Netflix (NASDAQ:NFLX) has officially reached peak cash burn. Its negative free cash flow of $3.3 billion in 2019 was about $250 million more than the previous year, but management is expecting to burn just $2.5 billion this year.
That's despite the fact that several high-profile competitors are entering the market in 2020, and the price of licensing and producing new television series and films has seemingly never been higher.
There are several factors that will lead to the considerable improvement in cash flow this year, and investors should expect those trends to continue for the foreseeable future. That provides a clear path to neutral cash flow for the streaming video leader. Here's how it'll get there.
Growing the top line
The more cash coming in, the easier it is to improve cash flow, so everything starts with growing revenue.
Netflix grew revenue 27.6% last year, but investors should expect a considerable slowdown in 2020 since 2019 was helped by price increases around the world. Average revenue per subscriber increased 17% in the U.S. and Canada in the back half of the year. Netflix had a similar price increase across Latin America, but foreign exchange headwinds knocked the increase down to around 9%. It's very unlikely Netflix will increase prices again in 2020 in most markets, given the competitive pressure and price sensitivity subscribers exhibited last spring.
Additionally, Netflix probably won't grow its subscriber base as quickly as last year. Netflix's first-quarter outlook calls for just seven million net additions compared to 9.6 million in the first quarter of 2019. While management expects a more even distribution of net additions in the first half of the year, it's still unlikely the company will grow subscribers at the same rate as last year, especially considering the fact it's building on a larger base.
That said, analysts still expect Netflix to produce revenue growth in excess of 20% this year. That'll come from continued subscriber growth, another quarter before it laps its previous price increase, and self-selection from subscribers to higher-priced tiers.
Expanding operating margin
Netflix has consistently expanded its operating margin three percentage points every year for the past three years. 2020 will be no different, with management planning to hit a 16% operating margin for the full year.
One area of operating leverage is in Netflix's marketing budget. The company greatly expanded its marketing budget in 2018, increasing spend around 50% that year. The focus of that increase was mostly around marketing specific original titles and "for your consideration" campaigns to win prestigious awards. And while Netflix certainly expanded its original content slate in 2019 and made an even bigger push at the Emmys and Oscars, its marketing budget increased just 12% for the full year.
The bulk of Netflix's increased marketing spend is international, where the company is seeing improved efficiency as it has become a more established brand over the last four years. Continued investment in international marketing could produce even better returns for the company and result in the operating leverage necessary in order to meet its 16% operating margin target.
Slower growth in cash content spending
Of course, the biggest cost for Netflix is its massive content library. The company amortized $9.2 billion of content expenses in 2019, which is the amount that goes into its income statement. But its cash flow statement saw about $14.6 billion in content spending as it continues to ramp up investments in originals and pre-commits to certain licensed content.
The content amortization increased about 22% last year, slightly faster than the 21% growth in 2018. CFO Spence Neumann told investors to expect another increase of around 20% for 2020.
But the growth in cash spend will be slightly slower. "The relationship between our cash spent and our amortization, that ratio was about 1.6, meaning 1.6 times the cash investment relative to our amortization," Neumann explained during Netflix's fourth-quarter earnings call. "You should see that ratio continue to come down a little bit."
If Netflix grows its amortized content expense 21% and decreases the ratio to 1.52, it'll spend about $17 billion in cash on its content in 2020. That's just 16% growth on by far the biggest line item in its cash flow statement. Combined with the streaming video company's revenue growth of about 20% and operating leverage of three percentage points, investors should see a marked improvement in free cash flow over the next four quarters.