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Netflix (Nasdaq: NFLX ) shares plunged as much as 7.5% overnight. The company is raising $400 million of fresh capital, half in stock sales and half in zero-coupon notes.
Bearish analysts immediately pounced on the deal. Wedbush Morgan worries about "deteriorating performance" causing damage to Netflix's liquidity. The firm lowered its Netflix price target to $45 per share. Caris looks at the two-part deal and sees evidence that "subscriber growth, and hence revenue growth, were not strong enough in either the current quarter, nor in the first half of F2012 to cover" the cost of ambitious content deals.
The capital deals were announced in dry-as-sawdust SEC filings, so I reached out to Netflix spokesman Steve Swasey for some color commentary. "We don't think we need the money, but it's nice to have more money than you need," he said. There are no immediate plans to put the money to work, and no cash-crunching liquidity crisis. And the capital comes from "two long-term-oriented partners," T. Rowe Price (Nasdaq: TROW ) and Technology Crossover Ventures, who see value in grabbing million-unit chunks of Netflix stock at today's prices.
In fact, the notes that TCV are buying only convert into shares at $85.50, which is a premium to current share prices. The venture capitalist is betting that the stock will rise above that level. Price is buying shares at $70 a pop, hoping to unload them at higher prices. If that happens, today's dilution might be forgiven. After all, share prices would obviously be up again.
Good riddance to buybacks
That said, it's not all gumdrops and lemonade. If the convertible bonds all get turned into shares, the combined deal adds about 5 million new shares to the total share count, or 10% dilution. And in effect, all of the money eventually comes out of the pockets of us common shareholders. Who else would buy the new shares down the road to make the whole transaction worth TCV's and Price's while?
Not the most shareholder-friendly policy, folks. Netflix could have grabbed about the same amount of extra cash by simply not buying back shares over the last two years. So the company bought high and sells low. Oh, dear.
But I'm flogging a deceased pony here. The buyback policy is gone at long last, and I hope it ain't coming back until the high-growth era has passed.
You say it did already? Sorry, but one customer-losing quarter does not make a trend. If so, Netflix would have stopped growing when Blockbuster launched its unsustainable Total Access assault way back in 2006. Netflix lost some customers then, but it gained them all back and then some as Blockbuster's strategy backfired.
This time, the subscriber losses are Netflix's own doing but just as short-term in nature. In the latest earnings report, CEO Reed Hastings predicted that defections would slow down in November and turn into another round of heady growth in December. The prospectus filing for the stock sale confirms that Netflix is on track to do exactly that.
What's good for one goose may be wrong for another
In my eyes, raising debt to support outsized growth is a perfectly valid strategy. If you disagree, feel free to sell your Netflix shares and buy some Buffalo Wild Wings (Nasdaq: BWLD ) instead. The sports-bar chain has chosen to grow at more modest speeds, leaving long-term debt as zero and stock sales very modest indeed.
This works in a mature industry like quick-serve restaurants, and I do love B-Dub's low-risk growth strategy. But Netflix is too busy defining a new industry to slow down and look at the scenery. Stop growing for too long, and Blockbuster could wrest back control of the new video-rental market with capital from corporate parent DISH Network (Nasdaq: DISH ) . Or perhaps Coinstar (Nasdaq: CSTR ) would have time to roll out a tremendous Redbox-branded service while Netflix isn't shouting its brand from the rooftops. Apple (Nasdaq: AAPL ) is always a credible threat in any digital-media market, and maybe even Comcast (Nasdaq: CMCSA ) could figure out how to beat Netflix at its own game.
This is why high long-term growth is so important for Netflix. By hook, crook, or somewhat icky capital grabs, the company must keep growing until the gold-rush land grab is done. Only then can Netflix afford to slow down, collect profits, and buy back shares.
That time is still years away, and that's why I'm OK with the company's raising capital today. Netflix remains a screaming buy.
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