Yes, We'll Still Be Watching Netflix with Ads

With Netflix’s stock down 60% in the past year, net subscriber losses in 1H2022 and fears of an upcoming recession, clearly the company is trying to figure out ways to boost revenue. When Netflix was consistently adding subscribers every quarter, advertising was not a priority to say the least and management laughed off the idea. The tables have turned now as Netflix readies to launch its $6.99 ad-supported tier, “Basic with Ads”, a month before Disney launches their ad-supported service.

Netflix still hasn’t finalized licensing agreements with Disney, NBC Universal, Sony Pictures Television, Warner Brothers and Lions Gate Entertainment according to the Wall Street Journal. Ad prices have also dropped, with the WSJ reporting Netflix had been looking to charge advertisers roughly $65 for reaching 1,000 viewers, but some advertisers have ended up paying roughly between $45 to $55. Despite this, Netflix told analysts during the Q3 call that the company was turning away advertisers due to the level of demand. Advertising is a new venture for Netflix and if the company can improve ad targeting capabilities and grow the ad-tier subscriber base, Netflix should be able to charge advertisers more.

Needing to pivot and depend on advertising shouldn’t come as a surprise to anyone following the streaming business. With 223 million global paid memberships, it’s to be expected that Netflix would add new subscribers at a slower pace than they’ve done historically and eventually slow down to a normalized single-digit growth rate. I think a lower priced model with ads should help Netflix add more incremental subscribers and boost top line revenue. It should also help incentivize folks to stay subscribed during months where Netflix just doesn’t have a new interesting hit show. As popular as shows like, “Stranger Things”, “The Jeffrey Dahmer Story” and “Squid Games” are with a mass audience, those blockbusters don’t come around every day and are the standouts among all the programming that Netflix spends $17 billion a year to produce. While that may be a staggering number, there are a lot of times where I’m scrolling through Netflix and I feel like they just don’t have anything new that I want to watch, and I’ll cancel until there’s a new hit show that captures my interest. But I’m also on the standard plan that’s $15 a month, for $6.99 a month, I’m more likely to just keep the plan active even if I’m not watching any content that Netflix provides. In the same way it makes sense for Netflix to be adding an advertising based option, it’s a logical move to me that they would start to crack down on password sharing and make users pay for the family and friends that watch Netflix on their account without paying.

Netflix would eventually get to their current point where the low hanging fruit has been picked. the company wouldn’t be able to count on a double digit growth rate of subscriber adds on a normalized basis, the competition would ramp up as we’ve seen, and now in 2022 between HBO, Hulu, Disney Plus, Peacock, Paramount Plus, Showtime, Starz, who doesn’t have a streaming service? Netflix doesn’t have anything to lose from adding an option for an advertising based tier, and will some people be annoyed when they try to watch their cousin’s Netflix account only to be told that they’ve got to pay for it? Sure, but it likely won’t piss enough people off to where the decision to crack down on password sharing turns out to be a net negative. If we do head into a recession in 2023, an ad-based offering for Netflix at a lower price point could turn out to be an even more well timed addition to help mitigate subscribers cancelling.

With revenue tailwinds from the ad-tier offering and crackdown on password sharing, it’s a stock I like heading into 2023 and at under 30x 2022 expected earnings, the valuation isn’t insane. I own Netflix stock in full disclosure and in my view Netflix is better for offering the option for ads as opposed to not doing so. It was an easy choice to make looking at how much of the land that Netflix has already conquered, and patient shareholders could be rewarded over the next year as Netflix moves into a new chapter.