U.S. Markets open in 1 hr 46 mins

Netflix bulls are ignoring a very bearish detail in the streaming giant's numbers

Brian Sozzi

Those obsessed with Netflix shares should keep in mind the old adage that cash is king.

That’s because at its current voracious pace of spending on original content such as House of Cards, Netflix is running the risk of ballooning debt and surging interest payments that could surprisingly hammer the bottom line. With Netflix long ago earning the momentum trade moniker, the last thing traders want is to be negatively surprised on an earnings release. And from a long-term investment standpoint, a balance sheet saddled with debt just as competition from Disney and others in streaming is poised to heat up is a very unsexy place to be.

Streaming media beast Netflix reported Tuesday that through the nine months ended Sept. 30 its free cash flow was an astounding $1.7 billion outflow.

Free cash flow is defined as cash flow from operations minus capital expenditures. It’s used by Wall Street analysts to measure the long-term value of a business. Since Netflix has blown through cash for the last six years, analysts have chosen to value the company based on subscriber growth potential (among other measures).

Cash burn

But the Netflix cash burn, as it’s called on the Street, is a worthy issue for investors to monitor as it’s starting to change the complexion of the company’s financials. Netflix now has $8.3 billion in long-term debt on the books, up from $6.5 billion at the end of 2017. Interest expense so far this year has swelled to $291 million versus $238 million for all of 2018. That is money that could be flowing to the bottom line, but it’s not.

Wall Street doesn’t see Netflix turning cash flow positive within the next four years, according to Bloomberg data. That suggests Netflix may have to issue more debt to fund its ambitious plans around original content and international expansion. Not a good look.

Unsurprisingly, Netflix CEO Reed Hastings and his exec team continue to downplay that the aggressive use of cash is an issue.

The Netflix logo is shown in this illustration photograph in Encinitas, California, U.S. REUTERS/Mike Blake

“Netflix is approaching a point where the growth in operating profit is going to grow faster than our growth in content cash spend, and that’s really going to drive the free cash flow towards improvement — It will eventually breakeven,” said Netflix chief financial officer David Wells on a conference call with analysts. Wells added he says “material improvement” in cash flow by 2020. Note he didn’t say Netflix would be a cash creating machine by that point.

Netflix expects to burn through more than $3 billion in cash this year and in 2019.

“That’s just crazy”

“My competitors have Netflix turning cash flow positive in two years, that’s just crazy – it’s not going to happen,” Wedbush technology analyst Michael Pachter said on Yahoo Finance’s “Midday Movers’ show. Pachter thinks that because Netflix doesn’t own a good chunk of its content it will be forced to pay out even more to get more content, creating a vicious circle when it comes to cash.

“Netflix is not building something for the future,” Pachter said. He has a Wall Street low $125 price target on Netflix.

Per the norm though on Netflix, investors have ignored the cash flow warnings from those like Pachter come earnings time.

Netflix shares spiked 11% in early trading Wednesday as it brought in 6.96 million total new subscribers’ in the third quarter. The company had guided to 5 million total member additions for the quarter. Netflix thinks it will add 9.4 million new members in the fourth quarter.

Brian Sozzi is an editor-at-large at Yahoo Finance. Follow him on Twitter @BrianSozzi

Read more:

Sears bankruptcy could make these 5 big companies multimillion-dollar losers

How Sears plans to save 400 stores from dying

Sears bankruptcy isn’t surprising when looking at these numbers

Philip Morris International tries risky move of making cigarettes extinct

3 massive problems J.C. Penney’s new CEO must solve