Negative Free Cash Flow Will Be an Indicator of Enormous Success For Netflix, Says CEO (barrons.com)

During Netflix's quarterly earnings call, in which it noted it had added more than five million subscribers in the last three months, CEO Red Hastings was also asked about the millions of dollars it burns every quarter. Hastings said that burning cash is a sign of success, in a way. Here's the money quote: Look, when we produce an amazing show like Stranger Things, that's a lot of capital up front, and then you get a payout over many years. And seeing the positive returns on that for the business as a whole is what makes us comfortable that we should continue to invest and integrate to basically self-develop many more properties as Ted (the content head) can find the appropriate ones. And then there's comfort with being able to finance it, and of course, our debt-to-market cap is incredibly low and conservative, so we've got lots of room there. And I think that combination that it's spent well and we can raise it is what makes us very excited. And the irony is the faster that we grow and the faster we grow the owned originals, the more drawn on free cash flow that we'll be. So in some senses, negative free cash flow will be an indicator of enormous success. On Monday, Netflix updated its estimate for negative free cash flow for 2017. While previously the company had said it would be $2 billion, Netflix now says it will be $2 to $2.5 billion (versus $1.7 billion in 2016).

Comments

Sell! Sell! Sell!

[Thelasko]

That statement makes no sense. He's saying his cash flow will be negative because they will be investing in new products. However, new products are not an indicator for success. Sales is!

Re:Sell! Sell! Sell!

[rogoshen1]

I think he's saying that spending money developing new shows is better than resting on their laurels and collecting cash.

Basically taking the long view.. it's no different than investing in a factory that increases output over the next 30 years, despite the current quarter's balance sheet taking a hit. (exactly the opposite what the fucking MBA culture seems to suggest.)

Re:Sell! Sell! Sell!

[Captain Splendid]

Sales is!

That'll be the 5 million new subscribers referenced in the summary then.

Re:Sell! Sell! Sell!

[Notabadguy]

That statement makes no sense. He's saying his cash flow will be negative because they will be investing in new products. However, new products are not an indicator for success. Sales is!

It's nicer than saying, "We're reinvesting our earnings into the long term growth of netflix rather than pushing net cashflow that can be paid out as investor dividends because I care more about the longevity of Netflix more than your capital gains" to your shareholders.

But shareholders don't want to hear about long term growth or longevity, they want quarterly stock gains and dividends at the expense of all else - which is why our economy is so skewed.

Re:Sell! Sell! Sell!

[TrekkieGod]

That statement makes no sense.

It makes perfect sense.

He's saying his cash flow will be negative because they will be investing in new products.

And that those products will lead to money in the long-term: "that's a lot of capital up front, and then you get a payout over many years"

However, new products are not an indicator for success. Sales is!

"During Netflix's quarterly earnings call, in which it noted it had added more than five million subscribers in the last three months..." Those are the sales, right? Ideally the new subscribers are going to stay with netflix and keep paying them for a long time.

Re:Sell! Sell! Sell!

[Junta]

I think the point is that while that can make sense for 'starting up', at *some* point you have to point and say 'here's where revenue will exceed investment'.

The problem is the statement on its face doesn't imply that the investment will stop.

If their investment outstrips subscription revenue by 2.5 billion annually, well you need to be able to find 2.5 billion worth of new subscribers. That's actually better than reality, as some analysts have noted that license costs grow with subscriber count for shows they don't own (including many 'netflix original series' like house of cards or orange is the new black, they license, not own), so the number is worse than 2.5 billion. Further complicating matters as that netflix may pretty well be close to saturating the market.

We are not talking about a capital 2.5 billion dollar investment and we are done either. We are talking about content creation, which means that they have to keep this up *every single year*, lest they stop having new content and subscribers tire of stale content.

Re:Sell! Sell! Sell!

[Thelasko]

I think he's saying that spending money developing new shows is better than resting on their laurels and collecting cash.

