Netflix Risks

Topics: Investment, Net present value, Rate of return Pages: 5 (1869 words) Published: April 19, 2012
Netflix was founded in 1997 and is headquartered in Los Gatos, California. Netflix is a company that provides online movie rental subscription services in the United States. The company offers its subscribers access to a library of movie, television, and other filmed entertainment titles on digital versatile disc (DVD) and Blu-Rays. Its members can get DVDs delivered to their homes and can instantly watch movies and TV episodes streamed to their TVs and PCs. It also partners with consumer electronics companies to offer a range of devices that can instantly stream movies and TV episodes to members' TVs from Netflix. Netflix entered the rental entertainment industry at a time where Blockbuster was king and renting movies required the consumers to drive to the store. However, Netflix realized that through innovation there was a much more efficient and cheaper way to provide the same service than the typical brick-and-mortar companies of the time. Customers of Blockbuster and other store rental places were attracted to the new features (monthly subscription, no late fees) provided by Netflix. Through innovation Netflix basically “changed” the way movie rentals were done and eventually became the leader of movie rental industry while Blockbuster and many other companies eventually became bankrupt. Netflix’s story of success is also one of caution as Netflix realizes that they will continue to face many risks throughout their business cycle and if they don’t anticipate and/or respond correctly, they too could face the same result as Blockbuster. As of December 31, 2009, Netflix served approximately 12 million subscribers. Currently, Netflix claims on its website to have over 20 million members, making it the leader in rental movie industry. However, Netflix faces many competitors that provide similar services: Comcast, Redbox from Coinstar and even Amazon is planning on also offering streaming services to its prime members. Therefore, if Netflix is to remain as the industry leader and continue its earnings and membership growth it will have to continue to innovate with new ideas. Generally, innovation requires a huge investment from companies in their Research and Development departments. These investments can come out from the companies own cash flow or from issuing loans. In order for a Company to decide if an investment is worth the money it uses either Net Present Value or Internal Rate of Return techniques which basically state that if the return on the investment is greater than the cost, then the company should go ahead and invest. But what is the cost of the investment? If Netflix plans to borrow money, then the cost will be the prevailing interest rate at the time of Issuance of the loan plus a spread premium for specific characteristics pertaining to Netflix. This poses a financial risk on Netflix, more specifically this is called interest rate risk. Interest rates tend to be volatile and there are many different theories (expectations theory, liquidity theory, preferred habitat theory, market segmentation theory) yet nobody really knows 100% for sure if interest rates are going to go up or down and by how much. However, based on the expectations of Netflix’s analysts they have a few choices on dealing with this risk depending on their expectations. If they expect interest rates to go up, then they should issue a long term bond or note now, because if they wait and interests rates do go up then it will be more costly for them to borrow the money they need which might end up affecting the Net Present Value of their investment project. On the other hand, if Netflix expects rates to go down then it will not be a good idea for Netflix to issue out a long term bond or note because if rates eventually do drop then Netflix be essentially borrowing at a higher rate than the prevailing market rate. So what Netflix should do instead is to issue short term debt such as commercial paper and continue to roll it over until...
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