Case Study of Financial Issues in Organizations

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Case Study of Financial Issues in Organizations

Case, Study, Financial, Issues, Organizations

Cases in Finance (presentation)

Outline Case Introduction 3 Identification of the challenge 4 Main facts and events of the core study 5 Research and analysis of the situation 5 SWOT Analysis of the Netflix, Inc. 5 Financial Statement Analysis of Netflix, Inc. 6 Financial Ratios of Netflix, Inc. 8 Formulation of the solutions 8 Discussion and selection of solutions 9 References 10 Appendices 11 Appendix A: Statement of Profit and Loss of Netflix, Inc. 11 Appendix B: Statement of Financial Position of Netflix, Inc. 12

Case Introduction

Netflix, Inc. is an American overdone content platform and production firm headquartered in California, USA. The company was established in the year 1997 by Reed Hastings and Marc Randolph in the Scotts Valley, in California. The principal operation of the firm is a subscription-grounded streaming facility presenting online streaming by an extensive list of movies and TV series, together with those produced internally.

As of July 2021, the platform possessed 209 million of subscribers, counting 72 million subscribers inside the USA and Canada (Kastrenakes, 2021). The platform is accessible globally apart from China (by reason of domestic limitations), Syria, North Korea, and Crimea (because of the U.S. sanctions).

The firm possesses offices in numerous other countries, comprising Canada, Brazil, France, the Netherlands, the UK, India, Japan, and South Korea (Netflix, Inc., 2021a). The firm is an associate of the Motion Picture Association (MPA), making and allotting content from states all over the world.

Figure 1: The Netflix, Inc. growth of subscribers in between Q2 2018 – Q4 2020 ( Epstein, 2021 )

The Netflix, Inc.’s original corporate model encompassed DVD sales and rent through mail; however, Hastings (the CEO) left the sales nearly after 12 months of the firm’s creation in order to concentrate on the original DVD renting commerce (Pogue, 2017). The company extended its business in the year 2007 through the presentation of streaming media although keeping the DVD and Blu-ray renting commerce.

Moreover, the firm expanded globally in the year 2010 through streaming obtainable in Canada, subsequently Latin America and the Caribbean. The company set foot in the content production sector in the year 2013, introducing its opening series “House of Cards” (Netflix, Inc., 2021a).

The media and entertainment sector (M&E) in the U.S.A. is an ample marketplace having a worth of USD 703 billion. It makes up 1/3 of the worldwide media and entertainment segment, which makes the U.S. the biggest M&E marketplace globally (Nead, 2018). The M&E sector is formulated of more than a few diverse elements.

The five foremost elements are movie, TV, video games, music and publishing. Netflix, Inc. falls under the movie and TV segments of this sector. Movie and TV solely make up 74 per cent of the overall M&E sector in the U.S.A. Even though the company may be taken into account as a technology, media or entertainment firm, the CEO Hastings stated that the company favors the entertainment sorting (Sherman, 2020).

As stated by the CEO, “media” has a tendency to contain advertising, and Netflix doesn’t stream ads on its watching platform. In keeping with Sherman (2020), Netflix’s valuing is substantially higher compared to the customary entertainment firms. This links with their innovation and exceptional method to watching movies and TV. For the years, the company has been the embodiment of the achievement in the streaming marketplace.

As Warren Buffett excellently stated, “The volatility is away from synonymous with risk”. Therefore, it could be apparent that individuals have to take into account debt, while they dwell on how chancy any specified stock is, for the reason that too much debt is able to sink a firm. Like lots of other firms, Netflix, Inc. also utilizes the debt.

Nonetheless, the actual question is if this debt is making the firm risky. An article by Laughlin and Winkler (2019) is amid countless articles, which claim that the company’s dependance on debt is challenging for its business. The critics frequently refer to the debt, which the firm has gathered as a main reason the firm is not well-placed for longstanding success.

It depends on credit markets as its capital decision for financing its operations, which is a risky action and theoretically a negative stratagem. The content production is a cost intensive operation; in order to produce additional content, the company will be obliged to endure borrowing, digging itself deeper to a cash-restrained hovel.

