For the investing community, the Netflix content spend is one of the most talked about items with respect to the bull case and bear case for investing in Netflix stock (NFLX). But few truly understand the Netflix content spend, why it’s important for the business, and what elements of the spend we should be truly monitoring. Let’s try to fully breakdown the Netflix content spend here and explain why it’s important.
How much does Netflix spend on content?
There are typically two ways you can look at with respect to how much Netflix is spending on content. First, Netflix quantifies an amortization amount each quarter and year which identifies essentially how much of its content assets Netflix is writing off each period. The more closely watched mark is the cash spend each quarter or year with respect to its content. In the below chart, we map out the Netflix content spend by year with both content amortization and cash spend clearly marked:
What’s the difference between Netflix’s content amortization and cash spend?
Amortization refers to how much of its content assets Netflix writes off during a given period. It’s a way of extending out the cost of content. Netflix attempts to match up the writing off of content with the useful life of the content.
Netflix articulates its amortization methodology as follows: “content assets are amortized over the shorter of the title’s window of availability or estimated period of use or 10 years. On average, over 90% of a licensed or produced streaming content asset is expected to be amortized within four years after its month of first availability.”
If you analyze Netflix’s financial statements, the amortization expense is recorded in the income statement as part of cost of revenue. The cash spent on content is better noted in Netflix’s cash flow statement.
Cash spend has been increasing in recent years clearly showing Netflix’s shift to producing more of its own content. When Netflix produces original content, the expenses are much more upfront (as compared to a licensing arrangement over time). As such, cash spend has been increasing faster than the amortized amounts.
One way investors monitor this (and Netflix mentions from time to time) is the ratio of cash spend to amortization. The following chart shows this ratio over the same time period as the above content spend chart. Note: The higher the ratio, the larger the gap between cash spend and amortization (cash spend being higher).
The above chart clearly shows how cash spend has been increasing faster than amortized content expenses. As Netflix prepared for the loss of licensed content and the shift in the competitive environment, it began investing heavily into its own exclusive content and this chart (along with the overall increase in content spend) clearly shows this move.
Is the shift to exclusive and original content a good move for Netflix?
It’s been an expensive move, and the cash spend as resulting negative cash flow in recent years is certainly a commonly cited element of the Netflix bear case. But will it work? As of now, I think the answer is a clear yes for several reasons.
First, subscriber growth and the Netflix stock price has seen incredible performance in recent years. Netflix has been one of the best performing stocks in recent years, and at the end of the day, this is mostly what matters.
Second, Netflix had no choice. Netflix management clearly saw the changing competitive environment before others and began investing heavily in its own content even before news began breaking of companies like Disney, NBC and WarnerMedia potentially pulling its licensed content from Netflix. Netflix couldn’t rely on third-party content especially when these companies realized that the market was shifting and they would need their own direct-to-consumer streaming services.
Lastly, it’s possible that Netflix’s costs will actually benefit from this. Producing content is quite expensive, but the costs are upfront and then Netflix owns the asset forever. Whether or not this will show itself to be a less expensive form of acquiring content long-term will depend on the long-term usefulness and development of major brands that users will want to enjoy for years and years. A home run is for one or more of Netflix’s owned series to achieve the popularity of a series such as Friends or The Office which are commonly some of the most streaming titles on Netflix many years after they left the air. Time will tell.
Overall, CEO Reed Hastings and other Netflix executives have commonly referred to the flywheel effect where as Netflix produces more content, they can acquire more users which lets them produce more content which lets them acquire more users.
It’s a positive feedback loop that will power the growth of the business for many years. While investors contemplate short term cash flow questions, it seems that Hastings and his team are focused on the long game and just how large its user base can be five and ten years down the road. Should Netflix succeed, negative cash flow and debt levels of 2018 and 2019 will feel trivial in comparison to the potential revenue and profitability of a globally dominant streaming service with several hundred million paying subscribers.
We’ll continue to update the data on Netflix content spending as the company continues to release data.