That might be what he meant to say, but that's not what he said. He should have said, "we anticipate a reduction in cash as we make substantial investment in our in house programming. We expect a substantial return on this investment in the future."

Instead, he basically said, "High cost structure is an indicator of a successful business." Which is the opposite of true.

Re:Sell! Sell! Sell!

[TrekkieGod]

I think the point is that while that can make sense for 'starting up', at *some* point you have to point and say 'here's where revenue will exceed investment'.

Agreed.

The problem is the statement on its face doesn't imply that the investment will stop.

Not agreed. It just means you need a critical mass of subscribers to support the continued investment.

If their investment outstrips subscription revenue by 2.5 billion annually, well you need to be able to find 2.5 billion worth of new subscribers.

Netflix costs more than $1 / year per subscriber. At the minimum of $8/month, it means they would need an additional ~26 million subscribers, and they got 5 million in the past 3 months. That's without considering the people paying $10 for hd streaming and $12 for 4k streaming, or excluding future price increases once they think they have enough content to keep subscribers with said increase.

Re:Sell! Sell! Sell!

[hey!]

However, new products are not an indicator for success. Sales is!

Not exactly; and sales does not necessarily equal good cash flow, although it contributes to it. You can nearly always generate more sales by spending more money on promotions -- more sales, more cash going in, but often even more cash going out.

What's more, sales and profit aren't necessarily the same thing; you can easily go bankrupt while profitable; you can also run a company that loses money for years on end if it has a cash cow.

What businesses need to keep going, day to day, is to meet current obligations (bills they have to pay right away). That's the significance of cash flow. Vendors will always accept cash for debt; getting them to accept a share of *Stranger Things* wouldn't work, although you can get bond holders, investors and banks to in effect do that, all at a price of course.

Having positive cash flow is always good; but burning cash, while always risky, is normal in certain circumstances (e.g. startups or companies acting like startups). So the big question isn't whether Netflix was cash negative, but whether cash flows are proceeding as planned.

If this is the cash flow situation Netflix expected, the CEO is right to point to things like the products they're developing. That shows that things are indeed proceeding as planned: they were always planning to burn cash over a number quarters to do stuff like that. However if cash inflows that were expected didn't materialize, or if cash outlays occurred that were unexpected, that's just bad. It's not necessarily fatal, however. As long as Netflix can keep paying the bills and is generating *value*, it's possible to engineer some kind of soft landing.

Re:Sell! Sell! Sell!

[Thelasko]

It's nicer than saying, "We're reinvesting our earnings into the long term growth of netflix rather than pushing net cashflow that can be paid out as investor dividends because I care more about the longevity of Netflix more than your capital gains" to your shareholders.

Most investors will accept that statement eagerly. If investors only cared about dividends, the startups in Silicon Valley would have no funding.

A company flush with cash has two options to make investors happy:
1. Invest the cash into a new area that promises to have a large return on investment (this case).
2. Pay a dividend, or buy back stock.

The worst thing a company can do is sit on loads of cash, like Apple.

Why Not?

[31415926535897]

Works for Amazon.

This is the world's new business model, for better or worse. If you don't run a business this way, you can't compete (with the likes of Amazon & Netflix) and they will crush you. And if you do run a business this way, you might [spectacularly] fail, but if you are able to survive, then you'll be the only player. It's like running a monopoly before it's officially a monopoly (the way Standard Oil used to undercut competitors until they went out of business). You can use debt, equity and VC funding to do this today instead of a monopolist's war chest.

As a major plus to those who make these decisions--the board, the CEO, and the rest of the executive team--they don't care. They get paid handsomely win or lose, and if everything goes bust, they can just spin up the next one while coasting on their ludicrous money from the last job.

ok, and?

[Anonymous Coward]

the only people who don't like the idea of spending X amount of money to make Y amount in returns over a few years time are idiot MBAs that continually screw us over for meaningless quarterly results. The Harvard Business School mentality is like some kind of plague on capitalism.