And most people argue that, debt is just making worse the issue. This case study scrutinizes Netflix, Inc. and its debt & equity situation, with the aim of understanding its current circumstances, and ways to refine the company’s debt condition.

Identification of the challenge

The selection on capital structure possesses a foremost part in maximizing company value and the performance of the business. This utilizes of a mixture of numerous bases of funds that a company makes use of in order to fund its processes and for capital reserves. These bases encompass the utilization of short-term and long-term debt; preferred and common stock or equity financing (Jackson et al., 2013).

Every business does not utilize the unvarying capital structure; they vary in their financial choices. It is a tough mission for companies to make decisions on the capital structure where risks and costs are minimalized, profits are maximized and shareholder wealth is increased.

The association of choices on capital structure with company performance were suggested in extensive amount of literature, of which the most well-known ones are Modigliani and Miller Theory (1958) and (1963), Agency Cost Theory (1976), Trade Off Theory (1977) and so forth.

Debt and further obligations turn out to be risky for a firm once it is not able to straightforwardly fulfill, either by free cash flow or through rising capital at a striking price. Eventually, in case the firm is not able to realize its legal responsibilities to pay back debt, stockholders might leave by nothing.

Nevertheless, an increasingly regular existence is where a firm has to issue stocks at bargain-basement prices, lastingly reducing stockholders, only for propping up its statement of financial position. Unquestionably, debt might be a significant tool in companies, predominantly in capital hefty firms. The initial move while considering a firm’s debt levels is to take into account its cash and debt in conjunction (Jackson et al., 2013).

Netflix, Inc.’s starvation for outside financing is fabled: this streaming giant has turned out to be one of the most valued American technology firms in stock markets through leaning seriously on debt to back its everyday processes. At the close of the first quarter of this year, the company possessed USD 15.6 billion of debt, increased from USD 14.7 billion from the year 2020. Nevertheless, as it holds a cash reserve of USD 8.40 billion, its net debt is lower, at approximately USD 7.16 billion.

As seen from the most current statement of financial position (Q1 2021), the company possessed current liabilities of USD 7.96 billion, and non-current liabilities of USD 19.3 billion (Netflix, Inc., 2021b). Counteracting this, it possessed USD 8.40 billion in cash and USD 807 million in short-term accounts receivables. Thus, its liabilities overall USD 18 billion over the mixture of its cash and short-term receivables.

Considering that the company possesses an enormous market capitalization of USD 236.3 billion, it might be tough to think that these liabilities can place much risk. Nonetheless, there are adequate amount of liabilities, which is definitely advised for shareholders to remain monitoring the statement of financial position, going onward.

Main facts and events of the core study

Netflix, Inc.’s debt-to-equity ratio has been surging by the year 2015, which reached 1.96 at the end of the Q2 of the year 2021. If completed in a correct way, debt might be a solid tool, and undertaking debt tactically, in the long term, is better for stockholders. Netflix company selects to fund its commercial operations with more debt in order to improve its cost of capital.

The content expenses make Netflix, Inc. an in-height capital expenditure business. As the capital spending of any further sector, it serves like a barricade to entrance. Netflix, Inc. expended USD 12.5 billion on content creation in the year 2020, and plans to raise this number to USD 17 billion in the current year.

As the company anticipates the high capital requirements necessitated for enduring development of its business, it must remain selecting financing consistent with its cost of capital. And the firm has selected to fund its content investments through both operating profits and the residual requests with the help of debt.

The company CEO openly specified that in improving its statement of financial position (SOFP), the company tries for the capital structure, which leads to the lowermost weighted average cost of capital (WACC). Considering the less interest rates, the tax deductibility of debt and its low debt to company value, financing development over the debt market is at present more effective compared to issuing equity (Sherman, 2020).

The business having high fixed costs guides us to the utmost significant fact: the moat the company is in the middle of structuring. This is a routine, which is hard to leave off. In case new content assists to increase subscribers, then understandably decreasing expenditure, and content, risks decreasing them as well. Last year, the company had negative free cash flow, which is anticipated to advance in this year, if company decreases the external financing.

