Can Netflix's Revenue Really Keep Up With Its Content Budget?

Netflix (NFLX 4.17%) gave investors a sneak peek of what's to come in 2018 when it released its third-quarter earnings last week. The streaming video company plans to spend between $7 billion and $8 billion on content next year, funding around 80 feature films and hundreds of original series episodes on top of its licensed content.

Not only is Netflix continuing to fund its international expansion, it's facing increased competition from all sorts of companies. As more companies enter the market with billions of dollars to spend on quality video content, Netflix has had to expand its budget to stay ahead. Eight billion dollars would represent a 33% increase in its content budget from this year's expected $6 billion.

During the earnings call, CEO Reed Hastings tried to put investors at ease: "Hopefully what gives investors confidence is ... we've grown the content budget, we've grown the content library, and made it better, but revenues have grown faster, which is what's driven the profit improvement and the marginal improvement over the years."

Indeed, Netflix is growing quickly, but so is its content spending. Let's take a closer look.

Image source: Netflix.

How much cash Netflix is spending on content right now

It's important to note Netflix's $6 billion content budget for 2017 is on a profit and loss basis. On a cash basis, Netflix is spending even more as it accelerates its original content production spending. And if you look at Netflix's cash flow statement, revenue actually isn't keeping up with content spending growth.

Data source: Netflix. *Based on "Additions to streaming content assets" plus "Change in streaming content liabilities" from Netflix's cash flow statement.

Netflix has spent around $8.5 billion in cash on content over the last 12 months. Some of that is for content that won't show up on Netflix's service until 2019, like the Martin Scorcese film that's just starting production. Still, Netflix is making the bet now that it will continue to pay off in subscriber and revenue growth in the long run.

So, while on a profit and loss basis Netflix's growth in content spending isn't outpacing its revenue growth, its cash spending certainly is. That's led to significant cash burn over the last few years. Netflix expects negative free cash flow between $2 billion and $2.5 billion this year. It continues to go back to the bond market to raise capital to fund its cash outlays for new content. It most recently announced a $1.6 billion bond proposal.

The next 12 months probably won't be different

Netflix hasn't indicated any plans to slow down its content spending. In fact, management has said the more successful it is, the more it will invest in content. And the company just reported a new record for net subscriber additions in the third quarter.

Even on a profit and loss basis, Netflix's $7 billion to $8 billion forecast for next year's content budget represents a 25% increase at its midpoint. Analysts are currently expecting revenue growth of just 23.5% next year. And keep in mind cash spending will likely grow faster as Netflix shifts its library to include a larger share of original productions and moves more of those productions in-house.

But Netflix is taking steps to maximize its revenue. It just announced a new price increase, raising the price 10% on its most popular plan in the United States and in several other mature markets. Most analysts expect very few customers will defect due to the price hike despite aggressive pricing from competitors. RBC's Mark Mahaney estimates it'll add around $650 million to the top line next year. That will certainly help offset the increase in content spending.

Of course, Netflix is also growing rapidly internationally, where there's still a huge opportunity. Netflix's international subscriber count surpassed its U.S. subscribers in the second quarter, and it's not slowing down anytime soon. Management expects to add another 5 million international subscribers by the end of the year.

But now with 109 million global subscribers, the international expansion isn't having as big of an impact on revenue growth on a percentage basis over the previous year as it once did.

Netflix appears to have its content budget under control and relatively in line with its revenue growth. But investors need to dig deeper and look at the cash outlays Netflix is making now that aren't contained within the budget number management likes to toss out. That's the figure that determines how much Netflix needs to tap the debt market.