Netflix and the HY bond market
Speaking of which, we read with interest that Netflix increased its cash burn from $1.7bn last year to $2.5bn this year on rising content costs. The content is really great, which is what you would expect for a company that has produced 4 of the 10 most expensive TV series ever made. And that (unlimited) blockbuster content only costs four people in the newly enlarged Snap Shots household £5.99 a month. Netflix produces and distributes this content at an operating margin of 4.6%.
That cost is almost too good to be true. If you consider that renting a single movie from the app store costs about £3.99 and Apple and the average content creator make a 20%+ margin each. Netflix has (smartly) been funding its content cash burn via the bond market since 2013. Its argument is that the upfront cost of content will be paid back over time. There are too many moving parts to go into more detail in a Snap Shot but it would come as no surprise to say this is a very finely balanced risk for a bondholder, especially when that money is being extended at an average “unsecured” cost of capital of 4.75%.
Tesla, another giant cash burner on its outlay for the much anticipated Model 3, also tapped the bond market at 5.3% unsecured to help balance its finances. We highlight these deals to illustrate some of the enormous risk High Yield bond investors are willing to take in the current market, which is one of the reasons we remain extremely cautious on this asset class.
In the last episode of Ozark that we watched it was the end of the tourist season and visitors were departing from the Missouri summer resort. We note that there are an increasing number of tourists arriving in the credit market. Bank capital saw an influx of corporate High Yield investors this summer. CLO equity and mezz has seen new arrivals from the hedge fund and family office community. The numbers of tourists arriving are not causing us any concern yet but we are monitoring their numbers and are wary of any rowdy behaviour. We therefore continue to remain constructive on both of these asset classes.
We think the market may be underestimating how close we came to a Washington collapse. Rumours are that the director of the National Economic Council, Gary Cohn, had written his resignation letter last week after Trump’s Charlottesville comments. We think this could have sent the markets into a tailspin. Thankfully for investors he put his personal disagreements with the statements aside and stepped up for his country and the markets.
… and Rome
Back in Europe we note that Berlusconi has again floated the idea of a parallel currency to help form a coalition with the far right Northern League ahead of elections early next year. According to Citibank, more than two thirds of Italian voters currently support parties with an anti-euro stance. Italexit is still a low probability event but the risks have shifted. We have highlighted Italian elections as a risk for some time and continue to watch developments closely.
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