Tech

Shira Ovide is a Bloomberg Gadfly columnist covering technology. She previously was a reporter for the Wall Street Journal.

Netflix Inc. is showing signs of prudent financial management. 

This is a surprise because the company seemed hell-bent on signing up as many customers as it could no matter the cost. That's one reason the company opened for business in nearly every country in the world and has been dive-bombing Hollywood with cash to buy more exclusive television series and movies. Those ambitions have made Netflix burn cash like crazy, but investors haven't been bothered.

Cash Bonfire
Netflix's free cash flow has turned negative in the last three years as the company spends on new programming and international expansion
Source: Bloomberg
Note: Free cash flow is cash from operations minus capital expenditures.

On Thursday, Netflix announced it would raise prices for many Americans who subscribe to its video-streaming service, to $10.99 a month for its most popular package from $9.99. When Netflix increased its U.S. monthly membership costs in 2015, the company took about a year to apply the price increases to all its customers. Netflix made it sound as if the extra costs would kick in more quickly this time around.

There's a natural effect when prices go up: Demand tends to go down. The company has acknowledged that its earlier U.S. price increase dragged down subscriber growth.

But it should be fine if history repeats itself. Netflix executives have chided Wall Street for focusing too much on its subscriber gains. (Mind you, they didn't mind this fixation when Netflix was posting eye-popping numbers of new customers.) Netflix is sensibly recognizing that its U.S. business is relatively mature now that roughly half of American households with Internet access have signed up for the service. Mature businesses don't grow that fast, but they can generate fat profits if managed correctly. 

The Cost of Ambition
Netflix has said it plans to spend $6 billion this year to buy or license entertainment programming
Sources: SNL Kagan, Netflix, company filings and Bloomberg Intelligence

An extra dollar a month from each of Netflix's 50 million paying streaming customers in the U.S. translates into roughly an extra $600 million a year in revenue, or about 5 percent of the company's expected 2017 revenue.   The company's spending is going up even more than that. This week, a Netflix executive said the company might budget $7 billion next year to license or purchase entertainment programming, up from an expected $6 billion this year.

The company may be setting up a bifurcated financial strategy by milking its U.S. business for profits and then plowing that money into building a global entertainment empire. This harvest-and-invest strategy makes sense. It's what Amazon is doing, too. Its U.S. e-commerce business generates operating profits, albeit puny ones. The Seattle company is unprofitable outside its home country. 

Cutting the Cord
Netflix's membership continues to grow in the U.S. but not at the same rate as prior years
Source: Netflix

There's one big potential problem, though, if the growth in Netflix customers starts to slow or the numbers shrink in the U.S. The company absolutely must get as many customers as it possibly can to justify its spending spree on programming. Those fixed costs only pay off if Netflix has more customers, and it's not yet clear that it can get enough profitable subscribers in places like Brazil and India to offset the possible loss of paying members in the U.S. 

Investing in Netflix takes a leap of faith. It requires believing the company's growing debt and continued burning cash will pay off in the future. And now, believing in Netflix also requires hoping the number of people signing up grows even as their bills do, too. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. This assumes Netflix's subscriber count stays flat.

To contact the author of this story:
Shira Ovide in New York at sovide@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net