Research and analysis of the situation

SWOT Analysis of the Netflix, Inc.

Strengths: The company’s principal strength is its scope. On the whole, the size (i.e., the market share) synchronizes with income in a straight line. Through the previous twenty years, Netflix, Inc. has expanded significantly. The other strength of the company is its fame and brand recognition, as the company is a reliable streaming facility, which has confirmed its value to the clienteles. In addition, the firm has been highly competitive with its price-setting stratagem.

A reasonably priced once-a-month charge is one of the topmost primacies of clients and Netflix delivers it. The firm’s introduction of original content is a significant strength as well. The creation of unique content is particularly significant for the firm since it delivers content, which cannot be misplaced. Another foremost strength company is having is nonexistence of ads on its viewing platform, which makes the firm exclusive amid its rivals.

Weaknesses: The chief weakness for Netflix, Inc. is the misplacement of content by creators that enter to the streaming sector by themselves. Netflix had contracts with firms, such as Disney and Warner Media for streaming rights to choose shows and movies, however by the growing fame of the streaming, these firms and lots of others have chosen to partake in the sector. In addition, Netflix possesses a huge quantity of non-current debt that is a chief weakness for the firm.

Since the firm remains to increase debt to finance the creation of the content, it does not seem that the firm will start returning its debt in near future. This might result in an increase in subscription fees. Another key weakness that the firm has to take into account is its reliance on the North American marketplace.

Opportunities: Netflix, Inc. holds the opportunity to stay being competitive with its pricing approach. One prospect that the firm possess is rewarding current clients with a promotional annual rate. The firm could possibly offer a yearly subscription against the normal once-a-month subscription.

The other opportunity that the firm holds is the capability to create unique content for certain areas. The firm has begun creating its own films and series, which presents them the aptitude to produce content for certain target viewers for better matching the requirements of its clients, without misplacing the content on its own platform.

Threats: It is unquestioned that, the main threat for the firm is the arrival of new sector players. Netflix, Inc. was the primary streaming facility in the M&E sector, however, after initiation their service line, the firm demonstrated that there is a request for streaming inside the industry. As the rivals increases their market share, Netflix might not remain on top.

As an instance, Disney introduced its individual streaming facility Disney+ in the year 2019. This platform solely is a foremost threat to Netflix, without even taking into account all of the further platforms as HBO Max and Hulu. Additional threat is the possibility of upsurge in subscription charges, which might increase Netflix’s affordable subscription fees. In response, this might cause the company to lose clients, especially price-sensitive of those.

As stated earlier, market saturation demonstrates being a huge threat to the company in terms of North American market. The weight of succeeding and expanding to novel region is especially problematic considering the government regulations (i.e., restrictions by Chinese government).

Financial Statement Analysis of Netflix, Inc.

The financial statements of the businesses deliver significant financial information on many facets of the commercial establishments. Firms utilize their statements for handling their commercial procedures and for delivering transparency to investors.

In order to present the financial facts, the comparison of the profit and loss statements and statements of financial positions for the previous 5 years for Netflix, Inc. will take place. These are able being utilized to assess the performance of a business and to liken the percentage vicissitudes through the years.

Table 1: Comparison of the P&L Statement of Netflix in between 2016-2020 ( Netflix Inc., 2021b )

Over the last 5 years, the company possessed an average upsurge in income of 22.86 per cent annually. Company’s 2020 close of year income was 2.83 times over than what it was in the year 2016. In general, firm’s income has surged in every period (Appendix A). Company possessed an average cost of income percent of 20.72%.

This for the year 2020 was 2.53 times more than the year 2016 cost of revenue. The firm also possessed an average upsurge of 47.05% in net income. By the year 2016 to the year 2017, its net income surged a noteworthy 54.66 %. Afterwards by the year 2017 to the year 2018, company had a record net income development of 66.01 %. In general, firm’s net income last year was 14.79 times more than its 2016 levels.

