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This Is the One Reason I Might Buy Netflix Stock Again

By Nicholas Rossolillo - Oct 28, 2020 at 8:28AM

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Cash flow generation is, at least for the time being, in positive territory.

For a number of years, I've been steering clear of Netflix ( NFLX 1.75% ) stock. With its price skyrocketing 380% over the last trailing five-year stretch, it goes without saying that my decision has been a mistake. But my reasons for avoiding the clear-cut leader in TV streaming might be changing, and if the trend holds I'll consider making a purchase after a long absence in my portfolio.  

Does positive cash flow equal no more debt issuance?

My reasons for ignoring Netflix stock have little to do with how "expensive" the stock is. At 9.2 and 78 times trailing 12-month sales and earnings per share, respectively, the entertainment stock looks like a reasonable value given its growth using these two metrics alone -- and has for some time, in my opinion. But the issue is that while Netflix reported positive earnings, it wasn't really profitable yet. Free cash flow (revenue less cash operating expenses and capital expenditures) has been negative for years -- until the pandemic hit.  

NFLX Free Cash Flow Chart

Data by YCharts.

The reason? It all has to do with amortization, the expensing of an intangible asset over time. In simple terms, the creation of a feature film or TV series (an intangible asset) is expensed over time, but in actuality, content creators get paid upfront by Netflix. This discrepancy in the timing of payment is the difference between earnings per share and free cash flow. Put another way, while Netflix shows positive earnings, it's simply because earnings haven't reflected the fronted full payment that leaves the balance sheet to pay for programming.

To make up for the cash outflows over the years, Netflix has accumulated over $16 billion in debt. Using debt to pay for the never-ending game of content creation for its diverse geographic markets was unsettling for me. That contrasts with a vertically integrated entertainer like Disney ( DIS 2.84% ) that has many more levers to monetize content via merchandising, advertising, and theme parks -- at least, that was the case pre-2020. 

Netflix had started to reach a global scale early in 2020 in which positive free cash flow was in sight within a few years' time; but COVID-19 and the subsequent shutdown of production meant no more payments to creators, positive free cash flow ($2.2 billion through the first nine months of 2020), and no issuance of new debt. Movie and TV production is restarting, but guidance for the fourth quarter of 2020 is calling for free cash flow to be negative $1 billion or possibly come in at breakeven in a best-case scenario. If Netflix can turn that corner and start generating positive cash (without the help of the pandemic), I might start flirting with the idea of purchasing the stock.  

A couple sitting on a couch and watching TV.

Image source: Getty Images.

New subscribers still a must

I'm not going to get hasty with a buy, though. Netflix is still in expansion mode in key markets in Asia and Latin America, and it is still churning out local language series and movies to encourage net new subscriber sign-ups. And to be clear, Netflix needs those subscribers to pay for all of that content. Some investors are concerned once again about the sluggish pace of just 2.2 million net new subscriber additions in the third quarter, though I think the low number compared to the recent past is likely also due to early effects from the pandemic.  

More importantly for me, if Netflix can get itself to free-cash-flow positive territory and wean itself off of new creditors, it would be a game-changer. Though I've missed out on quite a bit of growth the last few years, there is still plenty left in the tank. Riding the wave as a company transitions from all-out sales growth to bottom-line growth can be a highly rewarding journey, and if this is in fact Netflix's transition, I want to hop aboard.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Netflix, Inc. Stock Quote
Netflix, Inc.
$612.69 (1.75%) $10.56
The Walt Disney Company Stock Quote
The Walt Disney Company
$150.37 (2.84%) $4.15

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