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Why Netflix Just Became Less Risky

By Parkev Tatevosian - Jan 26, 2021 at 7:40AM

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A lower financing risk for a company is always good news for shareholders.

Netflix (NFLX 1.56%) reported fourth-quarter earnings on Jan. 19, and there was something in the report that indicated that the streaming giant is now a less risky stock to own. The company did mention competition and highlighted that Disney+ reached 86.8 million subscribers. However, that figure is far behind Netflix's totals. But staying ahead of its competition is not why Netflix just became a less risky investment. 

The decreasing riskiness has more to do with an internal milestone Netflix just reached. Let's take a look at what that was and why it matters. 

Exterior view of Netflix headquarters in Los Angeles.

Netflix surpasses 200 million subscribers. Image source: Netflix.

A self-sustaining business  

For years, Netflix has relied on external financing to fund its growth. The streaming content giant has been spending more cash than it has been bringing in through subscription revenue. That has put Netflix at the mercy of the market in determining how much cash it can raise to fund content purchases and original productions. Moreover, it exposes the company to the risk of debt markets drying up. 

Another side effect from relying on external financing is that it could limit growth opportunities. Management may identify an opportunity that it deems worthwhile but hesitates because it's nervous how the market may perceive its decision to undertake the project. And that can put a company at a competitive disadvantage against a well-capitalized rival like Disney (DIS -0.70%)

Fortunately for Netflix shareholders, it announced in its fourth-quarter earnings release that it would no longer need to rely on external financing. Now that it has over 203 million subscribers generating an average revenue per user over $10, it believes it can fund its day-to-day operations internally. Interestingly, it took Netflix bringing in over $2 billion per month in order to become self-sustaining.

The Netflix app displayed on a tablet screen.

Image source: Netflix.

What this means for investors 

At the very least, you can expect Netflix to become more profitable. For instance, it will be paying off its Febuary 2021 maturing 5.375% bond with cash on hand. In other words, the risk of relying on external financing has fallen. More importantly, this reduces the need to raise funds at unfavorable interest rates, or the need to sell equity at an unfavorable time. 

Recall that risk, or even potential risk, gets priced into a stock through its weighted average cost of capital (WACC). If a company can lower its capital risk, its WACC should fall while simultaneously making its future cash flows more valuable to investors. All else being equal, a company will be valued higher if it has a lower WACC versus one with a higher WACC. In part, that could explain why shares of Netflix popped over 12% the day after it announced its earnings.

Investors who were hesitant to consider Netflix because of its high-risk nature should take another look at the streaming giant now that it will not likely be required to raise capital from external sources.

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Stocks Mentioned

Netflix, Inc. Stock Quote
Netflix, Inc.
$186.35 (1.56%) $2.87
The Walt Disney Company Stock Quote
The Walt Disney Company
$102.42 (-0.70%) $0.72

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