Netflix is widely perceived as the gold standard in video-on-demand (VOD) content. Global subscriber count nearing 125 million validates the quality of content and the over 4,000 per cent return on the stock since 2010 is a nice nod of approval from Wall Street.

The catchphrase often used to characterise the times we are living in — “golden age of TV” — is at least partly driven by the swashbuckling disruption orchestrated by Netflix. Netflix’s spectacular rise is indeed a textbook example of evolution and disruption done right.

Notwithstanding its global subscriber base, Netflix’s penetration in India is still in its infancy. Estimated subscriber count in India is in the paltry one million range. With lofty pricing ranges (starting at ₹500/month for one screen), Netflix is clearly not in an aggressive ‘customer-grab’ play at the expense of margin dilution. India is a long-game, and loading up on low revenue subscribers for a few points of growth, may not be a compelling strategy. Why?

First, discounted prices would set a sticky pricing anchor, difficult to reverse in the future. Netflix already has experience in the US market on this front from its price-raising experiment in 2016 which backfired with an unexpected jump in churn.

Second, margin dilution does not bode well for the stock. The stock trades on growth and margin expectations, and while the growth story can be realised through international markets (including India) where the runway appears to be long even at current price points, margin pressure will most certainly drive re-rating in trading multiples.

Third, ‘quality content comes at a price’ and ‘price signals quality’ are theoretical ideologies that might resonate well in the Indian market, especially because Netflix is increasingly being viewed as a lifestyle choice and there is certainly a level of status symbolisation embedded in it.

The double-edged sword

For Netflix to thrive, like any other company, it has to impress both customers and shareholders. Impressing customers requires a steady and unceasing supply of high quality content without a hefty jump in prices. A daunting task in its own right but Netflix’s historical success, credentialises its ability to do so in future. However, impressing shareholders is a more precarious endeavour. In addition to subscriber growth, shareholders will eventually start wondering when Netflix will start generating free cash flow; now, it does not generate any free cash flow and is expected to burn $3-4 billion in 2018.

Here’s the catch. Without content investments, it’s inconceivable to generate new content, without which subscriber growth is nothing but a preposterous ambition. But shareholders see content investments as a double-edged sword, one which enhances Netflix’s value proposition, driving subscriber growth but also the biggest drag on free cash flow. So when will this never-ending cycle of content investment taper off or will it ever?

Netflix will continue to focus on growing its subscriber base, hoping that the rate of resulting growth in operating profit outpaces the rate of growth in content investments. Unless that happens, Netflix might find it difficult to reverse the cash burn and start generating free cash. If you raise prices or stop investing in content, notwithstanding an incredible content library, consumer economics and history will teach you that churn will show up in some form.

Balancing these two to address the free cash flow conundrum is going to be the theme for the next few years.

The writer is a former Equity Researcher at Canaccord Genuity, Toronto.

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