Netflix, Google and their Relationship With Debt
Netflix, after earning huge success from their original movie “To All The Boys I’ve Loved”, has recently announced their plan to raise $2 billion in debt to fund more original content. But why would Netflix want to raise their debt? What implications does this decision hold for the future of rom coms and documentaries?
What is debt financing and why is it so important to companies?
There are two main ways that a company can finance their business: through debt and through equity. While there are many different aspects to be considered when comparing the two, debt financing is considered the more stable method for the lender. Debt financing is the act of raising money by borrowing, the amount usually repaid with an addition of interest. Although there are many different types of debt financing, the two main types of debt financing are issuing debt securities and taking out loans from the bank. Other types of debt financing include vendor finance and securitisation, which are more specialized forms of debt finance. The business can identify which type of debt financing is right for them by looking at the creditworthiness of the borrower, the size of the borrower and the amount of money required.
However, why is debt so important that borrowers are working on their creditworthiness and identifying the correct type for them? Debt is generally seen as a bad thing, but for businesses it is extremely valuable tool. Using debt to finance a large portion of business is advantageous for businesses as the government gives businesses an incentive to use debt by deducting interest on debt from corporate income taxes. This means that the cost of the company’s debt is very low considering the tax break associated with interest. Moreover, debt is usually a cheaper form of financing than equity. This is mostly due to the fact that equity is riskier than debt, creating risks for the company who ask for a certain return rate and for the investor, who lose investments when the firm goes bankrupt. Lastly, debt financing is advantageous as the owner of the business does not lose ownership of the business like they would through equity financing. Thus, they have more control over their decisions and do not need to consult with shareholders constantly.
Some disadvantages to debt financing include:
- Debt must be repaid, unlike equity.
- High interest rates during a financial period have difficulty growing because of the high costs of debt.
- Debt instruments often restrict the company’s activities–limiting business owners to making decisions to core business opportunities.
However, the three above mentioned reasons make debt a very attractive way for businesses to grow their business. There are many different types of debt securities, which are debt instruments that are used when financing debt. The notable types are bonds, medium term notes and commercial paper. All of these types of securities can be easily traded, making them attractive for the investor.
Debt securities are very advantageous for both the investor and the borrower for several reasons. Some of these reasons are:
- Interest rates: Debt securities have more flexible interest rates for the borrower as debt securities can be fixed rate, floating rate, zero coupon.
- Broader investor base: Debt securities create access to a wider group of potential investors than a loan.
- Trading: As mentioned above, debt securities are transferable instruments, the best example of this being bonds, which are easily bought and sold. This makes it very attractive for the investor to lend money, as the debt security can be sold if the investor needs to. This helps lend the issuer when a bank loan may not be possible.
What implications does raising debt hold?
To answer this question, we are going to look at two different companies: Netflix and Google. While Netflix has recently announced their decision to raise debt by $2 billion, Google is a company that has very little total debt in comparison to their size. While Google’s decision is considered inefficient by many, Google’s strong cash flow and profit finance the business with retained earnings. Over time, Google may feel that it has to borrow more to fund their business. However, by having very little debt, Google establishes a low debt to equity ratio (0.05) which is very attractive for investors.
Netflix on the other hand, has a much higher debt to equity ratio of 1.81. They justify their reason to increase their debt to remain competitive and to release more original content. It could be that equity financing was not an efficient means for Netflix to fund original content as shareholders were against this decision. Netflix stated that their competitors like WarnerMedia, Hulu, Disney and Fox have been presenting more of their original content, which creates a disadvantage for Netflix. They believe that further producing original content will help them remain competitive. Raising debt holds the implication that the business has more control over their decisions, and what to do with the money.