Netflix (NASDAQ:NFLX) has been spending a lot more cash than it generates from subscriptions since it started ramping up its original content plans. Last year, for example, Netflix burned through about $2 billion in cash. This year, the company plans to spend a lot more on both content and marketing, and expects it to result in negative free cash flow between $3 billion and $4 billion.
The company has been funding its spending by issuing debt, despite a relatively poor credit rating. But the company just got a nice bump from Moody's, which increased its credit rating based on estimates that show the company turning cash-flow positive by 2022.
Here's how investors can expect Netflix to go from burning cash at unprecedented levels to rolling in the dough.
Subscriber growth is the biggest key
Netflix is investing all of this money in content and marketing now because it believes it will pay off in long-term subscriber growth. The company had nearly 111 million paid streaming subscribers as of the end of 2017, and Moody's analyst Neil Begley expects it to reach 200 million by the end of 2021.
That estimate basically assumes Netflix will see no slowdown in subscriber growth after adding 21.5 million net new subscribers in 2017. Netflix, in fact, has exhibited accelerating user growth over the past year despite lapping its global expansion launch at the beginning of last year.
Most of that growth will come from international markets, where Netflix is still relatively young. But Netflix's growth isn't really slowing down in the U.S., and management sees long-term potential for between 60 million and 90 million subscribers. It had 52.8 million as of the end of last year.
Due to Netflix's consistent pricing between countries, each subscriber is worth relatively the same amount to Netflix regardless of where they're located. That's in contrast to other companies that price their services based on the economies of individual markets. So, even if growth stagnates in the U.S., international growth is worth just as much to Netflix.
Raising the price again
Netflix customers in the U.S. saw a series of price increases from 2014 to 2017 that resulted in the price of the most popular Netflix plan increasing from $7.99 per month to $10.99 per month. Customers in more mature international markets saw similar price increases based on their currency and exchange rates.
In all likelihood, Netflix will continue to raise its rates over the next five years. Its price is still well below HBO Now, and it's even below Hulu's commercial-free price. Considering the quality of content, there's likely still room to increase the price.
Price increases coupled with continued subscriber growth ought to result in significant revenue growth over the next five years. An 80% increase in subscribers (to about 200 million) combined with a 10% increase in price (about $1 per subscriber) would result in nearly double the revenue.
Pulling back on content spend growth
The growth of Netflix's content spending is slowing on a relative basis. The company spent $6.4 billion on content last year, up from $5 billion in 2016, a 28% increase. This year it expects to spend between $7.5 billion and $8 billion on content, a 17% to 25% increase year over year.
Of course, those numbers only include the amortized figures Netflix uses to account for its content spending. Its actual cash payments are higher because actors and producers work in entertainment, not accounting, and need to be paid for their work as they're doing it. As it slows down its shift to from licensed content to more original content, the growth in cash used for content ought to slow even faster than the growth in amortized content spending.
In the company's fourth-quarter letter to shareholders, management wrote, "We are increasing operating margins and expect that in the future, a combination of rising operating profits and slowing growth in original content spend will turn our business [free cash flow] positive." The company is certainly executing on that plan.
Whether or not Netflix becomes cash-flow positive in 2022 (or sooner) is largely dependent on how effective its increased spending on content and marketing is. As long as Netflix's investments are paying off in subscriber growth and enable it to continue raising its prices, Netflix may keep pushing its spending higher. That would delay becoming cash-flow positive, but it would ultimately result in more cash coming in over the long run.