At the onset of 2020, Netflix (NASDAQ:NFLX) management told investors they should expect the company to burn through about $2.5 billion in cash over the course of the year. When the streaming video giant reported its fourth-quarter results last month, its final tally for the year was positive $1.9 billion in free cash flow. What’s more, management said the company expects to break even on the free cash flow front in 2021.
A few key factors led to Netflix outperforming its free cash flow expectations by a whopping $4.4 billion last year. They can be telling of why management had the confidence to increase its expectations for 2021 by about $1 billion.
Subscriber growth pull forward
Netflix experienced a huge influx of subscribers in the second quarter as people stayed home and on their couches. Management is of the view that the pandemic pulled forward much of the subscriber growth that would have come in later quarters — inducing people who had been thinking about signing up for the service to join sooner than they otherwise would have. As a consequence, it expects to underperform on subscriber net additions until the second half of 2021, after it has lapped last year’s unusual second quarter.
Netflix’s revenue climbed by 24% — $4.8 billion — from 2019. And it added around 8 million more subscribers in 2020 than in 2018 and 2019, but it also front-loaded its subscriber growth with a major spike in April. As a result, those added subscribers as a group were paying, on average, for more months of service in 2020 than usual — delivering even more revenue for the company.
That benefit will carry over into 2021 as Netflix starts the year with more subscribers than it had anticipated.
Netflix probably won’t add nearly as many subscribers this year as it did in 2020. Management expects first-quarter subscriber growth to trail the levels of the last three years. But it’s worth noting that its fourth-quarter net adds in 2020 were roughly in line with the numbers from 2018 and 2019.
Netflix can also offset the financial impact of slower subscriber growth by raising prices. It boosted its monthly prices in the U.S., Canada, and U.K. last year, and it could increase rates in other markets soon.
Efficient marketing spend
One of the most impressive aspects of Netflix’s 2020 performance is that the company attracted all of those new subscribers despite cutting its marketing spending by more than $400 million. While Netflix did pay more to its distribution partners, which collect commissions on new subscriptions, it spent $432 million less on advertising.
Also remarkable is that Netflix did all that at a time when competition in streaming had reached a new level of intensity. Several high-profile streaming services launched last year, and the media companies behind them spent a lot on marketing to promote them.
Whether Netflix can maintain or improve its marketing efficiency in 2021 remains to be seen. But it has worked hard to establish its brand around the world, and it could benefit from the secular trend toward streaming, carried along by the momentum of its prior investments.
Lower content spending
Netflix spent significantly less on content in 2020 than it planned to, as COVID-19 shut down production for months. Cash outlays for new content totaled just $12.5 billion, compared to $14.6 billion in 2019.
Those lower outlays were responsible for a big chunk of the company’s free cash flow outperformance in 2020, but its spending is ramping back up quickly. Netflix plans to release hundreds of new titles in 2021; it currently has over 500 in postproduction. Its content budget will likely top 2019’s, putting more than $2 billion in additional pressure on free cash flow in 2021.
Here’s the good news for investors. Content spending is one of the factors that has the biggest impact on Netflix’s free cash flow, but management has plenty of control over how much it lays out for that in any given year. With improving marketing efficiency and far more subscribers as it starts 2021 than it originally anticipated, Netflix could easily meet its objective to break even on the free cash flow front this year. In fact, its conservative forecast for subscriber growth to be slower than it was in 2018 and 2019 despite strong growth in the fourth quarter means it could produce another year of positive free cash flow.
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