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Netflix (NASDAQ: NFLX) borrows billions of dollars to fund its growing library of original content. Although the company realizes profits on paper, it spends billions of dollars in initial payments for the production of films, series and special films.
Last year, the company spent $ 3 billion more in cash than its business. Management initially expected a similar level of cash consumption in 2019, but it downgraded its guidance and generated negative free cash flow of $ 3.5 billion for that year. CFO Spencer Neumann reiterated its expectations for improving free cash flow from 2020.
Netflix's strategy of borrowing money to produce originals is perfect for investors. Mainly because it works: the number of Netflix subscribers has tripled in the last five years. However, any sign of slower growth in the number of subscribers – as the company warns in its outlook for the second quarter – undermines investor confidence that Netflix can continue to borrow money. to fund its original content strategy.
Promotional Art from the original Netflix series Strange things. Source of the image: Netflix.
Immerse yourself in the disappointing prospects of Netflix
Netflix expects to add 5 million subscribers to its service this quarter, down from 5.45 million last year. Analysts expected 6 million net additions.
Management highlighted recent price increases in the United States, Brazil, Mexico and parts of Europe, explaining why net additions will be lower this quarter. Some subscribers canceled their service when Netflix increased its rates, but the company stated that the gross additions were not affected.
As long as gross additions remain strong, Netflix should see growth in subscriber growth back to expected levels after tracking price increases in these markets.
If you ask management what motivates the raw additions, that is its original content. The company decided to substantially increase its marketing budget in 2018 by focusing on its original content, which resulted in over 7 million additional net additions to paying subscribers at the end of the year. world compared to 2017.
However, it is unclear whether this strategy will continue, as Netflix is facing new competition from several companies with significant budgets for content and marketing later this year. Management rejected the idea that new competitors would have a significant impact on its results. "There are already so many competitors for entertainment," said CEO Reed Hastings at the company's first quarter earnings call.
Make the most of your investment in content
While Netflix displays the debt balance, the company is increasingly in a hurry to maximize the revenue of its subscribers. It has managed to manage strong growth by deploying price increases in recent years, but is considering another approach.
Management confirmed that it was testing projects similar to a low-cost mobile option only in India. This would have a negative impact on Netflix's average revenue per user, but the marginal revenue generated by the new target market for which it is intended could be a substantial gain for the company.
New competitors are entering the market with lower prices than Netflix, and the company must consider the risk of losing a valuable market if it does not offer a low-cost option. This is not something that Netflix can afford with its huge investments in content and growing debt. Netflix must maximize its revenues to justify its debt.
That's why investors were a bit scared after Netflix had a disappointing outlook for second-quarter subscriber growth. And that's why investors need to pay attention to the measure, as well as how competitors evaluate and market their services – and how Netflix responds.
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