Netflix (NFLX 0.98%) has reached a big turning point in its history as a company.
After years of building up a massive catalog of original and licensed content, spending more and more money every year to do so, Netflix is finally happy with its level of content spending. In other words, management doesn't think spending more on content will move the needle enough on subscribers and engagement to make the extra outlay worthwhile. At the same time, the prospects for a return to meaningful revenue growth in 2023 are looking strong.
Considering content is, by far, Netflix's biggest cash expense, the implication of keeping it at the same level in the future means free cash flow at Netflix is about to explode.
Increasingly efficient content spending
Netflix has been at the content-creating game for more than a decade now, and it's become much more efficient producing engaging shows in that time.
"We learned a lot," co-CEO and Chief Content Officer Ted Sarandos said during the company's third-quarter earnings call. He noted the company has developed stronger partnerships and processes to improve the quality of the content it produces. The focus is now on driving efficiency. The goal is to get "better and better at getting more impact per $1 billion spend than anybody else," Sarandos said.
"We expect our content slate to get better and better each quarter and each year over the next couple of years," CFO Spence Neumann chimed in.
With the learnings of the last decade, combined with the easing of COVID restrictions enabling faster and less expensive production, Netflix should be able to show improved efficiency in content expenses for the next few years. Management said it will revisit spending levels as revenue reaccelerates.
NASDAQ: NFLX
Key Data Points
Revenue growth is coming
Netflix is working on several initiatives to reinvigorate revenue growth, but it might take some time for them to bear fruit.
Specifically, it has launched an ad-supported subscription tier and will be cracking down on password sharing. The ad-supported tier should help attract more price-sensitive customers and improve subscriber retention, helping bolster account growth. Meanwhile, plans to charge users extra for sharing accounts across households should drive revenue per account higher.
Management's fourth-quarter outlook calls for revenue to come in flat compared to a year ago, but that should improve in 2023. Analysts are expecting a slight acceleration in revenue growth next year.
Even if Netflix only manages to eke out revenue growth in the high single digits over the next few years, we're still talking about billions of dollars in new income on top of minimal increases in spending. That's a recipe for strong cash-flow growth.
Using cash to make shareholder-friendly moves
Excess cash flow gives management a lot of flexibility in where it goes from here.
Management has been very clear on its capital allocation approach with free cash flow. It's going to manage its net debt position and then prioritize investments in growth initiatives like advertising or mobile games. It might also find acquisitions that fold nicely into its business, such as its recent purchase of Animal Logic, an animation studio.
The company plans to keep two months' worth of revenue on hand in cash reserves but will deploy the rest into share buybacks. That will help support the stock price, as Netflix will have lots of cash to deploy in the near future.
Management isn't in a hurry to pay down its $13.9 billion in debt, nor should it be considering the relatively low interest rates on it. That amount of leverage is reasonable, and with future cash flows looking strong, there's no hurry to pay it down.
Netflix's financial footing is looking quite solid. The company should reward patient shareholders with its rapidly expanding free cash flow.
