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Netflix Details Its Path Toward Positive Cash Flow

By Demitri Kalogeropoulos - Feb 3, 2020 at 10:30AM

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CEO Reed Hastings and his team see a steady improvement in cash trends for the streaming giant beginning in 2020.

Netflix (NFLX 1.56%) recently closed the books on a strong fiscal 2019, which included 28 million new subscriptions, powering nearly 30% higher sales year over year. The streaming video giant made huge strides in improving its finances, too, thanks to the combination of increased revenue and rising operating profit margin.

Some of Netflix's biggest wins showed up in other business metrics, though. The management team discussed these lesser-known successes in its conference call with Wall Street analysts. Below, we'll take a look at some highlights from that presentation.

A man watching TV.

Image source: Getty Images.

The model is working

Thanks to the launch of new competing streaming platforms from Disney and Apple, and Netflix's major price increase last year, the fourth quarter provided an important test of the company's business model, which relies on steadily increasing prices to fund better content, which in turn supports satisfied customers who happily pay more for the service over time.

As Chief Product Officer Greg Peters said:

[W]e're not seeing anything that fundamentally contradicts our core model or suggests that it's changed in a material way. And that model is, if we do a good job of judiciously investing the money that our members give us every month ... then we occasionally earn the ability to come back to them and ask them for a little bit more money to keep that virtuous cycle of improvements going. And everything we're seeing continues to support [the fact that] that core model is intact.

Sure, the last round of price increases and the new platforms each pressured Netflix's growth last year. However, management is seeing ample support in the data for confirmation that their approach is working. They cited the fact that per-member viewing was up last quarter, for example, and that membership growth was strong in most markets even as profitability increased.

Another reason to avoid advertising plans

Executives have declined to seriously entertain the idea of an advertising-supported streaming plan that could lower monthly prices and widen its potential membership base. Their biggest reason for passing on that approach has been that it would dilute the brand and split Netflix's focus away from producing and delivering the best possible mix of content to TV fans.

And this week, executives added an even stronger reason to stay out of advertising: business risk. Specifically, Hastings noted that to compete on the level of Facebook and Alphabet's Google, the tech company would have to invest resources toward capturing and maintaining huge, detailed databases of consumer information.

Hastings said:

[W]e're not tied up with all that controversy around advertising. ... [Y]ou've got to spend very heavily on that and track [user] locations and all kinds of other things that we're not interested in doing. We want to be the safer spy where you can explore ... and have none of the controversy around exploiting users with advertising.

On the glide path

On the company moving toward positive free cash flow, Hastings said:

It is a huge milestone in our growth of last year being peak negative free cash flow. And so we're on the glide path slowly toward positive free cash flow. ... [b]ut that's not coming from shrinking back our content spending. That's coming from the increase in revenue and operating income.

Netflix predicted that cash burn rates in 2020 would improve to $2.5 billion from $3.3 billion. It's understandable that Wall Street would be cautious about celebrating the outflow of over $2 billion of cash, but management thinks the shifting trend is perhaps more important than many investors realize.

The company is now spending well over half of its annual content budget on original shows and films, which constitutes a major transformation compared to four years ago when licensed content was the bulk of Netflix's expense. While these exclusive projects require more cash up-front to produce, the assets help the financial picture in latter years. Investors are starting to see better trends in working capital, for example, and in the ratio between cash spending and content amortization.

The real power of this content funding transformation will be clearer in a few years, but there's a strong indication of that financial win embedded in management's projection of improving cash flow in 2020 despite expectations of significantly higher content spending.

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