How Netflix Reached Positive Quarterly Free Cash Flow for the First Time in Years

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Netflix CEO Reed Hastings

The streaming giant now expects a free cash flow deficit of only $1 billion or less for the year amid production shutdowns due to the coronavirus pandemic, compared with $2.5 billion previously.

Netflix's first-quarter earnings report Tuesday once again focused much attention and debate on the global streamer's subscriber momentum, which exceeded even the most bullish expectations amid the coronavirus pandemic. But the company also surprised Wall Street by posting positive free cash flow for the latest quarter, the first time it has done so in years.

One key question for analysts has long been when Netflix can get to the point where it can self-fund its spending, including its annual content budget that has grown to more than $15 billion.

In that context, one figure that drew much attention was the streaming giant's forecast for a reduced free cash flow loss in 2020 of $1 billion "or better" amid shuttered productions of original content.

The company, led by CEO Reed Hastings, had in late January reported a 2019 free cash flow loss of $3.3 billion, highlighting that it expects this to have been "the peak in our annual free cash flow deficit." Netflix back then also said: "Our plan is to continually improve free cash flow each year and to move slowly toward free cash flow positive," forecasting a 2020 free cash flow deficit of approximately $2.5 billion.

"With our productions currently paused, this will shift out some cash spending on content to future years," the firm said. "Due to the production shutdown, some cash spending on content will be delayed, improving our free cash flow" this year.

Netflix on Tuesday reported positive free cash flow of $162 million for the first quarter, compared with a year-ago loss of $460 million.

"That wasn't COVID-related," CFO Spencer Neumann told analysts during an earnings interview, signaling the key factor was the timing of content spending. "To be clear, I mean, we would have been positive free cash flow without the recent COVID events," despite some benefit from delayed spending. 

Neumann also signaled that the spending postponements would mean 2021 free cash flow losses will widen over 2020. "As productions ramp, that cash spend will increase again," he explained.  "It's still a multiyear path to sustained free cash flow positive. It's just going to be a little bit choppier getting there. And 2019 will still be our maximum negative year."

Wedbush Securities analyst Michael Pachter tells THR that one has to go back a few years for another positive free cash flow quarter for Netflix. "They generated positive free cash flow every year from 2002 until 2011 and generated positive free cash flow for a quarter as recently as the second quarter of 2014," he explains. 

Netflix for its second quarter of 2014 had reported positive free cash flow of $16 million before turning to a third-quarter 2014 loss of $74 million, saying: "Our increased use of cash for content, especially originals, will cause free cash flow to be materially less than net income, at least for the years ahead while we are increasing our investment in this area."

"It has been consistently negative since, but a spike in memberships and the inability to spend on content explain why it turned this quarter," explains Pachter.

The free cash flow commentary led Wall Street analysts to update their projections for 2020 and beyond, but most didn't change their expectation for what year will turn free cash flow positive. Said Guggenheim Securities analyst Michael Morris: "The path to free cash flow positive is likely to take the same amount of time given shifts in programming investment."

Evercore ISI analyst Lee Horowitz had on April 16 forecast better free cash flow trends for Netflix in 2020 caused by production delays. Back then, he predicted a free cash flow loss of $2.10 billion in 2020, followed by a $1.80 billion loss in 2021 and a loss of $294 million in 2022, before the company turns a free cash flow profit of $898 million in 2023. On Wednesday, he updated his forecasts to a 2020 loss of $988 million, a 2021 loss of $2.02 billion, a 2022 loss of $449 million and a 2023 profit of $986 million.

Morris on Tuesday narrowed his 2020 free cash flow loss forecast from $2.5 billion to $951 million, predicting losses for the three remaining quarters of the year. He sees the loss widen to $1.14 billion in 2021 and drop to $157 million in 2022 before turning to a free cash flow profit of $1.14 billion in 2023.