Netflix’s Global Funding Makes Sense — If It Can Rescue Domestic

Netflix (NSDQ: NFLX) shares opened four percent lower Tuesday after Monday’s after-market announcement that it is taking $400 million to fuel international expansion and that 2012 will be a loss-making year.

The firm is raising $200 million in equity from T. Rowe Price at $70 per share and taking a $200 million notes loan from Technology Crossover Ventures (TCV).

Netflix had already warned last month that the cost of launching in the UK and Ireland in Q1 2012 will make it “unprofitable for a few quarters”, forcing it to stop international further expansion. But Monday’s guidance said the whole of the 2012 calendar year would show a loss.

Netflix acknowledges “operating in international markets requires significant resources.” See paidContent’s recent breakdown of those costs.

Though the stock is down, one analyst, Barclays Capital, sees logic in raising money…

“We believe this capital infusion enhances NFLX’s financial flexibility and also may represent a vote of confidence from prominent long-term investors … downside is limited… could be interpreted as a positive

“We are reducing our 2012 estimates accordingly to a loss of $0.12 from a profit of $0.96 … Downward revisions are unlikely to affect valuation. More importantly, we are maintaining our revenue and subscriber estimates for 2012 and continue to believe in the long-term strategic value of the Netflix subscriber base.”

But Cowen’s Jim Friedland, who expects expansion will consume all the $400 million raised, is more cautious…

“The offering signals that the cash outflows necessary to fund the company’s international streaming expansion are greater than initially expected. We are also concerned that domestic streaming could experience a modest headwind after the Starz deal ends in Q1:12.

“The deal for Season 4 of Arrested Development bodes well for the future … Nevertheless, we think that competitive alternatives, combined with the loss of Starz content, could weigh on domestic net additions in 2012.”

But this is how company spokesperson Steve Swasey tells it to paidContent…

“We raised money now to strengthen the balance sheet. We have no cash or general liquidity needs, and therefore have no immediate plans to use this capital. We are pleased to have two long-term oriented partners make meaningful investments in the large market opportunity in front of us.”

Netflix’s market cap has collapsed since its July high.

Netflix Stock Chart

The real story is this…

Netflix might have been able to finance international expansion from day-to-day activities and share income. But the company’s strategic indecision and missteps over how it manages its continuing domestic DVD business and streaming conversion has jeopardised Netflix’s reserves.

Even in this situation, it makes total sense that Netflix should tap institutional investors to finance the odyssey. The UK and Ireland have windows of opportunity, and globalisation could make Netflix even more successful than it has already been as an international subscription entertainment brand. After all, Netflix is in the sweet spot of recurring monthly revenue.

The 2012 loss forecast should not come as a surprise, since Netflix had already mostly flagged it up last month.

But the international project and the pressure of new investment make domestic competence and turnaround more critical. In its Monday disclosure, Netflix acknowledged…

“Consumer reaction to the price change, and to a lesser degree, the branding announcement, was very negative, leading to significant customer cancellations and a decline in gross subscriber additions.

“If we are unable to repair the damage to our brand and reverse negative subscriber growth, our business, results of operations, including cash flows, and financial condition will continue to be adversely affected.”

Netflix forecasts November domestic net subscriber additions will be flat in November but “strongly positive” in December. Netflix’s Swaey tells paidContent: “Subscriber trends are consistent with our guidance outlook – specifically, cancellations have continued to decline.”

International losses from just Canada and Latin America doubled to $23 million in Q3 2011 alone as marketing costs nearly doubled to $46 million. Q4 2011 international losses are forecast to be far higher at $60 to $70 million, with slower revenue growth of $25 to $30 million from an estimated 1.6 to two million subscribers.

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Netflix Revenues Chart