Check out the latest Netflix earnings call transcript.
Spencer Neumann has a big task to take on as the new CFO of Netflix (NASDAQ:NFLX). The video-streaming pioneer has been bleeding cash for the last five years or so as it delves deeper into original programming and expands globally.
A headline in The Wall Street Journal (subscription required) shortly after Netflix announced Neumann's new job said he'll have to tackle Netflix's "cash flow conundrum."
Netflix's cash burn is becoming increasingly expensive in an environment with rising interest rates, but it's hardly a conundrum. Netflix's decision to spend more cash than it takes in is a calculated risk, and it's one with relatively little downside despite increasing competition from the likes of Disney (NYSE:DIS) and AT&T's (NYSE:T) WarnerMedia.
Peak cash burn
Netflix had some good news for investors when it released its third-quarter earnings report in mid-October. Cash burn in 2018 will come in at the low end of its original outlook of $3 billion to $4 billion. What's more, it expects a similar level of cash burn in 2019 before showing improvements back toward positive cash flow in 2020.
There are several factors at play here. First, Netflix may be reaching a sustainable level of investment in original content. Over the past few years, it became increasingly evident that traditional media companies like Disney and WarnerMedia would recapture some of their licensed content from Netflix in order to improve viewing through their own channels. Both have since announced their own direct-to-consumer plans.
Netflix quickly ramped up the volume of original content as well as the marketing spend on promoting those series, films, and comedy specials. But the need to replace licensed content with originals is subsiding. That's not to say Netflix won't continue to ramp up original content spending and marketing, it's just that it won't outspend the increase in net cash generated from operating activities.
On top of that, Netflix is still growing subscribers quickly. Netflix members increased 25% year over year in the third quarter. It added more subscribers through the first nine months of 2018 than in any other year.
And those subscribers are paying more, on average, than they did last year. Netflix has continually raised prices as it increases the value of the service, and it ought to continue that pattern. WarnerMedia's HBO charges $15 per month for HBO Now, and many subscribers (and critics) say Netflix's content is even better. Neflix's last price increase was in October 2017. Netflix's plans range from $7.99 to $13.99 per month.
The combination of increasing subscriber growth and higher average revenue per user is leading to better top-line growth for the company -- top-line growth that's in line with the increase in content spending. Revenue increased 34% year over year in the third quarter while cash spent on content increased 35%.
All this is to say Netflix has already proven its strategy works. Neumann's job is to make sure the company stays on the path it's been on for the last few years by managing content and marketing spend to grow the subscriber base and executing appropriate price increases.
One small challenge
Running the company with cash burn will become slightly more challenging going forward. Netflix funds its investments in original content and marketing by tapping the debt market. As the Fed has raised interest rates, using debt has become more expensive for Netflix.
That adds another factor for Neumann to consider in the financial algebra surrounding original content. Higher interest rates certainly make the operation more expensive. In the end, however, it shouldn't change the underlying strategy.
Will competition change things?
Starting at the end of the year, Netflix will face two new competitors with a lot of demand for their content. Disney will launch Disney+ and WarnerMedia will launch its own streaming service featuring content from Warner Bros. studios, its cable television networks, and HBO.
What's more, licensed content has proven extremely popular on Netflix. So if subscribers can get access to that content through other services, that might hurt Netflix's ability to keep growing subscribers.
But Netflix has shown originals are driving subscriber sign-ups more than access to reruns of consumers' favorite shows. While people love to watch reruns of Friends, they're not going to sign up just because Netflix has a 20-year-old show. They're going to sign up to watch Stranger Things or the newest creation from Shonda Rhimes. Netflix's data shows as much, which is why it decided to increase its marketing budget last year to promote more originals.
Neumann's task in managing Netflix's financial decisions is big, but there's no conundrum. Just keep doing what the company has already shown works.