October 10, 2018
With more than 130 million subscribers and growing globally, SVOD behemoth Netflix has few problems – except an operating strategy bent on spending every free dollar (and more) it generates.
The service reported negative free cash flow (FCF) of $559 million in the most-recent quarter ended June 30 – part of a projected $3+ billion negative free cash flow in 2018.
Free cash flow is the cash a company produces through its operations, less the cost of expenditures on assets. In other words, FCF is the cash left over after a company pays for its operating expenses and capital expenditures.
And with Netflix on a breakneck pace to outspend ($13 billion this year) every competitor on original content, the SVOD pioneer continues to significantly exceed internal fiscal resources – typically a red flag to Wall Street.
But Netflix isn’t a typical company.
In Q2, the service completed a bond (debt) deal, raising $1.9 billion. At the end of the fiscal period, its gross debt stood at $8.4 billion, with a cash balance of $3.9 billion and a $500 million undrawn credit facility.
“We judge that our after-tax cost of debt continues to be lower than our cost of equity, so we anticipate that we’ll continue to finance our capital needs in the high yield market,” CEO Reed Hastings and CFO David Wells wrote in the shareholder letter.
Michael Pachter, media analyst at Wedbush Securities in Los Angeles, contends Netflix could remedy (break-even) its cash flow issue by raising the subscription price to $15 monthly.
“While an increase of $4 per month for domestic subs and $6 for international subs would add around $7.6 billion to revenue, more than offsetting negative free cash flow, we think that higher pricing would result in even higher content and marketing spending,” Pachter wrote in a note.
In other words, Pachter believes Netflix would continue spending like a drunken sailor.
While any mention of a price hike undoubtedly causes nightmares for Netflix brass following the well-documented fiscal debacle in 2011 when it raised – by 60% — the price of a popular hybrid streaming/DVD subscription plan. More than 800,000 subs dropped the service, and Netflix shares plummeted 75% in value, losing billions in market capitalization.
Pachter said anything charged above $15 per month would likely drive substantial profits, although, at higher prices, subscribers would expect more, and content license costs would likely rise.
“We estimate that at $20 per month, Netflix would generate around $3 per month in cash profit per subscriber,” he wrote.
In the meantime, Pachter expects Netflix to impose modest price increase every 18 – 24 months for the foreseeable future and thinks it could take as long as eight years to generate meaningful positive free cash flow.
To do so, Netflix has to keep adding subs at current growth levels – not unreasonable considering original programming continues to generate the bulk of online attention among consumers, according to Parrot Analytics.
“[Netflix] is likely to top out at around 200 million global customers,” wrote Pachter. “At that level, FCF would be $600 million per month, or $7.2 billion annually.”
Netflix reports Q3 financial results Oct. 16.