Scandal? Netflix Piles Up More Debt

Even as it racked up another quarter of record subscriber and revenue growth, Netflix is significantly increasing its spending in multiple key areas to stay at least one step ahead of its growing number of streaming rivals. As a result, it's pushing its already high debt load even higher.

In its fourth-quarter letter to shareholders released late Monday, Netflix Inc. (Nasdaq: NFLX) reported that it plans to spend a whopping $7.5 billion to $8 billion on content in 2018, up as much as 33% from about $6 billion last year. With 25% of its content budget now devoted to original TV programming and films, the streaming giant particularly intends to boost its spending on international content this year as it continues to grow faster outside the US than inside its home country. For instance, it aims to launch 30 international original series in 2018, including projects from France, India, Japan, Korea and Poland.

"We're growing faster than we expected, which allows us to invest more in original content than we had planned," the company explained in its shareholders letter. "Given our track record of content investments helping to increase growth, we are excited about the growth in future years from the increased investments we are making in original content this year."

At the same time, Netflix plans to spend about $2 billion on marketing this year, up more than 50% from $1.3 billion in 2017, to promote all that fresh content and stoke further growth. So, even though its subscribers, revenue and net income are all rising at a healthy clip, its promotional spending is rising even faster.

"We're taking marketing spend up a little faster than revenue for this year because our testing results indicate this is wise," the company noted in the shareholders letter. "We want great content, and we want the budget to make the hits we have really big, to drive our membership growth."

Further, Netflix intends to increase its investment in technology and development to roughly $1.3 billion in 2018, also up from last year. The company did not reveal exactly how much it spent in that category in 2017.

Netflix is making all these moves to rev up its growth engine even more as existing competitors such as Amazon Studios, Apple, Hulu, YouTube and Facebook continue to expand their video streaming efforts and such major new rivals as Walt Disney Co. (NYSE: DIS) prepare to enter the streaming space. While Netflix executives like to argue that there's plenty of room for all, they are not exactly sitting back and watching things unfold.

Due largely to these planned spending hikes, particularly on content, Netflix expects its free cash flow picture to worsen substantially in 2018. The company expects its negative free cash flow to balloon by 50% to 100% this year, increasing from negative $2 billion in 2017 to negative $3 billion to $4 billion this year. But the company almost blithely dismisses this development as just a temporary but necessary cost of expanding so aggressively.

"When we develop a title like 'Bright,' the cash spend is one to three years before the viewing, associated membership growth and P&L expense," the company said in the shareholders letter. "Thus, the faster we grow our originals budget (particularly for self-produced content), the more cash we consume. We are increasing operating margins and expect that in the future, a combination of rising operating profits and slowing growth in original content spend will turn our business FCF (free cash flow) positive."

In addition to the much higher negative free cash flow, Netflix is also facing a much larger debt burden because of its free-spending ways. The company said its total liabilities rose by almost 50% last year, increasing from $10.9 billion at the end of 2016 to $15.4 billion at the close of 2017. In particular, its long-term debt skyrocketed, nearly doubling from $3.4 billion to $6.5 billion over the year's span. (See Netflix's Busy Week: Debt, Data & Video Monogamy.)

With Netflix posting record subscriber gains (up 8.3 million to 117.6 million), surging revenues ($3.28 billion, up from $2.47 billion a year earlier) and rising net income ($186.5 million, up from $129.6 million) in Q4 and forecasting an even stronger 2018, though, investors continue to shrug off any concerns about the company's mounting debt load and negative free cash flow. Consequently, Netflix shares climbed 8.3% ($18.92) to $247.50 each in after-hours trading Monday evening. Maybe investors have seen stranger things. (See Netflix Hikes Rates, Tries to Outrun Debt.)

— Alan Breznick, Cable/Video Practice Leader, Light Reading

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