Netflix crushed its growth targets for the second quarter, adding over five million subscribers worldwide, and was rewarded with a stock price that soared to an all-time high Tuesday.
The party is in full swing for Netflix investors.
And they have reason to be jubilant, since Netflix said it expects much of the Q2 momentum to carry forward.
But there is one area that still has some analysts concerned: Netflix’s large negative free cash flow, which it expects to continue “for many years.”
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).
What’s the source of the cash burn?
“When we produce an amazing show like ‘Stranger Things,’ that’s a lot of capital up front, and then you get a payout over it over many years,” CEO Reed Hastings explained Monday. “And seeing the positive returns on that for the business as a whole is what makes us comfortable that we should continue to invest.”
Put more formally: “With our content strategy paying off in strong member, revenue and profit growth, we think it’s wise to continue to invest,” Netflix wrote in its letter to shareholders. “In continued success, we will deploy increased capital in content, particularly in owned originals, and, as we have said before, we expect to be FCF negative for many years.”
This strategy gives some analysts pause.
Here’s a good expression of the concern from MoffettNathanson’s Michael Nathanson (via Deadline):
“We’ve mused that the current model is akin to a new restaurant serving the best filet mignon for $10 per steak and watching happy patrons fill every seat. At some point, the restaurant’s owners (and lenders) will start asking about a path to generating cash flow on that investment … we just don’t believe that Netflix is building an impenetrable moat that justifies its $80 billion in market cap.”
Netflix management, however, sees its high cash burn as a sign of success, since it means its original content strategy is working.
“The irony is the faster we grow, and the faster we grow owned originals, the more drawn on free cash flow that will be,” Hastings said. “In some senses the negative free cash flow will be an indicator of enormous success.”