Currency Pulse #13 - Netflix’s Class Act

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Layered hedging: Netflix’s Class Act

‘Class Act’ (2023) is Netflix’s series on the life and times of Bernard Tapie (1943-2021), the flamboyant French business tycoon, one-time owner of sportswear firm Adidas, whose career ended in disgrace following some high-profile bribing scandals.

The drive, the ambition —and the extreme hubris— of the self-made man are well rendered by actor Laurent Laffite. If there ever was a narcissistic CEO, it was Mr. Tapie.

There is a lot more to this story. The recent strength of the U.S. dollar is having profound consequences for Netflix. The company mentions “best-in-class local-language wins” like Class Act in its latest letter to shareholders. Therein lies the problem: some of these series generate euro-denominated sales that are less valuable because of dollar strength.

“Over the past few months, the US dollar strengthened versus other currencies, representing a roughly $200M expected drag on Q4 revenue and Average Revenue per Member. We have exposure to over 45 currencies and fluctuations in FX rates impact both our revenue and operating profit” — Netflix

Netflix’s non-US dollar revenue is currently roughly 60% of total companywide revenue and is likely to increase over time. It therefore comes as no surprise that the company has just announced the implementation of a layered FX hedging program, with hedges in the shape of standard forward contracts starting to mature in early 2024.

Layered hedging works by building the FX rate in advance, instead of protecting a budget rate like in static programs. By creating a commonality between hedge rates, a layered FX hedging program smoothes out the hedge rate and reduces the ‘cliff’ between average hedge rates over time.

That’s how a company protects its profit margins without having to change prices. Here are some elements that the team led by Netflix CFO Spencer Neumann needs to consider:

• Program length. The length of the program largely determines the degree to which the FX hedge rate can be smoothed out. This, in turn, raises other questions, such as the distance between the hedge rate and the spot market.?

• Forward points. Can the treasury team configure the program to optimise forward points? Series like Class Act and Dear Child yield revenue in EUR (favourable forward points), but Sintonia does so in BRL (unfavourable forward points).?

• Automation. Can the firm perform a layered FX program for dozens of currencies without automation? If manually executed, this is a very resource-intensive activity, as it implies a precise and demanding schedule for hedge execution.

This last point is intriguing. Netflix says that not all 45 currencies are included in the layered hedging program. Is this a sign of an excessive manual burden?

Bi-weekly backtest: Seafood European company hedging USD purchases (*)

A European company buys a range of seafood products from two South American countries, paying in USD. The firm applies a suboptimal time-based hedging program that fails to adequately capture favourable forward points, as USD trades at a 1.28% one-year discount to EUR.

We backtested a market-based program that hedges all of the exposure in the shape of firm purchase orders while anticipating hedge execution as much as possible in order to take advantage of favourable interest rate differentials.

Given the dollar’s 1.95% average annual discount to EUR between 2020 and 2023, financial gains of 32 basis points per annum were obtained, assuming a 60-day delay between firm commitments and their settlement.?

This represents a little less than 7% of the gains generated by the program in terms of transactional risk reduction. Further gains can be obtained by using the best-price execution feature of Multi-Dealer Trading platforms.

Finally, from the commercial perspective, profit margins can be enhanced by capturing markups when selling in local currencies. Using evidence from the industry, these markups are estimated at 0.90% on average, to which favourable forward points can be added in CHF-denominated sales.?

(*) Every two weeks, Currency Pulse presents a real-life case. No names are mentioned, and absolute values are changed. We use simulation tools to backtest, with historical data, our proposed hedging programs.

“We’ll end up in a world of balance”: Interview with Sean O’Connor

Our podcast CurrencyCast features our recent interview with Sean O'Connor, Treasury Director at MongoDB. Mr O’Connor previously worked at Aer Lingus and Xerox, where he oversaw a wide-ranging treasury centralisation project.

The conversion covers a wide range of topics: FX sensitivity, the role of Application Programming Interfaces in treasury operations, layered hedging (in FX and commodities) and exposure netting. Sean even shares his views on how to tackle the ups and downs of GBP-USD and GBP-EUR from a corporate FX risk management perspective.

Last but not least: why treasurers need to act, more and more, as relationship managers within the organisation.

Age of Giants: Instant Payments

Instant payments are credit transfers that make funds available in a payee’s account within ten seconds of a payment order being made. Known in Europe as TIPS, and based on the SEPA Instant Credit Transfer (SCT Inst), instant payments were developed for any country within the SEPA.?

The central banks of Sweden, Denmark and Norway have shown interest in joining. In the UK, the Faster Payments Service (FPS) saw the light of day in 2008. Now the U.S. Federal Reserve is launching FedNow? Service, its own instant payments service, offering instant settling and clearing at all times of day. The more the merrier.?

“For CFOs, a key selling point of real-time payments is the ability to closely manage working capital. Companies can use the systems to pay their bills on the last possible day, meaning they can hold on to their cash longer. Real-time payments can also provide them with the certainty of knowing exactly when their payments will settle” — Kristin Broughton (*)

With both the ECB and the FED decidedly coming off the sidelines, the ‘Age of Giants’ in instant payments is upon us. The EUR-USD exchange rate, once labelled “the world’s most important price” by Nobel Prize-winning economist Robert Mundell, will only gain in importance.?

(*) Kristin Broughton: “Finance Chiefs Take Measured Approach to Using Real-Time Payments”, Wall Street Journal, November 2, 2023.

Five Useful Links

1. The Economist on international tourism. In its 2024 edition of The World Ahead, The Economist forecasts that international tourism will create record revenue of $1.5 trillion, fuelled by high prices and post-pandemic wanderlust. Tremendous if proven right.?
2. The importance of small optimisations. The WSJ’s CFO Journal interviews Michael Linford, CFO of fintech ‘Buy-Now-Pay-Later’ fintech Affirm. Says Mr. Linford: “Very small optimisations matter”. Indeed. That sums up our own experience with fintech companies.?
3. AFTE’s November Survey. Treasurers at medium-to-large French firms reported tighter standards, but higher demand, for commercial and industrial loans in November. Also, most French treasurers welcomed the euro’s weakness over recent months.?
4. Czech CFOs and the euro. A Bloomberg article describes the impatience of Czech CFOs with the countries’ authorities regarding a timetable for euro adoption. Prague-based CFOs of exporting firms are already "requesting contracts in euros". See our LinkedIn post.?
5. Treasury centralisation—again. Over at TMI, Eleanor Hill discusses centralisation with ING’s Dick Oskam. “The trend towards treasury centralisation is once again picking up pace among corporates as they look to optimise visibility, efficiency, and control".

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