Table 2: Comparison of the SOFP of Netflix in between 2016-2020 ( Netflix Inc., 2021b )

For the total assets, the firm possessed an average yearly growth of 23.10%. the company’s overall assets in last year accounted 2.89 times more than its overall assets five years ago. The company’s cash and equivalents had a middling growth percentage of 34.21%. These for last year was 5.59 times more than the year 2016.

Property and equipment have gradually grown as well, its growth rate being an average of 28.09% annually. For over-all liabilities and shareholders’ equity, the firm possessed an average yearly upsurge of 23.10%. As the overall assets, the liabilities and shareholders’ equity last year were 2.89 times more compared to what it was five years ago.

The company’s present content liabilities growth ratio has fell steadily through the five-year period, middling just 4.52%. Accounts payable held a per year growth level of 15.72%. Accumulated expenditures had a comparatively consistent yearly growing rate of 34.56% annually.

The form did not possess any short-term debt till the last year. The company’s overall liabilities growing rate through the five-year period middled 20.70%. Overall liabilities last year were 2.59 times more than the liabilities five years ago. Common stock has held a middling growing rate of 17.45% through the last 5 periods.

Financial Ratios of Netflix, Inc.

Table 3: Comparison of the main financial ratios of Netflix in between 2016-2020 ( Netflix Inc., 2021b )

Formulation of the solutions

Businesses are able to make moves in order to decrease and recover their debt-to-capital ratio. Amid the approaches, which might be applied are upsurging lucrativeness and reformation of the debt. The means utilized to lessen the ratio are better utilized sequentially with one another and, in case the market timing is accurate, utilized in unification with an increase in the pricing of their products and/or services.

Upsurged Income – The utmost reasonable move that Netflix, Inc. may make for lessening its debt-to-capital ratio is upsurging the incomes and expectantly the profits. This might be attained through raising the prices, surging sales, or lessening the expenses. The additional cash collected could at that point be utilized to pay back the prevailing debts.

Debt Reformation – Reforming debt delivers additional means in order to decrease the debt-to-capital ratio of the firm. In case the firm is principally paying comparatively in-height interest rates on its credits, and current interest rates are substantially lesser, the firm might attempt to refund its present debt.

This would lessen both interest expenditures and once-a-month payments, refining the firm’s bottom-line profitability, cash flow and surging its stores of the capital. This is known as a general and direct technique utilized to arrange improved terms for the firm and its outlays.

Discussion and selection of solutions

As stated above, Netflix, Inc. is able to utilize specific tools, for instance, debt reformation with the intention of lessening their debt-to-capital ratio. Through means of specific bottom-line book-keeping methods, the Netflix, Inc might make itself seem in an improved financial standing lacking the fear of bankruptcy. Interestingly, financial pointers specify that the company is leveraging its capital effectively.

It has upsurged its return on invested capital by the year 2017. In comparison with rivals, the company’s return-on-equity ratio (ROE) is performing healthy as well, a pointer of a firm’s long-term well-being and the efficiency of its present functioning structure to create cash (Table 3).

In the beginning of the current year, Netflix Inc. stated that it anticipates to be cash-flow neutral in current year and cash-flow positive every period after this year, and will no longer necessitate outside financing for funding its processes, finishing a ten-year long tendency and supporting stockholders that have tilled funds to the firm notwithstanding its cash-burning means.

In addition, the company stated that it will take into account share buybacks, an exercise it has not implemented by the year 2011 – the past time Netflix, Inc. had positive cash flow.

The statement arose as share of the company’s earnings declaration, in which the firm declared USD 1.19 earnings per share on incomes of USD 6.64 billion for the Q4, and 203.66 million worldwide subscribers, surged from 26 million at the close of the year 2011. Shares surged nearly 10 per cent on the news (Sherman, 2021).

The company’s market capitalization in January of the year 2011 was USD 11.5 billion, which is in excess of USD 220 billion at the moment. The COVID-19 pandemic lockdowns have substantially increased the company’s reappearance to positive cash flow. Having production hindered amongst COVID-19 lockdowns and individuals being stuck at home globally, the firm gained 36.57 million subscribers in the year 2020 though expending less funds on content compared to normal.

