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Netflix has gone from offering a great product in a business it rules, to offering a great product in what will soon become a tough, crowded business that colossal invaders want to rule.

That shift became apparent on July 17, when, for the first time in years, Netflix announced weak growth in subscribers during the second quarter. The backlash was brutal: Investors dumped the stock, tanking Netflix’s market cap by $24 billion or 15.2% over the next three days. However, evan after the steep selloff, they’re awarding Netflix a gargantuan valuation relative to its still puny earnings. (Its stock has bounced back but is still down 13% from its high in early July.) To merit its P/E multiple of 130, Netflix needs to keep performing action-hero heroics.

The disappointing news––Netflix added just 2.7 million new members, half the number it had forecast, and saw a decrease in subscribers in the U.S.––has raised questions about whether Netflix can grow rapidly and profitably enough to be worth anything like $145 billion. The main issue is the discrepancy between Netflix’s negative-and-sinking cash flow and rising profit numbers. While its net earnings have jumped from $187 million to $1.2 billion from 2016 to 2018, its free cash flow has headed the other way, going from a negative $1.7 billion to minus $2.9 billion, with a $3.5 billion deficit forecast for this year. To bridge the gap, Netflix is borrowing heavily. As I pointed out in an earlier story, it’s devoured so much cash over the past four years that its $12.6 billion in long-term debt exceeds that of that of cash burners such as Uber and Tesla.

Netflix purchases movies and series from outside production companies, and also develops its own shows. The amounts it’s been spending right now, in cash, on buying and making content far exceeds the what it’s receiving in subscriptions from its 150 million members, less the cash spent on salaries, marketing, and R&D. Its net income is positive because under GAAP accounting rules, media companies are required to expense movies and shows not when they’re purchased, but to “amortize” those costs over the entire period the company expects them to generate revenues. (It’s the same story with building an auto plant: The cash gets spent over the year or two it takes to build the factory, and those costs are taken as an “expense” that’s deducted from net income over future years when the cars are rolling off the assembly line and selling in dealerships.)

Because Netflix’s content spending is on a steep upward curve, its amortization expense lags what it’s laying out in cash, explaining the gulf between cash flow and net income. On average, Netflix writes off the cost of acquiring its shows over around four years. Amortization periods for entertainment assets are highly subjective, but most analysts agree that Netflix is exercising caution. “Netflix amortizes its entertainment assets in an extremely conservative manner,” says Albert Meyer, an investigative accountant, and chief of investment fund Bastiat Capital, which doesn’t own Netflix stock. “If it purchased other entertainment companies to get content instead of buying and making shows, those assets would count as ‘goodwill’ that it wouldn’t have to expense at all, making its earnings look artificially big. Netflix has never taken that approach.”

The importance of free cash flow

Netflix’s favorable net earnings may be fully justified, and its highly-respected co-founder and CEO Reed Hastings claims that those rising profits auger great things to come. But to reward investors, Netflix must begin to generate hugely positive free cash flow. That’s defined as “cash from operations” generated from making and selling products, minus capital expenditures needed to keep its plants, buildings and other assets in good condition. It’s free cash flow that drives stock prices over the long-term. It’s the money available to reward shareholders, in the form of dividends, buybacks, or purchases of other enterprises or brands that drive growth.

The math is basic: If the “present value” of its future cash flows equals Netflix’s current market cap of $145 billion, then investors are correctly valuing the streaming colossus. (Present value is calculated by discounting the cash flows at a rate investors could receive on holdings of comparable risk.) And if Netflix can beat the market’s now downsized expectations, its current shareholders will reap big gains.

Netflix management regularly acknowledges this challenge. In its shareholder letter for Q2, 2017, they wrote, “Eventually, at a much larger revenue base, original content and revenue growth will be slower, and we anticipate substantial positive FCF [free cash flow], like our media peers.”

We don’t know how Netflix will fare over the next fifteen years or so, but we can make a good forecast of what it has to do to grow into its still gigantic valuation. Surprisingly, hitting the cash flow hurdles required to get there will be difficult, but doable if Netflix can achieve two goals: Grow its revenue less expenses for marketing, R&D, overhead, and interest at average mid-double digit levels over the next decade and beyond, and at the same time, rein in its spending on content. What threatens that scenario: the prospect that its pace of adding new members is slowing just when Disney, AT&T, Amazon and Comcast’s NBC are all launching or expanding their own streaming services. That mid-single digit bogey sounds easy compared to what Netflix has been achieving. But it’s now apparent that tomorrow’s burgeoning global revenues from streaming will be divided among a lot more players as the biggest names in show business cross swords with Netflix. Another danger: Netflix is forced to keep spending lavishly on content to beat a Disney or NBC in the contest for new subscribers, and to keep its members from defecting. In that scenario, it could fail to raise free cash flow fast enough even if revenues rise briskly.

Fortune‘s model

I’ve developed a model that projects in the inflow and outflow of cash, over the next sixteen years, that’s needed for Netflix to maintain its $145 billion valuation, and grow that number at the returns investors require from a risky stock. This is not a forecast of Netflix’s future performance. Instead, the methodology shows what trajectory is needed to generate what matters: fast-rising free cash flow. If Netflix raises revenues faster than assumed in the model and the holds increases in content spending to the specified levels, it will exceed the cash flows needed for its current valuation, and is probably undervalued. But if sales fall below the benchmarks, and Netflix doesn’t tighten spending on new productions beyond the numbers in the narrative, Netflix’s debt load could rise to worrisome levels, hammering cash flows with mounting interest expense, and its stock could fare poorly.

