Netflix‘s (NASDAQ: NFLX) New co-CEO Ted Sarandos might feel a little strange these days. The video streaming pioneer is producing hundreds of millions in positive free cash flow after its second consecutive quarter in the black. What does the content have to do with pockets full of cash during a pandemic?
Netflix previously had not produced two consecutive quarters of positive free cash flow since 2014. It now expects a balanced or better cash flow for 2020.
However, that will not last. Sarandos and the rest of the Netflix team are eager to increase production again, and CFO Spence Neumann expects free cash flow to fall back into negative territory next year. And despite operating margin expanding to 22% in the last quarter, Neumann still expects to manage the company at a margin of 16% by 2020 and 19% in 2021.
Image source: Netflix.
Reinvestment of income
The increase in subscribers in the first two quarters of 2020 has generated higher revenues than expected at the beginning of the year. Management reiterated its warning that it sees much of that subscriber growth as a preview of members who may have signed up later in the year. That’s evident in her forecast for just 2.5 million net subscriber additions in the third quarter, compared to 6.77 million last year.
“Any upside benefit, we would tend to put more content in for our members, driving more growth over time,” co-CEO Reed Hastings said during the second-quarter earnings call. However, with many productions closed at the moment, Netflix has a limited ability to reinvest revenue. But “that would be the plan,” Hastings said.
Netflix remarkably manages its content and marketing expenses to achieve an operating margin target. And it has consistently reached that margin in recent years. “There may be some upward margin this year in 2020,” said Neumann, “but we are really trying to achieve that multiple year by continuing to increase our margins.”
Plenty of room to continue expanding the margin
Netflix’s second-quarter results indicate that there is still plenty of room to continue expanding the operating margin for the business. So next year’s 300 basis point expansion will likely be followed by another 300 basis point expansion in 2022.
As the operating margin expands, so does the free cash flow margin. Neumann noted that the second quarter offers investors in FAANG shares a sneak peek at how finances look when cash spending on content equals their spending on content. The company posted a free cash flow margin of 15%, which investors in FAANG shares could consider a floor for the free cash flow margin.
“By the time our cash to cash redemption ratio reaches 1x on a sustained basis (which is still many years away), we expect to have many more members and higher revenues, operating margin and FCF,” wrote management in the letter. of the second quarter to shareholders.
But increasing production again is still the number 1 priority on Netflix. Sarandos and Neumann reiterated that Netflix will be a better service in 2021 than in 2020, which means more content and better recommendations.
Neumann has a long track to keep expanding the operating margin target, while Netflix spends billions more each year on new originals and licensed content. And there is no rush for the company to reach a terminal profit margin or a free cash flow margin profile in the short term.
