The Netflix Inc. app is displayed for a photograph. (Photographer: Daniel Acker/Bloomberg)

Netflix Earnings: Growth Is in the Eye of the Beholder

(Bloomberg Gadfly) -- Netflix Inc. is the Uber of the entertainment programming business. Whether Netflix investors recoil or cheer at the comparison depends on their risk tolerance. 

Netflix doesn't share Uber's inclination to push boundaries, and it has a well-functioning business. But both companies are impressive growth machines that rely on outside funding to maintain the momentum. And in both cases, it's not clear what the real trajectory of the business would look like if access to capital dried up. 

First, let's run through the impressive growth part of the Netflix machine. 

Netflix Earnings: Growth Is in the Eye of the Beholder

Netflix said on Monday that it added 8.3 million more subscribers than it lost for its streaming service. That was the most new streaming customers in Netflix's history. Even in the U.S., where analysts believe more than half of households with fast internet service already subscribe to Netflix, the company added more net new streaming customers in 2017 than it did the year before. The continued pace of customer additions validates both Netflix's recent decision to raise prices on many subscribers in the U.S. and to go all-in on a globalization strategy the company unveiled two years ago. 

But just like at Uber, growth comes at a cost for Netflix. That cost is the piles of money Netflix has set alight for three years to finance its globe-trotting ambitions, and to purchase -- rather than rent -- more of the TV shows and movies the company makes available to streaming subscribers. The cash costs for Netflix's streaming programming reached $8.9 billion in 2017, about double the costs from two years earlier. The number of Netflix streaming customers hasn't increased as much, at about 60 percent, over that period.

Netflix Earnings: Growth Is in the Eye of the Beholder

Netflix also said its free cash flow would widen to as much as negative $4 billion in 2018, compared with an already stunning negative $2 billion in 2017. Netflix has already been clear it won't generate positive cash flow for years as it tries to become the preferred entertainment source for the world, and one that has profitable economics. But potentially burning through $4 billion in cash is staggering. Netflix and Uber are betting that the companies should lean into their growth and spend even more to get bigger fast. It could turn out to be a stellar bet. Or fail spectacularly.

Netflix's strategy means two things: The company must keep churning out shows compelling enough to persuade more people to subscribe, and it needs to be able to continue borrowing money at low cost to finance its losses.

So far, Netflix stock and debt investors aren't worried. Netflix bonds due in 2026 have been trading just below 100 cents on the dollar. Netflix shares shot up about 9 percent in after-hours trading after the company released its financial results. Already the company's enterprise value is more than 50 times estimated 2018 earnings excluding interest, taxes, depreciation, amortization and employee stock compensation costs. Those are not characteristics indicating signs of worry. 

It's hard to find fault with Netflix's execution or its track record. The company is making a rational decision to splurge while it can and borrow money while it's cheap. But no one knows what Netflix looks like in normal funding times. What happens if the debt market isn't as compliant in coming years? The Netflix growth machine suddenly looks less like a sure thing. I'd call it a roller-coaster ride, but at least roller coasters tend to follow a predictable trajectory and wind up exactly where they started. For Netflix, confidence about where the company ends up is all in the eye of the beholder.  

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

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

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

©2018 Bloomberg L.P.