GB 550 Unit 3 Final
November 19, 2018
This paper has the purpose to inform the reader about Netflix and analyze the capital structure theory also known as the hypothesis, problem and disputes of Netflix, and show the way this structure affects the company in the risk profile as well as in the return on investment (ROI). The most favorable capital structure for a company is the one which combines the debt as well as equity which can cause the stock price to increase.
The goal of the management is to have a specific capital structure goal which will focus on being the optimal achievement for the company, the company and manager must understand that the goal will continue to change over time. There are several different elements which can impact a company, which are:
• Alternatives of growth
• Risks of business
• Financial requirements
• Tax Position
This document will present an investigation as well as research Netflix, Inc. capital structure, problems with the capital structure, as well as financial risks. The research will be used to look directly at the capital structure, company’s favorable capital and the involvement of Netflix, Inc. Modigliani and Miller’s theory will be used to assess the judgment of the company. The Purdue Library and other educational resources to analyzing Netflix, Inc. capital structure. The purpose of the research is to show the confirmation as well as verification of the capital structure which is pertinent to Netflix, Inc success.
TABLE OF CONTENTS
TITLE PAGE 1
ABSTRACT 2 TABLE OF CONTENTS 3
PROBLEMS IN CAPTIAL STRUCTURE 4
BUSINESS AND FINANCIAL RISK 6
MODILGLIANI AND MILLER THEORY 6
MODIGLIANI AND MILLER MODEL 7
FAVORABLE CAPITAL 7
ALTERNATIVES FOR GROWTH 10
Netflix, Inc. is a multinational American provider who supplies the consumer with internet streaming media and mail service DVD rentals. Marc Randolph established the company in 1997 located in Los Gatos, California. In 1999, the company started as a startup subscription-based company with limited DVD rentals. In 2011, the company reached 23 million subscribers stateside and worldwide of 26 million. In 2018, the company reached 137 million subscribers worldwide.
Problems in Capital Structure
Netflix, Inc. capital structure is made up of a combination of the company’s debt and equity. Generalized speaking the goal is for a company to keep their financing combo near the target capital. The way in which the capital structure is determined is the average maturity of debt as well as the types of financing which is used at any given time. The management then uses the data to see where the company’s worth, nature and makeup consist. There are several problems which management must review when looking at and determining a company’s capital structure, the problems are listed below:
• Debt increases which cause changes of stock cost
• Debt lowers what the company must pay in taxes
• Bankruptcy lost
• Weight of Net Influence on the average cost of capital
• Possibility of bankruptcy
o Lower free cash flow
o Agency cost influences
• Summary of debt ratios
Currently Netflix, Inc. has a -$2.5 billion in free cash flow, as the company seems to continue to use the original programming to invest into even though the company has seen negative free cash flow starting in 2014 (Market watch, 2018). Netflix stated to its shareholders in their annual financial report “We’re growing faster than we expected, which allows us to invest more in original content than we had planned, so our FCF will be around negative $3B-$4B in 2018,” (Pelts, 2018). The recorded debt for the company is as follows $4.8 billion, cash and cash equivalents of $8.1 million on balance sheet in 3Q18, resulting in a net debt of 1.3 billion (Pelts, 2018).
The letter to shareholders does give promises that the company is still in good ratings with the BB credit rating despite the negative cash flow. The company is vulnerable due to nonpayment issues and the company also has a low capitalization ration for debt-to-market, which shows less debt than comparing to the market value. The chart below shows Netflix Inc.’s capital structure.
Business and Financial Risk
The capital structure can be defined as how a company finances the operations as well as the growth with the help of different funds. There are several forms of debt:
• Long-term notes payable
• Bonds issued
• Common stock equity
• Preferred stock
• Retained earnings
The company can also incur short-term debt which is also considered in the capital structure (Investopedia, 2018). To determine the risk, it is dependent on the variability in which the company’s goods are in demand. A suggest for Netflix is to look at the operating power of influence to help lower the risk to the company. The company is also at risk for monetary loss which places the stockholders at greater risk when the company continues to finance judgments with debt.
Modigliani and Miller Theory
The Modigliani and Miller theory (MM) approach is the capital theory which suggest valuation of a firm would be irrelevant to capital structure of the company (Brigham ; Ehrhardt, 2016). The theory is no matter where the company is on the leverage (high or low) or the debt component (high or low) this would have no reflection on the market value of the company. MM theory looks at the potential or perspective growth of the company to see how it will affect the market value of the firm excluding the risk involvement of the investment (E finance, 2018). The MM theory approach has the following assumptions:
• No tax
• Transaction cost for securities as well as bankruptcy cost are nil
• Information symmetry
o Investor and corporate all have same access to information
• Borrow cost same for investor and company
• EBIT not affect debt finance
Modigliani and Miller Model
While calculating finance cost, the most expense debt is equity as well as bankruptcy when applicable. If a company were to experience a bankruptcy, the debt holders will receive compensation before the stockholders will receive any compensation. The default-free debt static model is what the MM model is molded after (E Finance, 2018). This model has it where a business has monetary solid ground making it appear to be a monetarily risk-free company. The model does lack the thought if a company is unable to continue to succeed and must file for bankruptcy or if the debt to ratio decreases causes default or bankruptcy. Another disadvantage to the MM model is the model doesn’t look at what happens if a business deal goes wrong and the company has more debt (E Finance, 2018).
A company’s ability to choose the right favorable capital structure is an important choice which can help the company succeed. When looking at the favorable structure in a technical stand point the structure is the balance of equity to debt which a company finances their assets, daily operations as well as future growth (Pelts, 2018). The tactical stand point looks at the company risk profile including the things which can affect the changes to this, the way in which the company funds their expenses, investors return, expectation of the lender, and how macroeconomics as well as microeconomics effects the company (Zhu, 2014).
Netflix, Inc continues to find it hard to optimize the capital structure based on the company mainly being an online internet streamed program. this causes the company to have to depend on another company (internet) for the company to succeed. This affects the level of capital based on the amount which the person pays for internet plus cost of Netflix services.
Netflix Inc. has seen a decrease in risk for the company after the establishment of the validity of their company giving movies at the hand of the consumer. The risk though has increased as other companies are looking at streaming their business to include movies across the internet. The company has to stay in accordance with business and the quality of their product. The investors will have to see the risk of the business and compare it to the company’s morals and values to ensure if the investment is worth the risk. The investors need to ensure the look at the projected out comes as well as the debt of the business to make sure this is a company they want to invest in (Ingram, 2016).
The tax placement of Netflix brings up much criticism. The company makes many business deals where the tax decision is subject to change, so the company does not have a definite tax situation. The company does have funds set aside for any changes which could occur due to changes in the taxes or interest which the company may have to pay later. The funds are placed in high satisfactory state to stay during the fiscal year if the tax situation were to ever change (Pendola, 2013). The income tax is something which can change regarding the company’s net interest.
The leader in streaming videos on the internet is Netflix, this is by the company’s ability to see how a person watches television and what they are wanting from the television. The company uses the data which it compiles to see what the consumers are wanting to watch. This is then used to make Netflix selections as well as the shows which they will offer to the consumer. The consumer needs to ensure their internet is superior to get the best viewing of Netflix. The objective of Netflix is to give the consumer their television in the palm of their hands whether viewed on the television, tablet, or phone.
This has been Netflix continues to grow since starting with the DVD rentals in the mail. The company started streaming movies online which took over the television industry. The company is projected to continue to increase. The company is expected to continue to see profit and size increase as more “Netflix originals” come to the screen (Morning Star, 2018). Pendola (2013) explains how the increase of the growth has slowed due to the risk of the competition since the rate of growth grew quicker than expected.
Many see Netflix, Inc. to be the future of television. The company though does not release any of the rating as to how a show is doing unlike the local cable companies. Alan Wurtzel of NBC Universal says that Netflix can affect them based on the consistent basis (Ingram, 2016). NBC Universal has the same scare as Blockbuster did when Netflix started sending DVD rentals to people in the mail. The management of Netflix continues to show ways in which the company can excel in the terms of broad streaming by continuing to research what the viewer is looking for from the company.
Alternative for Growth
As Netflix continues to grow as a company the capital which is necessary for investments will continue to increase as well. The company needs to be able to find a way to balance the equity and debt which the company must increase the company’s worth. The company must see what the consumer is looking for to consistently increase their options, and the content which the company offers must also be well balanced as well as good quality. The company should investigate ways to grow to other contents as well such as in European countries (Wall Street, 2016).
Netflix, Inc has continued to increase since the company started. The company has been able to establish an optimal structure of capital but has ways to continue to improve as a company. The company must utilize the ability to have dual-centered capital structure which will help more investors and shareholders be drawn to the company to increase the company’s revenues. The company has implemented some strategies from the MM Theory but should consider implementing more. The company has continued to offer “Netflix Originals” but needs to continue to see ways to increase revenue for the company to help relieve the net debt of the company. Netflix is a threat to the television marketplace as it has the potential to take over the market if the company can increase their profits to decrease the net debt of the company. Many investors, shareholders, and consumers consider Netflix as being the future of the television.
Brigham, E.F., & Ehrhardt, M.C. (2016). Financial management; theory and practice (15th ed.). Mason, Oh. South-Western, Cengage Learning.
E Finance Management (2018). Capital Structure Theory – Modigliani and Miller (MM) Approach, Retrieved from http://www.efinancemanagement.com/financial-leverage/capital-structure-theory-modigliani-and-miller-mm-approach
Ingram, M. (2016). Netflix Is No Threat to Conventional TV, NBC Exec Says, Fortune, Retrieved from http://fortune.com/2016/01/14/nbc-netflix/
Investopedia (2018). Netflix, Inc. Retrieved from http://www.investopedia.com/termsc/capitalstructure
Market Watch, (2018). Netflix, Inc., Retrieved from http://www.marketwatch.com/investing/stock/nflx/profile
Morning Star, (2018). Netflix, Inc., Retrieved from http://quicktake.morningstar.com/stocknet/bonds.aspx?symbol=nflx
Pelts, S. (2016). A Look at Netflix’s Capital Structure, Market Realist, Retrieved from http://marketrealist.com/2016/01/look-netflixs-capital-structure/
Pendola, R., (2013). At Netflix, It’s Not About Magic, It’s About Tricks, The Street. Retrieved from http://www.thestreet.com/story/11938103/1/at-netflix-its-not-about-magic-its-about-tricks.html
Stock Analysis on Net, (2018). Netflix, Inc., Retrieved from https://www.stock-analysis-on.net/NASDAQ/Company/Netflix-Inc
The Wall Street Journal, (2018). Netflix, Inc., Retrieved from http://quotes.wsj.com/NFLX/financials