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Netflix still has a big appetite for debt

This article was originally published on All figures quoted in US dollars unless otherwise stated.

Just a few days after setting a massive new record for quarterly operating income, Netflix (NASDAQ: NFLX) plans to tap the debt market once again to fund its content budget. The streaming leader aims to raise another $2 billion in U.S. dollars and euros just six months after its last $2 billion bond issue. The move underlines the expectation Netflix will burn $3.5 billion in cash this year, and negative cash flow will remain elevated for the foreseeable future even as it starts to trend back toward breakeven next year.

Netflix ended the third quarter with $12.4 billion in long-term debt and $4.4 billion in cash and equivalents. But with big competitors entering the market and weak domestic subscriber growth, Netflix needs to keep investing in original content to maintain its position well ahead of the pack.

Where will all the cash go?

CFO Spence Neumann reiterated his outlook for negative $3.5 billion in cash flow in Netflix's third-quarter letter to shareholders, but the company's only tallied about $1.6 billion in negative cash flow through the first nine months of the year. In other words, Neumann expects $1.9 billion in negative free cash flow in the fourth quarter.

"That is investment in future content to be delivered on our service," Neumann said on the earnings call. 

Additionally, it's likely Netflix will see increased marketing spend in the fourth quarter given some big-name content releases including The Irishman and season 3 of The Crown. The fourth quarter is also when Netflix will spend most of its marketing budget to try to win awards. Marketing expenses totaled just $683 million through the first nine months of the year, less than it spent in the same period last year.

Netflix has a lot of spending already planned for the fourth quarter, and just $4.4 billion in cash. And while that's slightly more than it ended 2018 with, the company is facing a future in which it admitted to having "less precision in our ability to forecast" due to new upcoming intellectual property launches and new competition. If ever it needed a bigger cash buffer, it's this quarter.

A growing original content budget

The incoming competition is impacting Netflix's content budget in a couple ways, requiring it to invest more in original content. And original content requires big up-front cash investments with the expense amortized over the useful life of the production. Licensed content doesn't require nearly as much cash up front.

On one side, companies like Disney and AT&T's WarnerMedia are taking back popular licensed content for their own streaming services. There are fewer and fewer pieces of high-quality licensed content still available on the market, and the price for that content has increased considerably over the last half decade. As a result, Netflix is being forced to shift more of its content spend to originals.

On the other side, the growing competition puts further pressure on Netflix to create blockbuster original series and films that can keep viewers interested. That's especially pertinent after two disappointing quarters in a row of domestic subscriber additions. In its second-quarter letter to shareholders, management said its second quarter content slate was to blame for its lower-than-expected net additions. Content chief Ted Sarandos is putting more focus on new original content projects driving a number of new signups commensurate with the budget for those projects.

Netflix has some big cash expenses coming up as it faces pressure from new competition. On top of that, all the new entrants in the market will make it more difficult for Netflix to accurately project its future earnings and cash needs. While the company will move toward breakeven cash flow over the long term, the near-term pressure may produce some noise around its results. As such, Netflix needs to raise more debt, and that's not going to change much in 2020.

This article was originally published on All figures quoted in US dollars unless otherwise stated.

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Adam Levy owns shares of Walt Disney. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of and recommends Netflix. The Motley Fool Australia has recommended Netflix. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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