Forward thinking != automatic success

[Roger W Moore]

I think he's saying that spending money developing new shows is better than resting on their laurels and collecting cash.

If so he is saying very wrong. Investing in the future is a great way to ensure success in the future but it is by no means an indication or guarantee of success in the present or future. It's entirely possible to invest heavily and be an utter failure e.g. if they invested in shows which were complete flops. The fact that their CEO equates investment in the future to automatic success is not a healthy sign since it suggests they have not planned for what happens if the investments go awry.

Re:Forward thinking != automatic success

[alvinrod]

Well the alternatives are sitting on the cash under the assumption that they will somehow be able to invest it more wisely in growing the business in the future or returning the additional money to shareholders under the assumption that Netflix can't invest the money better than the shareholders would be able to do so.

Unless you have a really good reason for the first (e.g. key talent viewed as valuable currently being tied up in other projects for a short term basis, etc.) there isn't any good reason for a company to sit on huge piles of cash. If they really don't want to hand it over to shareholders, the company can just invest it in other companies or investment vehicles, but that's also essentially admitting that the company can't put the money to good use itself.

Netflix has a pretty good track record, so unless the CEO is spouting some off-the-rails crap, I'll assume that they have a good plan in place. That's probably not something they're going to fully expound upon in detail in a shareholder meeting, so the CEO just makes some terse comments to assure shareholders that the company is taking the best course of action.

Re:Forward thinking != automatic success

[cfalcon]

> Most successful enterprises start out with debt

So do almost all unsuccessful ones.

Re:Forward thinking != automatic success

[IsaacGrimnebulin]

Your logic really isn't logic at all. To put it simply, I am a Netflix subscriber. I give them money every month because I want to watch the content they provide on their service. Netflix on the other hand work to make sure when I have consumed that content, I have more content to consume and that is our relationship. Now if Netflix decided to stop investing in new content the day would come when I would run out of things I want to watch on Netflix and I would terminate our contract. In order for that not to happen, Netflix need to invest in more for me to watch. Investment isn't foolproof, you can always get it wrong but then again neither is driving foolproof, thousands of people die on the road everyday, taking a risk isn't business, it's existence. Now if you drive at 300MPH blackout drunk through a busy city during lunch hour then you are probably going to have a memorable evening. However you can mitigate the risk by sobering up, catching a bus or just staying home and watching the service that replaced Netflix or whatever it was called before they went bankrupt because Stranger Things is only good the first 89 times. Netflix intends to invest 6 billion USD in content this year if I remember correctly. Now if they made Game of Drones for 6 dillion dollars and their investment failed, they would be in serious trouble and probably selling assets to keep afloat. However maybe they could take that 6 billion dollars and divide it into chunks, a LOT of chunks and then they could have 10 investments instead of 1, or maybe even 100 investments, or even more! Now naturally we can't do the mathematics to calculate the future outcome of investments(at least not yet) so every investment, however wise or not wise can only be seen as such after the fact. However this is a situation with binary outcomes and yes, investing is the more complicated one because there are more outcomes but that isn't very reassuring when the only outcome for not investing is being replaced by that service that made Stranger Things season 2. Bad investments hurt. No investment doesn't hurt very long, because you just don't have long enough to get to that part.

Re:Forward thinking != automatic success

[DontBeAMoran]

As a paying subscriber, I don't give a rat's ass about the shareholders returns or whatnot. The only way to keep me as a paying subscriber is to give me things to watch - that's what Netflix is for.

Yes, it is always true.

[140Mandak262Jamuna]

I can "invest" in beany baby dolls or original content, it does not matter. The accounting laws are strict. The SEC disclosure is clear. You have state how much cash you spent on them. Then it is up to the management to convince, and the investors to agree, that the baseball cards, rental properties, mortgage backed securities or original content will produce positive cash flow at some point in the future.

He is doing his job convincing people there is value created in all those properties. As long as the investors buy that story, it is all hunky-dory.

Debt to Market Cap...

[Tulsa_Time]

Wow, that is the new measure of low risk ?