This Day On The Street
Continue to site right-arrow
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
Stocks Under $10 with 50-100% upside potential - 14 days FREE!

Beware Deteriorating Cash Flow in Netflix, Amazon, Google Earnings

Stocks in this article: AAPL NFLX AMZN GOOG

NEW YORK ( TheStreet) -- When it comes to judging the earnings growth of top-performing tech and media giants such as Netflix (NFLX), Google (GOOG) and Amazon (AMZN ), investors need to follow the money and not just the hype.

A paper chase for cash from the respective leaders in streaming video, Internet search and e-commerce indicates each company is prone to a deterioration in operating cash flow, which raises question marks about the quality of recent earnings.

Two successive quarters of negative cash flow at Netflix, falling figures from Google and forecasts of record profits for but dropping operating cash flow at Amazon in 2013 may all pose underappreciated risks for investors.

Over the long-term, cash flow from operations should match the general direction of earnings. Once this quarter's earnings conclude, however, earnings among top-performing tech bellwethers are likely to show a marked divergence between flat-to-declining cash flow and rising profitability.

Were cash flow figures to be a reflection of the true earnings prospects for Netflix, Google and Amazon in 2013, investor expectations may have run too far.

Netflix Builds A House of Cards

At Netflix, successive quarters of negative free cash flow and rising profits leave open question marks about the company's much hyped effort to create original shows such as House of Cards, Arrested Development and Hemlock Grove for its streaming subscribers.

Following the money in Netflix's earnings indicates that while original content may be driving user growth and excitement surrounding the streaming service, profits from the strategy remain far from assured.

In fact, negative cash flow signals the company has set a high bar to achieving profitability from original content in coming quarters.

Netflix reported operating profits of $31.8 million and adjusted earnings per share of 31 cents in the first quarter of 2013. Those figures, however, excluded $45 million in quarterly cash costs related to original content that pushed overall free cash flow to negative $42 million.

Similarly, in the fourth quarter of 2012, Netflix reported $19.6 million in operating profit but negative $51 million in free cash flow, driven by un-expensed original content spending.

The divergence in Netflix's net income to cash flow has to do with how the company expects to profit from shows like House of Cards.

While the company expensed some cash costs to produce original shows in the past two quarters, the majority of Netflix's content expense is yet to be amortized. Only then will the costs of original content truly hit Netflix's bottom line and show just how profitable the company's strategy can be.

Put another way, Netflix didn't need to recover every dollar it spent on House of Cards in the first quarter, when the series was released. Netflix's expectation, as per its accounting, is that the company will see long-term revenue from current content spending among subscriptions paid by its 29 million users.

If Netflix is correct on its assumptions, it should earn revenue equal or beyond the amortization of spending, which drove cash flow negative in the last two quarters.

As of the first quarter, Netflix's cash flow statement shows $591 million in cash spent on its streaming content library, but just $485 million in streaming content expense amortized over the period.

With cash flow from operations to net income divergent by about $100 million, Netflix has set a very high bar. The company, after all, has only reported about $10 million in net income over the past two quarters.

Continued negative cash flow on original content will likely also remain a factor for all of 2013, according to Netflix's own statements.

"The investments that will continue to weigh on our cash flow relative to net income are Originals and non-Originals content (ongoing) and our Open Connect conversion (primarily in 2013)," the company said in its earnings release Monday.

Those comments appear to differ from the fourth quarter, when Netflix said a divergence in cash flow and expense would end in the first quarter.

"The bulk of our remaining cash payments for our current originals will be in Q1, driving FCF materially more negative than Q4, and then FCF will improve substantially in subsequent quarters," Netflix said in its fourth earnings release.

Even as investors cheer Netflix rising profits, the question is whether unamortized current original content spending will wipe out future earnings.

While CEO Reed Hastings is right to see about 2 million new subscriber additions in the first quarter as validation of the appeal of original content, Netflix may need far more new users to prove the rationale to investors. Hastings said Monday he sees a total addressable subscriber market of up to 90 million users for Netflix.

1 of 3

Select the service that is right for you!

Action Alerts PLUS
Try it NOW

Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
  • Weekly roundups
TheStreet Quant Ratings
Try it NOW
Only $49.95/yr

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
  • Upgrade/downgrade alerts
Stocks Under $10
Try it NOW

David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
  • Weekly roundups
Dividend Stock Advisor
Try it NOW

Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Alerts when market news affect the portfolio
  • Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
Real Money Pro
Try it NOW

All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.

Product Features:
  • Real Money + Doug Kass Plus 15 more Wall Street Pros
  • Intraday commentary & news
  • Ultra-actionable trading ideas
Options Profits
Try it NOW

Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • 100+ monthly options trading ideas
  • Actionable options commentary & news
  • Real-time trading community
  • Options TV
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!


DOW 17,356.87 +288.00 1.69%
S&P 500 2,012.89 +40.15 2.04%
NASDAQ 4,644.3120 +96.4780 2.12%

Brokerage Partners

Rates from

  • Mortgage
  • Credit Cards
  • Auto

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs