Study: Netflix Amortisation Expense
In this post, we examine how accounting methods for amortisation can understate the real economic value of Netflix’s business.
What is Amortisation?
In accounting, depreciation is a method of systematically allocating the cost of a tangible asset (buildings, equipment, vehicles…) over its useful life. It reflects the gradual decrease in an asset’s value due to wear and tear, obsolescence, or normal use.
Similarly, amortisation is just depreciation for intangible assets (patents, trademark, software…). Obviously, Netflix is a streaming platform and has very little plant, property & equipment. Their assets are mainly intangible content.
Cost of Goods Sold (COGS)
Netflix generates revenue primarily from subscription fees and advertising. The COGS that are related to these revenues include the amortisation of content. This directly hits the P&L and is a non-cash item with respect to operating cashflows.
In 2024, COGS was $21b against revenues of $39b. Out of this $21b, amortisation costs of $15b were a significant portion.
The remainder in COGS consists of things like talent fees, cloud infrastructure, customer service, and just any other cost associated with actually delivering content to consumers.
Amortisation Costs are Real
First, let’s consider a car manufacturing company which has to build a factory to produce cars. The cost of this factory is depreciated across its useful life and will have to be replaced when it’s old.
In this case, there is a recurring expense if the car company were to continue operations.
Now, let’s think about the popular Netflix in-house movie, House of Cards. This movie was created in 2013, more than 10 years ago, and some subscribers are still watching this movie today. In other words, Netflix is still delivering value to consumers even though the company does not need to reproduce House of Cards again.
Let’s assume a straight line amortisation schedule and see what happens:
Netflix has $100m of cash on the balance sheet.
It uses this cash to produce a movie. This movie is recorded as a non-current asset of $100m.
Netflix amortises content over the maximum allowable 10 years. So, on year 1, $10m hits the P&L in COGS.
At the same time, the content asset is reduced by $10m.
This accounting treatment continues until year 10 when the full $100m has been amortised through P&L. And the content asset is reduced to zero on balance sheet.
In reality, Netflix doesn’t use a straight line method because new movies are usually consumed within the first few years of release, meaning that amortisation is front-loaded. After the first 4 years of a movie release, we can expect that the content asset will be almost zero on the balance sheet, and will surely be zero after 10 years.
Think about it: when you are watching a movie on Netflix that is more than 10 years old, the value of it is zero on their balance sheet. In fact, anything older than 4 years is essentially not carried on the balance sheet.
This does not suggest that Netflix can stop producing content and that amortisation is an accounting trick. Of course, Netflix must continue to produce good content to grow revenues, even though the company is still providing value to consumers for old content, which costs nothing.
Economic Reality vs Accounting Rules
The mismatch between economic earning power and accounting is not a new idea. This is well understood by the market that there exists off-balance sheet value. That’s why Netflix stock appears to trade at persistently high multiples, whether on earnings or cashflow basis.
Think about these questions that make economic sense even though GAAP accounting doesn’t do justice:
1. How many shows have people re-watched years after release, or recommended to friends who missed these shows?
2. How many video games can be developed out of IP developed in-house by Netflix?
The content library of Netflix is a compounding machine from which sequels are produced and merchandise can be sold. But under GAAP accounting, these assets are like a derelict factory.