Netflix's (NFLX) debt is causing caution on Wall Street ahead of the company's earnings release Tuesday evening.
The company has recently made efforts to increase subscribers through marketing and a ramp-up in original content production. This effort has not been cheap, though.
The debt burden has prompted recent price target trimming from both Raymond James, to $400 from $450, and Morgan Stanley, to $450 from $480.
"We lower our 2018 and 2019 EBIT forecast by 2% and 4% respectively vs. our prior estimates, largely reflecting the impact of the strengthened dollar," Morgan Stanley analyst Benjamin Swinburne said in his earnings preview on Tuesday morning.
He added that the company's expenses will leave it in debt for years to come, hampering his ambitious prior price target.
"We also raise the incremental cost of debt based on rising interest rates, with Netflix still needing to raise an additional $5bn of debt over the next two years before reaching positive free cash flow in 2021," he said.
High-Yield Debt Poses High Risks
The forecast of additional debt raising comes amid an already looming debt issue for the company that has enticed short-sellers.
Netflix has issued a staggering $8.4 billion in high-yield bonds. The problem with these outstanding bonds is only exacerbated now that rates are rising, increasing the cost of the company's incremental debt, which shows no signs of slowing.
The company is expected to have nearly $14 billion in long-term debt by the close of 2019, according to Wedbush Securities. The ramp-up to that debt level would represent a nearly $10.5 billion increase in long-term debt from the first quarter of 2017.
"We don't expect visibility during 2018, and think that another trip to the debt markets, combined with worsening cash burn, could cause Netflix's share price to deteriorate," Wedbush analyst Michael Pachter wrote in his earnings preview released on Friday.
Based on the potential powder keg of debt and an "unwarranted" valuation, he set a paltry price target of just $125, among the Street's most bearish outlooks.
The company's debt has garnered attention from more than just analysts, however.
Short-sellers have noticed the balance sheet and have begun to bet against the company's bonds that are rated as junk by both Moody's and Standard & Poor's.
According to a Reuters report, bets against the company's burgeoning debt totaled $347 million, tripling in 2018 alone.
These bets could pay big for bears if Netflix continues its debt-happy drive and the balance sheet deteriorates. Pachter's price target would likely become much more probable as a result as well.
Dance With Disney
Netflix's rising debt is not without reason.
The company is competing with Disney (DIS) , which is looking to create its own lower-cost alternative to Netflix while wiping its content from Netflix's catalog in 2019.
The move by Disney forces Netflix to focus on creating more original content, but also content that commands the higher price point Netflix needs.
The competition against Disney is not the only front in Netflix's war, however.
Comcast's (CMCSA) Sky acquisition offers an inroad into pay-TV customers in Europe, which will tangentially compete with Netflix's targeted international expansion.
The rivals Netflix will encounter only get deeper-pocketed from there, with Amazon's (AMZN) Prime service being a prime pressure on Netflix that is prompting its recent expenditures.
"We expect the company to continue to increase its marketing content spending over the next several years in order to maintain the pace of its subscriber growth," Pachter noted in the face of these challenges.
With the company continuing to issue high-yield bonds in order to keep that all-important subscriber share and stave off its challengers, the debt burden is likely to worsen.
As the market draws a magnifying glass on subscriber growth and revenues, helping the stock rise 1.7% shortly after Tuesday's market open, analysts will surely be mindful of the company's debt load.
Netflix's earnings presentation is scheduled for 6 p.m. ET Tuesday evening, wherein cautious analysts will expect company comment on its debt in a rising rate environment.