Unless you’ve been living under a rock, you’ve heard about the monumental rise of online streaming service Netflix, Inc. (NASDAQ:NFLX). The company has become a consumer favorite for streaming subscription services. And Netflix stock has been a market darling over the past year.
In 2017, NFLX delivered 55% growth to investors and the stock looks set to continue soaring in the year to come. So far this year, Netflix stock has risen 45% — and that’s taking into account the pullback that investors saw during the correction.
Although there’s a lot to like about Netflix stock right now, it’s not all roses. In the fourth quarter, NFLX reported free cash flow of -$524 million. That’s concerning. It suggests that the company’s expenses are outpacing subscription revenue, a model that won’t be sustainable in the long term.
When you take a close look at Netflix’s future plans, however, the negative cash flow looks less ominous.
The Spacey Effect
A large part of the reason for NFLX’s negative cash flow was that the firm canceled all of its projects involving actor Kevin Spacey. In 2017, Spacey became the subject of controversial allegations regarding sexual misconduct. As a response, Netflix management decided to pull the plug on an original movie and pause production the company’s massively successful series, House of Cards.
The abandoned Spacey projects are estimated to have cost Netflix around $39 million. And while that’s certainly not an immediate positive for the company, it was ultimately the right thing to do.
Sexual misconduct and harassment is a hot topic right now in Hollywood. Had Netflix gone ahead with the projects after reports that Spacey behaved inappropriately with more than 30 men at various times in his career, it would have painted a poor picture of the firm’s ethics.
Netflix is reportedly writing Spacey’s character in House of Cards out of the series, so the sixth and final installment will eventually be released once it has been re-shot. As for the movie, Netflix appears to have shelved it indefinitely.
However, the good news for shareholders is that NFLX avoided what could have become a public relations nightmare. The wasted spending to make the projects and the cost to shelve and reshoot, were one-time costs that will not appear in the firm’s expenses moving forward — and reflect well on Netflix’s reputation in general.
Content is King
The other reason to overlook NFLX’s quickly rising expenses is that the industry is reaching a saturation point in which only the strong will survive.
Netflix is making sure that it’s one of the strong. When the streaming platforms are providing similar services, the biggest factor keeping existing users and attracting new subscribers is content. And Netflix has been a leader in original programming since the firm first started producing its own TV shows and movies.
With Walt Disney Company (NYSE:DIS) making its grand entrance into streaming subscription services soon and companies like Alphabet Inc. (NASDAQ:GOOG) building out their own content libraries, Netflix needs to stand out from the crowd.
Netflix recently lured producer and director Ryan Murphy and his production company into a five-year contract that will make his highly anticipated new series exclusive to Netflix. Murphy is behind hugely successful shows like Glee and American Horror Story, so his contract with Netflix will likely bring a great deal of quality content to the NFLX library.
Not only will spending on premium content help NFLX stand out in a crowd, but it also gives the firm a great deal of pricing power.
Last year, we saw Netflix raise its subscription costs — something many worried would drive away some existing users. The price hike was little more than a blip on the radar for the majority of Netflix users, however. This proves that people are willing to pay a little more for content they like.
The Bottom Line For Netflix Stock
Netflix stock price has already delivered impressive gains over the past 5 years. But as the streaming space matures and the battle for market share heats up, NFLX is likely to continue climbing higher.
Netflix has established itself as a market leader. And its spending is necessary to continue growing and improving its content library.
Barring any other large write downs like the Spacey films in the fourth quarter, Netflix is unlikely to see such troubling cash flow figures and investors shouldn’t worry.
As of this writing, Laura Hoy was long NFLX.