Netflix’s (NFLX) Bulls and Bears
August 1, 2017, 10:22 am
Netflix (NFLX) remains a company admired by many, but somehow it always manages to stir the pot at the same time. We’re seeing that again following the company’s earnings report and the differing opinion between growth and value investors. Put simply, growth investors think the numbers were great while value investors feel the opposite. Let me explain why.
Growth investors tend to look at the company’s top-line growth of 30%, its opportunity to grow even faster in international markets (which account for over half of sales now) and its chance to monetize the value of its content beyond its platform.
Value investors and more hard-bitten types are quick to point out that NFLX sells at 93X next year’s EPS estimates, growth in the United States has slowed significantly and the company’s overall top-line growth is expected to slow from 30% this year to 20% in 2018. Bears have also highlighted that NFLX has negative free cash flow, and it is funding its operations through borrowing.
This is a special case where both sides are right. It is expensive to create and purchase content (management spent $8.7 billion on it last year), and had they spent it all at once the company would have reported a loss. However, accounting conventions allow NFLX to amortize this asset over a two- to three-year period, the time frame where management can expect to use this. By not expensing the content costs all at once, NFLX reports a profit even though it expects to have negative free cash flow in excess of $2 billion this year.
Few great companies have negative free cash flow for extended periods. McDonald’s (MCD) did this for the first two decades of its existence as it built its vast empire that generates quite a bit of free cash flow now. As long as Netflix continues to grow rapidly, it will be able to get away with having negative free cash flow. However, it could become a problem if it persists while NFLX’s growth slows.
It’s hard to say what’s in store for Netflix next, but it will certainly be interesting to see how the company evolves on cash flow over time.