Free Cash Flow Return on Invested Capital

Free Cash Flow Analysis of NetFlix 

Mar 10, 2010

The following is a free cash flow analysis of NetFlix’s(NFLX) using FROIC and Price to Free Cash Flow.

FROIC for those who don’t know is = Free Cash Flow Return on Invested Capital.

Over the years I have tested out various ratios and have found very few that can compete with FROIC, in getting down to the real cash that a company is generating on Main Street .

Basically FROIC tells the investor how much free cash flow is actually generated as a percentage of the total capital that the company employs. To put it more simply, “How much free cash flow is generated for every $1 of capital that a company employs”

How does one calculate FROIC?

FROIC = Free Cash Flow/Total Capital

The way to determine Free Cash Flow is by taking a company's “Cash from Operations” and subtracting its “Capital expenditures” from it.

So in Netflix’s case its 2009 “Cash from Operations” was $325.1 million while its capital expenditures were only $45.9 million. Thus when we subtract $45.1 from $325.1 we get $280 million in free cash flow. We next take the company's $280 in free cash flow and divide it by its 58.416 million diluted shares outstanding and we get $4.79 a share in free cash flow.

If we then divide that number into the closing price of March 9, 2010 of $69.94, ($69.94/$4.79) we get a price to free cash flow of 14.6.

A price to free cash flow result of 14.6 is very attractive and I proved that in doing a backtest on price to free cash flow in the investment process”, using the DJIA 30 stocks from 1950-2007, and found that by only buying stocks that were selling for 15 times their price to free cash flow or less one would have substantially beat the DJIA 30 by a very large margin compared to buying the entire Index.

Now that we have seen what the free cash flow is for Netflix, let us now go and determine what its total capital employed is.

Basically Total Capital = Long Term Debt + Shareholders Equity

Taking just basic Total Capital is too easy in my view and I prefer is make it a little more difficult for a company to pass this test and add “other long term debt” to the equation. So for NetFlix we have the following for the year 2009.

Long Term Debt = $200 million

Other Long Term Debt = $54.2 million

Shareholders Equity = $199 million

When you add all those together you get $453.20 million for total capital employed.

Having done that we can now calculate FROIC as $280/$453.2 million or 61.78%.

What does this 61.78% mean?

For every $1 of total capital employed, NetFlix generates 62 cents in free cash flow.

I welcome everyone to go and try out FROIC on your own. In the end you will find that there are very few companies whose stock price trades for less than 15 times their free cash flow and generates 61.785 cents in free cash flow for every dollar of capital employed.


http://seekingalpha.com/instablog/498843-peter-mycroft-psaras/58154-free-cash-flow-analysis-of-netflix