This model is a problem only if you insist on calculating your own free cash flow totals, and you forget about the investing activities. That seems like a rare combination of doing your homework and forgetting the details. Wouldn’t “most investors and analysts,” as Karpf puts it, fall back on the provided free cash flow calculations rather than making this very particular mistake?
No big deal
Karpf makes it sound like DVD purchases make up the lion’s share of Netflix’s expenses. That used to be true, but it’s simply not anymore.
Netflix was all about DVD rentals up until 2007. Disc purchases peaked that year, just as streaming content deals were about to ramp up. Now, DVD purchases account for a measly 1.9% of the company’s total content costs.
Data from S&P Capital IQ.
I think it’s fair to say that DVD costs don’t really matter to Netflix investors anymore. The company is amortizing its DVD library faster than it’s refilled with fresh content, and that trend is not likely to reverse anytime soon — or ever, for that matter. Hard-copy content is going out of style like bell-bottom jeans and pet rocks. Digital content is the new normal.
Netflix heard you already, Mr. Karpf
If this industry standard practice bothers Karpf, he’ll be happy to see that Netflix is abandoning it.
You’ve already seen how streaming content costs outweigh DVD purchases by a massive margin. The streaming costs are presented in the operating activities section of cash flow statements, and that’s not new: They’ve been there since 2010.
It seems like CEO Reed Hastings and his leadership team agrees with Karpf, and would rather report content costs as operating activities. But the common practice in DVD rentals was to lump it under investing activities, perhaps due to the physical nature and resale value of actual discs.
So the main content costs already go exactly where Karpf wants them, while the DVD operations get phased out over time. This “accounting trick” is as good as gone.
The Foolish bottom line
All things considered, I was never worried about the accounting practice here because everybody’s doing it — and the correct free cash flow figure was always reported in plain sight anyhow. The practice is fading away as Netflix goes all in on digital content, which carries no resale value and doesn’t belong under investments.
If you dismiss Netflix due to its handling of DVD purchase accounting, you’re just missing out on a fantastic investment opportunity for no good reason.
The article Can You Trust Netflix’s Cash Flow Statements? originally appeared on Fool.com and is written by Anders Bylund.
Fool contributor Anders Bylund owns shares of Netflix, but he holds no other position in any company mentioned. Check out Anders’ bio and holdings or follow him on Twitter and Google+.The Motley Fool recommends Netflix. The Motley Fool owns shares of Hertz Global Holdings (NYSE:HTZ) and Netflix.
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