Will Netflix Stock Become A Cash Generating Machine?

While Netflix (NASDAQ: NFLX) has consistently improved its profitability, with EPS rising 20x over the last five years, this came at the expense of deteriorating cash flows, as the company doubled down on content investments. Cash burn, measured in terms of free cash flows deteriorated from around -$840 million in 2015 to a whopping -$3.3 billion in 2019. However, in 2020 Netflix turned cash flow positive for the first time in almost nine years, generating about $1.9 billion cash as its subscriber base and revenues soared through Covid-19, while content spending moderated on account of slower production. For perspective, cash spent on content fell from $14.6 billion in 2019 to $12.5 billion in 2020, as Revenues rose from about $20 billion to $25 billion. Netflix is looking to sustain this momentum, noting that it should be cash-flow neutral this year while posting positive free cash flows for every year after 2021. The company also indicated in an earnings call back in January that it would stop taking on further debt and that it would consider share buybacks. So how is Netflix going to manage this? See our analysis on A Deep Dive Into Netflix Content Spending for a detailed look at how Netflix spends on content and how it impacts the company’s profitability and cash flows.

Although content investments are likely to remain high as Netflix needs to keep adding to its library to engage existing subscribers and add new ones, it’s likely that it will better match spends with its revenue and subscriber growth. For perspective, while cash content spends per subscriber jumped from about $62 per year in 2015 to $82 in 2019, it fell to about $60 in 2020 due to Covid-19. Netflix could use this Covid-19 related pullback to bring some more discipline into its content spending.

Subscriber growth is also likely to remain strong. Netflix added a record 32 million subscribers last year, and growth is likely to continue given there is still a lot of room for international expansion. We estimate that about 90% of the company’s subscriber growth over the next five years will come from overseas. This means that much of the company’s North American content library will potentially find new audiences abroad and this is likely to also reduce incremental content spends.

Netflix is also becoming more confident about its pricing power and the value proposition of its services. It increased the monthly prices of its most popular plan from $11 to $13 in early 2019 and once again to $14 last October and subscriber growth has held up despite this. Considering the price increases and subscriber gains, the consensus estimates are that Netflix revenues will grow by 20% this year and by about 15% next year. Moreover, the company is testing a password-sharing prevention feature that could also eventually help to drive up subscriptions.

[4/30/2020] Is Netflix Making Or Losing Money?

Netflix stock has emerged a star performer through the coronavirus pandemic, rising by ~25% year-to-date, as people consume more content while being confined to their homes. The company added close to 16 million subscribers over the first quarter, handily beating its guidance of about 7 million new subscribers. However, one key question investors are likely to have is whether Netflix is actually making money? The answer depends on whether you look at accounting profits or underlying cash flows. We answer this in our dashboard analysis Netflix Free Cash Flow: Why Is Netflix’s Profitability Improving While Its Cash Burn Is Accelerating? Parts of this analysis are summarized below.

Growing Net Income, Higher Cash Burn

Viewed from the lens of net income, Netflix has been performing well, with its net profits growing 3x from around $0.6 billion in 2017 to $1.9 billion in 2019. That said, the company has been burning cash, with free cash flows falling from -$2 billion in 2017 to -$3.3 billion in 2019. The sizeable difference between these two numbers is explained by how Netflix accounts for its content investments, amortizing (expensing) only a portion of its content each year on its income statement. The company’s cash spending on content is growing fast, rising from about $9 billion in 2017 to $14.6 billion in 2019. In comparison, the amortization of content has been relatively lower, growing from $6.2 billion to $9.2 billion over the same period. Netflix says that about 90% of the value of a show is expensed within 4 years of its debut.

Netflix content outlays have been growing not just in absolute terms, but also in terms of content spending per active subscriber and the company faces a paradox, in a sense. While it needs to rein in content spending in the long-run to boost cash flows, this could prove tricky, as subscriber growth could slow (or even decline) if it doesn’t keep updating its library at the same pace, given the competition in the streaming space with the likes of Disney
DIS
, Appl
AAPL
e, and the upcoming HBO Max vying for market share.

Cash Burn Should Decline In 2020, As Coronavirus Reduces Production

That said, 2020 could prove an interesting year for the company, as content production is likely to slow down with the pandemic, potentially reducing its cash spending on content. While the company previously indicated that it could see -$2.5 billion of free cash flow for 2020, it now expects the number to be less than -$1 billion.

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