For most of the past decade, a valid concern that Netflix (NFLX -9.09%) naysayers pointed to was the possibility its business would never be able to generate free cash flow (FCF). This argument was supported by the fact the company spent billions of dollars every year licensing and producing content.
Well, amid what was a historically difficult year for Netflix in 2022, when the streaming juggernaut added only 8.9 million net new subscribers, it still proved the naysayers wrong. And now, the key metric Netflix bulls must pay attention to is free cash flow.
Pressing play on the cash machine
Netflix generated $1.6 billion of FCF in 2022, above management's internal estimate of $1 billion. And the leadership team expects the business to produce at least $3 billion of FCF this year. That is in stark contrast to most of the past decade, meaning Netflix has cleared the hurdle to transition from a perennial cash-losing enterprise to one that is on its way to becoming a cash cow.
The credit goes to Netflix's massive scale. The company posted sales of $31.6 billion in 2022, up 6.5% year over year. And it now counts a whopping 230.8 million subscribers, the most of any single streaming service out there. This success was achieved thanks to Netflix's first-mover advantage in the streaming industry for much of the previous decade when former CEO (now executive chairman) Reed Hastings correctly predicted streaming would help spur the decline of traditional cable TV, with viewing time shifting to the more convenient option.
It also didn't hurt that Netflix was the main streaming service provider for many years. This meant that what it was really selling was a better user experience above all else, as opposed to competing over better content. This allowed the business to attract viewers rapidly.
Moreover, it's not a coincidence that Netflix's monster growth happened during the post-Great Recession period when central banks around the world were extremely accommodating with their monetary policies, trying to drive economic growth following one of the worst downturns in history. This resulted in Netflix taking full advantage of low borrowing costs, which funded its growth.
We're seeing other streaming companies struggle to achieve profitability now. Take Walt Disney, which didn't launch Disney+ until late 2019, more than a decade after Netflix's streaming debut. The House of Mouse's direct-to-consumer segment, which contains all of its streaming services, posted an operating loss of $1.1 billion in its latest fiscal quarter. And CEO Bob Iger is focused on aggressively cutting costs.
Also making a big impact on Netflix's cash generation is the trend around its content spending. With cash outlays for content, by far its biggest expense category, at roughly $17 billion in 2021 and 2022, management has said spending will remain in this ballpark in 2023, so any increase in revenue should flow to FCF. This isn't to say that content spending will hold constant. In fact, it's reasonable to assume that it will continue to rise, especially as competition for the best screenwriters, producers, and actors intensifies. However, it appears as though Netflix has passed the inflection point where revenue growth can outpace cash outlays.
The new Netflix is here to stay
The Netflix bulls can rejoice -- this favorable financial situation is what they have long been waiting for. In fact, management is now confident the business can sustain this positive FCF, and according to consensus analyst estimates, the metric will increase from $1.6 billion in 2022 to $9.6 billion in 2027, good for average annual FCF growth of 43%.
Investors might want to take a fresh look at the new and improved Netflix, especially as the stock is still down 50% from its previous peak.