What the model shows is that to be worth $145 billion, Netflix needs a blend of strong growth in cash from gaining new subscribers before it spends a dollar on content––growth driven by revenues––and much smaller increases in spending on fresh entertainment than in the past.

I’ve based the analysis on two key numbers, and I’ve given them both acronyms. The first is Cash Available For Entertainment Assets, or CAF. The second is Cash Allocated To Entertainment Assets, or CAT.

Let’s start with CAF. It’s the cash that Netflix generates from its operations, consisting of revenues less costs of marketing, R&D, overhead, and interest, after capex, and before expenditures on content. Meyer advises Netflix to use this number “to determine how much they can spend on content acquisitions.” Adds Meyer, “If they do that, they will keep content acquisition within reasonable limits.”

Today, the rub is that Netflix is spending a lot more than the CAF that it garners from operations on movies and series, and is borrowing the fast-expanding balance. In 2018, Netflix generated $10.2 billon in CAF from subscriber fees less expenses, after subtracting capex (a modest $192 million). From 2014 through 2018, CAF has grown by 30% annually. Sounds great.

The rub is that CAT, spending on content, outraced CAF, soaring 36% a year over the same period, hitting $13 billion in 2018. That left Netflix with negative free cash flow of $2.8 billion.

What Netflix needs to do

The objective is obvious, as Netflix acknowledges: It needs to flip the two numbers, so that CAF gradually grows a lot larger then CAT, the dynamic needed to generate the big positive cash flow Netflix needs to prove it’s worth $145 billion, and rising. That’s also part of its plan to fully pay for content acquisitions not with more debt, but organically, with plentiful cash flow.

Here are CAF and CAT numbers that would meet that standard. For CAF, cash from operations before spending on content, let’s assume that the number rises 20% in 2019, then increases at rates that decrease by .8% a year over the following 15 years, so that in 2034, CAFE increases 8%, and simply keeps rising at that rate thereafter. CAF is mainly driven by revenue growth. It’s almost certain that Netflix’s other expenses will fall as a share of sales as it expands, helping margins, but the contribution will be small in comparison with the trend in revenues.. Marketing, R&D, overhead and interest equal only around one-quarter of Netflix’s revenues. The overwhelming cash cost is for content.

That 20%-and-falling curve looks easy to beat. From 2014 to 2018, Netflix’s revenues jumped 30% a year on average. But in the first half of 2019, they expanded just 24%, and the fall U.S. subscribers could signal slower times ahead. It’s important to note that Netflix predicts that subscriber growth will be strong in the second half of 2019. As the company stated in the Q2 report, “We expect to return to my typical growth in Q3, and are seeing that in these early weeks of Q3. Our internal forecast still currently calls for annual global net adds [additions to subscribers] to be up year over year.”

Even if sales grow well above 20% this year, the model calls for Netflix to expand from $15.8 billion in 2018 to around $60 billion by the end of 2028, at a rate of almost 15% annually. While that might seem a snap to Netflix fans on Wall Street, keep in mind that the streaming pie will be feeding a clutch of hungry new players. By the way, the recent drop in Netflix’s share price has lowered the bar for sales growth. Prior to the disappointing Q2 announcement, Netflix would have had to grow at 15.5% a year to grow into its then-$164 billion market cap in early July.

As for CAT, Netflix has provided guidance suggesting a slowdown in its rate of content spending. In its Q2 letter, after re-stating that free cash flow would total a record, negative $3.5 billion for 2019, management pledged “improvement in 2020,” adding that “from there, we’ll continue to reduce our free cash flow deficit.” Using our relatively conservative CAF numbers, to send the FCF shortfall below $3.5 billion and shrinking from there, our model calls for the pace of content spending to fall a lot more rapidly than the gradual decline in CAF growth.

To incorporate management’s forecast, and get the stream of free cash flow––the difference between CAF and CAT––to equal $145 billion, content acquisition (CAT) would downshift from a 20% increase this year, to 15% in 2020, then in 10% in 2021, and gradually declining from there to 8% at the end of our horizon, in 2034. In that scenario, free cash flow would improve in 2020 as management predicted, though just a touch, to -$3.4 billion. By 2023, Netflix would be breaking even on FCF, and in 2028, CAF would exceed CAT by $9.6 billion, remaining on the righteous path and hitting $21.2 billion in 2034. (From that point on, our model assumes that the big growth days are over, and that Netflix simply earns its costs of capital of 8%.)

Discount the yearly data points (at that 8% cost of capital) charting the journey from deep deficits to plentiful free cash, and Netflix meets the $145 billion test. The hardest part will be restraining the entertainment spend in a world where viewers have an appetite for limitless options.

Netflix’s fast-falling cash flow and burgeoning debt has naysayers branding the great disruptor as a house of cards. It isn’t. May I humbly suggest, along with investigative accountant Albert Meyer, that Netflix adopt CAT as its guide, and to set limits on what it can really afford to pay for new shows. It’s reassuring that Netflix talks about accounting and cash flows in its earnings letters amid all the hoopla over mega-hits like Stranger Things, The Crown and La Casa de Papel (Money Heist).

Because from now on, Netflix will need financial discipline as much as blockbusters to keep reigning as streaming’s mega-star.