Netflix Investors Should Focus on This Alarming Number—Not Subscriber Growth

As a consumer, I love Netflix. When I’m binge-watching a police drama set in Hong Kong, or Helsinki, or Belfast, one episode per evening over a full month or so, I’m spending so much time with the tortured cops that they feel like old friends. It’s a hoot rooting for these action heroes as they careen through a saga of serial cliffhangers.

But as a business, Netflix is chilling its audience of investors in the latest episode of a long-running, super-suspenseful saga of its own. After the market close on July 17, the streaming service announced that its membership grew by 2.7 million customers in the second quarter, half the 5.5 million added in Q2 of 2018, and far below the company’s forecast of 5 million. Membership was flat. Investors who are counting on gigantic growth to sustain Netflix’s lofty valuation (P/E prior to announcement: 129) reacted with terror, hammering its share price by 11% at the start of trading, and erasing $ 17 billion in market cap.

On the business TV shows, the analysts and hosts focused on the slowdown in new subscribers. During the conference call following the announcement, CEO Reed Hastings and other top executives attributed part of the problem to seasonality, and stressed that Netflix’s growth prospects are stronger than ever.

During that call, no questions were posed on the huge growth in its debt. In fact, the words “debt,” “borrowings,” or “cash flow” never merited a mention. But those are crucial measures, and they’re heading the wrong way, casting doubt on Netflix’s future profitability. What really matters is how quickly Netflix can reach the point where its revenues from members, less marketing and other expenses, will exceed the costs of producing and acquiring all the new series that entice those subscribers. Today, those content costs far exceed the cash Netflix is generating from its basic business of attracting customers and promoting hit shows, and the gap isn’t shrinking, but growing.

Netflix is bridging the gulf with borrowings that are expanding so fast that the service might be nicknamed “Debtflix.”

It’s instructive to compare the cash burn rate at Netflix with the numbers at other glamorous, high-P/E, fast-growers that are renowned for devouring capital. A few weeks ago, I wrote a story showing that four “breakneck burners,” Tesla, Uber, Snap and Lyft, had posted total negative free cash flow of around $ 24 billion since their launch, versus approximately $ 1 billion in combined burn by Apple, Google, Facebook and Amazon in their early years. Conclusion: The breakneck burners may one day become highly profitable, as investors are betting, but the claim that churning through all that cash is remotely normal, is incorrect.

So what’s the amount, and the trend, in Netflix’s cash deficit compared to the four breakneck burners? The measure is free cash flow, consisting of (negative) cash from operations plus capital expenditures. We’ll examine the numbers since 2016. Over that period, Netflix has consumed fast-rising amounts of cash, funded by ever-increasing debt. The deficits were $ 1.66 billion for 2016, $ 2.04 billion for 2017, $ 2.68 billion in 2018, and $ 1.054 billion in the first six months of 2019, out of the company’s projection for the full year of $ 3.5 billion.

Put simply, Netflix is setting a new pace by outrunning the breakneck burners in almost all categories. Here are three areas where Netflix either occupies first place, or vies for the lead.

Negative free cash flow YTD

Tesla, Uber, Lyft, and Snap haven’t yet announced results for Q2, so we’ll compare numbers for all five companies from the start of 2018 through the first quarter. Here, the Netflix cash deficit of $ 2.68 billion ranks first, exceeding number two Uber at $ 2.4 billion, Tesla at $ 1.14 billion, Snap at $ 880 million and Lyft at $ 458 million. Netflix’s projected total of $ 3.5 billion is also likely to take the prize for 2019.

Negative free cash flow since 2016

Here, Netflix at $ 6.94 billion through Q1 actually lags Uber at $ 9.3 billion. But the streaming colossus leads Tesla ($ 5.4 billion), Lyft ($ 1.4 billion) and Snap ($ 2.4 billion). Netflix’s forecast of $ 3.5 billion in negative free cash flow for the year would bring the total over four years to almost $ 10 billion. That would put the streaming service in a horse race with Uber for the four year total.

Increase in debt

Since the end of 2015, Netflix added $ 8.03 billion in new debt. That jump beats Uber at $ 5.5 billion, and Tesla at $ 7 billion. Lyft raised $ 5.4 billion in from preferred stock, and Snap has financed its cash burn by issuing common stock. Netflix also takes the trophy for exceeding all of the breakneck burners in total long-term debt. At the end of Q1, that burden stood at $ 10.4 billion versus $ 9.4 billion for Tesla, and $ 6.9 billion for Uber. (Lyft and Snap are virtually long-term debt free because of their preferred and common stock financing.) Netflix borrowed an additional $ 2.4 billion in Q2, raising its total to $ 12.6 billion and in all probability widening the gap from Tesla and Uber.

That debt load will keep rising, Netflix acknowledges. In its Q2 letter, Netflix states that it “expects an improvement in 2020. From there, we’ll continue to reduce our free cash flow deficit as we intend to continue growing our member base, revenues and operating margin, which provide a clear path towards positive free cash flow. There’s no change in our plan to use the high yield market to finance our cash needs.” If Netflix’s growth falters, as it did in Q2, that crossover point will keep getting pushed back, and burgeoning interest expense that now totals 25% of operating earnings will take an even bigger share.

Stay tuned for the next episode.

More must-read stories from Fortune:

—Meet the A.I. landlord that’s building a single-family-home empire

—You might have longer than you think to invest for retirement

—Will the Fed cut interest rates to prevent recession? 6 predictions

—Schwab’s ‘Project Bear’ uses A.I. to predict when investors are getting nervous

—When the next recession hits, four good things could happen