Currently, the firm plans to issue no less than a new film each week in the year 2021, in addition to its regular agenda of television series, biographies, and specials. Netflix’s content creation was not as influenced through the epidemic as that of further Hollywood film studios that had to stop filming novel content for quite a few months, and have just lately restarted with novel procedures in position.

Nevertheless, Netflix was capable of continuing the production of lots of new shows and films globally in late spring last year (Epstein, 2021).

The unidentified query is how stockholders will react to the alteration in Netflix’s narrative. Despite the fact functioning a maintainable commerce without the necessity of external debt and share buybacks is “Business 101” action, the company’s stock has increased as shareholders have gradually concluded that the firm would achieve well on that potential.

As stated by Hastings, the company tries to be a much greater and much more lucrative self-financing firm by time and dedicated to develop its cash flow outline expressively, beginning in the current year 2021 and every period subsequently (Williams & Rasay, 2021).

The increasing rivalry from Disney, Apple, Warner Media and further sector players might fester Netflix’s subscriber progress. Shareholders might reprove the company for share buybacks rather than utilizing it for increased content.

In case the firm is selecting to utilize surplus cash for buybacks, it might happen for the reason that Hastings and Sarandos think the firm’s position – and capacity to increase fees in the forthcoming – is so solid that they might begin to changeover the firm to a novel, increasingly settled stage without experiencing a successive loss in worth.

References

Denning, S. (2019). “Why Debt Isn’t Killing Netflix Any Time Soon”. Forbes Magazine, 2019. Available from: https://www.forbes.com/sites/stephaniedenning/2019/05/26/why-debt-isnt-killing-netflix/?sh=640ba4875407

Epstein, A. (2021). “Netflix says it has solved its skeptics’ biggest complaint”. Quartz Media, Inc., 2021. Accessed 01 August 2021. Available from: https://qz.com/1959586/netflix-says-it-doesnt-need-to-raise-debt-anymore/

Jackson, S. B., Keune, T. M. & Salzsieder, L. (2013). “Debt, equity, and capital investment”. Journal of Accounting and Economics, Vol. 56, Issues 2-3, pp. 291-310.

Kastrenakes, J. (2021). “Netflix subscriber growth is stalling as it runs low on hits”. Vox Media LLC. Accessed on 28 July 2021. Available from: https://www.theverge.com/2021/4/20/22394425/netflix-subscriber-growth-stalls-2021

Laughlin, L. S. & Winkler, E. (2019). “No Reason for Netflix Investors to Chill”. The Wall Street Journal, 2019. Available from: https://www.wsj.com/articles/no-reason-for-netflix-investors-to-chill-11557745201

Nead, N. (2018). “Media and Entertainment Industry Overview”. Accessed on 27 July 2021. Available from: https://investmentbank.com/media-and-entertainment-industry-overview/

Netflix, Inc (2021a). “About Us”. Accessed on 27 July 2021. Available from: https://about.netflix.com/en

Netflix, Inc. (2021b). “Annual Reports & Proxies”. Accessed on 28 July 2021. Available from: https://ir.netflix.net/financials/annual-reports-and-proxies/default.aspx

Pogue, D. (2007). “A Stream of Movies, Sort of Free”. The New York Times, 2007. Available from: https://www.nytimes.com/2007/01/25/technology/25pogue.html

Sherman, A. (2020). “Netflix isn’t a media company or a technology company – it’s an entertainment company, CEO Reed Hastings says”. CNBC, 2020. Available from: https://www.cnbc.com/2020/09/09/reed-hastings-netflix-isnt-tech-or-media-its-entertainment.html

Spangler, T. (2020). “Netflix Plans to Raise $1 Billion Through Debt Offering”. Variety.com, 2020. Accessed on 28 July 2021. Available from: https://variety.com/2020/digital/news/netflix-raise-1-billion-debt-offering-1234587050/

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