Streaming video veteran Netflix (NASDAQ: NFLX) has its critics. The company may be adding millions of new subscribers every year while also driving revenues higher through price increases, but earnings turned solidly positive only recently, and Netflix is still burning a ton of cash.
So, if you judge investments only on how quickly the company can generate cash for its shareholders, well, Netflix is moving in the wrong direction.
That being said, share prices are soaring near all-time highs, and analysts carry 39 "buy" ratings against just 7 "sells" right now. Somebody out there still thinks Netflix's stock should keep moving higher despite the massive cash burns -- and management has not been shy about committing to several more years of negative cash flows.
Let's make some sense out of that controversial tension between crushing cash losses and soaring share prices.
The tale of the tape
How was Netflix able to produce $559 million of positive GAAP earnings while also burning a cool $2 billion of free cash over the last four quarters? Here are the largest items on Netflix's path from bottom-line earnings to free cash flows in 2017:
| Line Item | Fiscal Year 2017 | Fiscal Year 2016 | Fiscal Year 2015 |
|---|---|---|---|
| Net income | $559 million | $187 million | $123 million |
| Additions to streaming content assets | ($9.8 billion) | ($8.7 billion) | (5.8 billion) |
| Change in streaming content liabilities | $900 million | $1.8 billion | $1.2 billion |
| Amortization of streaming content assets | $6.2 billion | $4.8 billion | $3.4 billion |
| Free cash flows | ($2.0 billion) | ($1.7 billion) | ($921 million) |
Data source: Netflix filings.
The biggest drag on Netflix's cash profits is its streaming content costs -- $9.8 billion and rising in 2017. That huge line is partly balanced out by $6.2 billion of amortization of streaming assets and another $0.9 billion of increases to the company's streaming content liabilities.
As Netflix explains it, the actual cash cost of the year's content additions can be found by summing up the "additions" and "change in liabilities" lines. That works out to $8.91 billion for 2017, up from $6.88 billion in 2016 and $4.61 billion in 2015.
The sea change of 2017
Netflix is expanding its content budget year by year. Importantly, those costs are growing slower than the top-line revenues -- and they are slowing down even further while Netflix is accelerating its sales growth:
Data source: Netflix filings. Chart created by the author.
2017 was an important turning point in Netflix's quest for sustainable growth. As you can see in the chart above, revenues increased faster than both accounting-based and cash costs for new content. This was a sharp break from much swifter expense growth in 2016, and like I said, the long-term trends are all pointing to further improvements in the next few years.