The Skinny On...

Answering your questions about the meltdown in global bond markets earlier this week and updating you on everyone’s favorite deal drama!

— Jen & Kristen

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WTF happened in Japan’s bond market???

I barely have a social life.

But fittingly, the one day that I hop on a flight for a girls’ trip to the Caribbean with my college roommate, the market melts down. You should have seen me desperately trying to connect to the internet on a ferry to figure out what was going on in the Japanese bond market while questions were flooding in from our DMs.

I’ve finally got a WiFi connection, and the markets appear to have come to their senses. So let’s talk about it.

Japan has, for all of my adult life, been the land of the low yields. The Japanese central bank has used long end bond purchases (“Quantitative Easing”) for decades to fight deflation and support the economy.  At its height, the BOJ owned something like 50% of all the outstanding government bonds in the market. The latest round of QE ran from 2013 to 2024, when the central bank reversed course with a multi-year tapering program, slowing the pace of its purchases and hiking short term interest rates. When this commenced at a faster-than-expected pace in 2024, it shocked the markets, causing a chaotic unwind of the “carry trade”, where investors borrow on the cheap in JPY where interest rates have traditionally been lower, and lend (invest) in USD, EUR, GBP, or other currencies where rates are higher. 

Since August of 2024 (with a few notable exceptions), long end JGB yields have been on a one way train higher. With the BOJ stepping back, investors haven’t exactly rushed in to fill that gap in demand.

And that’s not just the story for Japan. It’s been the case for nearly all G7 sovereign debt markets due to both structural and strategic reasons (which we discussed specifically with the Dutch pension funds), save the US. In fact, we’ve talked about this long end term premium building since our first newsletter article of the year. As governments continue the trend of fiscal irresponsibility — meaning, more spending with no plan to bring money in to pay those debts off — investors continue to demand higher and higher interest rates as compensation for investing in increasingly risky bonds. 

But Japan has given us real cause for concern.  In May of last year, we had our first warning signs of an investor boycott when the government auctioned off their regularly scheduled 20 year and 40 year bond issuances. 

If you’re not familiar with bond auctions, they don’t all work like auctions at Christie’s and Sotheby’s, where the highest bid wins the painting and everyone else misses out. Some bond auctions, like 10 year JGBs, are multiple-price auctions.  If the bonds are trading at 4.00% heading into the auction and you really want them, so you bid 3.95% to make sure you get them — reminder price and yield are inverted so a higher price means you’re willing to accept a lower yield — you buy them at 3.95% when someone else who cares less might only bid 3.96% and get them there. Someone who bids 4.02% might not get any bonds if they are all spoken for at lower yields. But there’s a winner’s curse, where you feel like a dummy buying at 3.95% when everyone else gets 3.99%.  

20- and 40-year JGB auctions however, like all nominal Treasury bonds, are Dutch auctions. Investors from all over the world submit the lowest yield (meaning, highest price) they are willing to accept for their investment. All the bonds have to be sold. So it’s not the most expensive bid that wins — rather, the lowest yield that makes sure ALL BONDS are spoken for is where the entire auction clears. Let’s say bonds are trading at 4.00% heading into an auction. If the most desperate investor bids 3.95% and the most skeptical investor willingly bids 3.99%, all bonds are sold at 3.99%. In that case, the auction is said to be “stopping through” by a margin of 1 basis point. But if investors aren’t particularly interested, and instead are only willing to buy the bonds at cheaper levels, say 4.01%, those bonds will be issued at higher yields than the market anticipated. A bond trading at 4.00% heading into an auction that clears at 4.01% is said to have “tailed” by 1 basis point. A “tail” means investor demand was weaker than anticipated.  

Both the 20 year and 40 year JBG bond auctions in May of 2025 tailed by over a basis point, margins not seen in long end JGBs since the 1980s. Goldman research at the time called it “the canary in the global duration coal mine”.

On November 21, 2025, the Japanese government announced a JPY21.3tr stimulus package — aka, more spending. Yet, no real plan to pay for said spending.

So this all came to a head on Tuesday, when the 20 year JGB auction tailed by over 2 basis points, with a statistically low bid-to-cover ratio. Meaning, fewer buyers showed up, and they were only willing to buy bonds at cheaper yields than where the bonds were trading prior to the auction. 

This buyer boycott had massive repercussions. Long dated JGBs sold off (meaning, yields rose) by 20-30 basis points. This was a “black swan” level event in terms of the order of magnitude of the move. But more importantly, the global bond markets took this as a definitive referendum on fiscal irresponsibility, and it sparked immediate contagion in other G7 sovereign debt markets. 

