sell such core assets to raise capital.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

Moody's would consider upgrading Netflix's ratings to investment grade if management is committed to sustaining investment-grade credit metrics, the company is able to sustain debt-to-EBITDA leverage below 2.5x (including Moody's adjustments), positive free cash flow is highly likely to be sustained, margins and subscriber counts continue to expand and liquidity remains very good.

Given the positive outlook, a downgrade of Netflix's ratings is unlikely. However, Moody's could downgrade Netflix's ratings if operating performance deteriorates such that leverage is no longer on track to be sustained below 3.0x, or margin trends reverse and decline.

The principal methodology used in these ratings was Business and Consumer Service Industry published in October 2016 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1037985. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

Netflix, Inc., with its headquarters in Los Gatos, California, is the world's leading subscription video on demand ("SVOD") streaming television platform, with total streaming subscribers reaching close to 204 million as of December 31, 2020. Consolidated revenues for FY 2020 was about $25 billion.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1243406.

At least one ESG consideration was material to the credit rating action(s) announced and described above.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the UK and is endorsed by Moody's Investors Service Limited, One Canada Square, Canary Wharf, London E14 5FA under the law applicable to credit rating agencies in the UK. Further information on the UK endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

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.
© 2021 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved.

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