Please ensure Javascript is enabled for purposes of website accessibility

Because of Coronavirus, Netflix Is Profitable ... for Now

By Nicholas Rossolillo – Apr 23, 2020 at 9:49AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

A temporary halt in content production means cash flow is now positive.

Surprising no one, Netflix (NFLX 0.71%) reported a massive surge in net new subscribers during the first quarter of 2020. Net additions were just shy of 15.8 million, more than double the outlook provided earlier in the year, bringing the streaming leader's total count up to 183 million. As many of those subscribers came in the final weeks of March, revenue "only" increased 28% year over year to $5.77 billion. The outlook for another 7.5 million net adds in the second quarter is likely a conservative one, given the ongoing lockdown on the global economy to slow the spread of COVID-19.  

Looking beyond the headline, though, something far more interesting occurred on the bottom line. Netflix reported that it was free cash flow-positive in the quarter, and that should occur again in Q2. It's a departure from the way business was trending before, and just like the surge in subscriptions because of people being stuck at home, the newfound profits are due to coronavirus.

Hasn't Netflix reported positive earnings before?

If this situation sounds confusing, it's because most headlines home in on earnings per share. And on that front, earnings have been positive at Netflix for a long time.

However, earnings are not a true measure of profitability. Earnings include the effects from items such as depreciation and amortization on items that were paid for in the past but couldn't be fully expensed up front. Content creation is one of those items. Though the cash leaves the balance sheet to pay for a new movie or TV show, the actual expense is realized over time.

Thus, free cash flow -- which measures cash operating expenses and capital expenditures, and excludes non-current depreciation and amortization and other non-cash items -- has been negative at Netflix for a while. That has especially been the case in recent years as the company's strategy has shifted more toward developing its own movies and shows.

NFLX Normalized Diluted EPS (TTM) Chart

Data by YCharts.

That strategy just took a dramatic turn, though. The company has had to stop production on its content because of coronavirus, and plans to resume have been delayed until later in the year. As a result, free cash flow was positive $162 million during the first quarter. New full-year free cash flow guidance of negative $1 billion or less (compared with negative $3.3 billion to negative $2.5 billion before) still indicates that the entertainment company plans on letting its creative teams get back to work sooner than later.  

A couple sitting on a couch watching TV

Image source: Getty Images.

A glimpse into the distant future

This is the reason I've steered clear of Netflix stock (admittedly to my detriment). Cash expenses have to come from somewhere, and in this case, it's from issuing new debt. At the end of Q1 2020, the company had $5.2 billion in cash and equivalents on the books. The new cash outflow expectation for the year means it will likely be able to delay raising new debt for now, but even with a big jump in new subscribers, this demonstrates that Netflix's strategy of creating its own content is still a ways off from breaking even.  

Total long-term debt of $14.2 billion at the end of the quarter is a manageable sum for a company the size of Netflix (market cap of $186 billion), but bear in mind that total debt was $2.37 billion at the end of 2015. I'd like to think this is the end of the line for that increase, but management's comments made it clear it expects to tap debt markets again once its productions are up and running at full steam. As impressive as the net new subscriber additions were, make no mistake: Netflix absolutely needs every single one of them -- and a lot more -- to pay for its entertainment content.

Streaming has been a disruptive force that is continuing to grow while traditional entertainment isn't doing so hot. Given that situation, it appears Netflix stock will continue to trade based on the most headline-worthy numbers: subscriber count and revenue. I'm not comfortable with that given the underlying structure to pay for the business model, and especially considering how big of a company Netflix already is.

I will likely get penalized for that viewpoint if shares continue to chug higher; but as the current coronavirus crisis has demonstrated, balance sheets matter. Just ask the movie theater industry. When it comes to debt, there is always an eventual day of reckoning, and sometimes it doesn't get resolved elegantly.

Nicholas Rossolillo and his clients have no position in any of the stocks mentioned, but own Vanguard Growth ETF, of which Netflix is a top holding. The Motley Fool owns shares of and recommends Netflix. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Netflix, Inc. Stock Quote
Netflix, Inc.
$240.74 (0.71%) $1.70

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 10/04/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.