Now, anecdotally, whenever there’s a big move in the Japanese markets, it tends to be outsized in nature because liquidity is thin in the overnight markets. If the move happens on a Monday — or in this case, the Tuesday after a US holiday — forget about it, all bets are off.  To be honest, it’s days like these that I was GLAD to be in transit, because when you’re watching the screens, it can feel like the world is ending. Sure enough, within 24 hours markets had regained their senses, retracing much of the move.

But like we’ve been saying since the beginning of the year, questions about who will show up for the long end of global bond curves have yet to be answered. If anything, we now have more concerning data points to show us just how fragile G7 bond markets are under current fiscal regimes. 

Netflix revised their $27.75 / share offer for Warner Bros. to ALL CASH. Why Netflix’s stock price tanked…

While Jen was off living her best island life, there was a big development in the Netflix–Warner Bros. Discovery saga.

LAST WEEK, Netflix announced that they were planning to revise their bid for Warner Bros. Discovery, shifting from a mix of cash and stock to an all-cash offer. THIS WEEK on Tuesday — the day they announced earnings — they made it official. 

On the surface, that sounds like good news: less uncertainty, no stock dilution, and a cleaner deal. But the market hated it. Netflix shares sold off on the initial report last Wednesday Jan 14, and again after the confirmation Jan 20 — the day they announced earnings — DESPITE mostly beating expectations.

Let’s unpack why investors reacted so negatively.

First, Netflix investors don’t love the deal. Even if they win, they have to get through anti-trust…which is not a done deal. Moreover, PSKY’s hostile bid is still outstanding and they may still increase their bid, which leaves some chance that Netflix will sweeten further. Not to mention even if they do win at this price, M&A is notorious for destroying shareholder value. In fact, Warner Brothers itself has been a cursed asset. Quite literally the poster child for the worst deal of all time is AOL / Time Warner which resulted in a $100 BILLION write down of goodwill within a few years of the acquisition…another story for another day.

But in the immediate term, making the switch to an all cash deal makes things WORSE for Netflix shareholders in terms of expected EPS. And all else equal, lower EPS means lower share price. Why?

Think about it in this rather simplistic way: PE = Stock price / EPS. 

Said differently, Stock price = PE x EPS. Assuming a constant PE (big “if”, but still…), if EPS goes up, the share price goes up.

Ok, so why is this negative for EPS? Two reasons.

First, during their earnings call, Netflix announced they’re pausing share buybacks to help fund the deal. That’s negative for EPS, even without considering the Warner Bros. merger.

Why? Because earnings per share (EPS) is calculated as:

EPS = Net Income / Shares

When a company buys back its own shares, it reduces the number of shares in circulation. That boosts EPS, even if net income stays flat. Investors like this because it mathematically improves EPS.

So if analysts were modeling a decline in share count due to continued buybacks, and now that’s off the table, it means the denominator (shares) will stay higher than expected. EPS will drop vs. their expectations.

But on top of that, how the deal is financed plays a huge role in that EPS math, since using cash vs. stock are not equivalent in terms of their relative cost.

So which is more expensive? Let's calculate it.

Cost of Stock: Netflix is trading at a P/E of ~37x. When companies issue shares to fund an acquisition, it increases the share count. To get a rough approximation of how much issuing shares “costs” in terms of EPS accretion/ dilution, we take the inverse of the P/E ratio. This means issuing stock has an implied cost of ~2.7% (1 ÷ 37).

Cost of Debt: Netflix doesn’t have $72bn sitting around, therefore they’ll fund a significant component of the cash consideration by raising debt. Let's assume something like a 5.5% interest rate on that debt — which, after adjusting for a 25% tax shield, is a 4.125% after-tax cost.

So which is cheaper?

✔️ Stock at 2.7%
❌ Debt at 4.1%

Said differently: Netflix’s stock is a highly valuable acquisition currency. Issuing stock to fund the deal is more accretive to EPS than borrowing debt. So switching to all cash makes this deal more expensive and WORSE for shareholders of Netflix.

You can also look at this by instead comparing the relative PEs; their actual PE vs. PE of debt. Stock = 37x (P/E). PE of Debt = 1 / (cost of debt x (1 - tax rate) = ~24x implied P/E. The consideration with the higher P/E is more accretive.

So why didn’t the earnings win on Tuesday help? After all, Netflix reported EPS of $0.56 versus $0.55 expected, revenue of $12.05 billion versus $11.97 billion expected, and year-over-year revenue growth of about 18%. Solid results, and yet the stock still sold off around 6%.

That’s because markets care about future expectations, not past performance. Between management flagging potential growth headwinds, the cessation of share buybacks, increased certainty this deal will go through, and confirming an all-cash deal (which lowers future EPS), the outlook dimmed and spooked investors.

Looking ahead, the next chess move we’re watching for is Paramount sweetening its bid. Back in December, leaks suggested Paramount was running scenarios to raise its offer by around 10 percent. We haven’t seen that yet, but Netflix’s all-cash shift may force their hand.