Ethan Miller
Netflix’s (NASDAQ:NFLX) plan to launch a version of its service supported by advertising represents something of a high-stakes move for a company that set the standard in streaming success – until it finally seemed to run into a growth wall.
Netflix stock (NFLX) wrapped up 2021 at a $602 price point (not so far below its all-time high of $700.99 touched last Nov. 17); but two rough earnings reports this year showed subscriber growth was no longer a given (or that the company could actually shed subs) and took the shine off the former new-media darling.
The streaming pioneer beat user expectations for the third quarter of 2021, but January brought a report that fourth-quarter adds of 8.28M subscribers fell short of guidance for 8.5M, sending the stock reeling. April’s first-quarter report was definitely no better; shares slid 35% after the company actually lost 200,000 subs.
The result is a stock down 62% in 2022. (To its credit, Netflix has been mostly flat over the past two months; see a chart vs. streaming rivals here.)
Now it’s time to bring in the advertisers, a move the company signaled was coming in its downbeat April earnings call.
Recapping the details of the plan: Netflix’s regular ad-free Basic, Standard and Premium Plans are unaffected, and they’re currently priced per month in the U.S. at $9.99, $15.49 and $19.99 respectively.
The “Basic with Ads” plan launches Nov. 3 at $6.99 per month, and (for now) will feature some 4-5 minutes of ads per hour, delivered before and during movies and shows, at an average of 15-30 seconds in length. Netflix has suggested it would be biased toward pre-roll ads on movies rather than mid-roll, to prevent disruption of the movie experience.
The offering will come at 720p (basic) high definition, and those on Netflix’s ad-free Basic plan will also now get 720p HD, up from their previous 480p standard definition. The ad-supported plan won’t allow for downloading programs as the ad-free plans do, and certain programs won’t be available on the ad tier due to licensing restrictions.
Netflix’s move to an ad plan (and rival Disney (NYSE:DIS) joining the market in a few weeks) sets up a more complete comparison of what the streaming pricing landscape looks like now that most key rivals are getting on the ad train. Disney+ (DIS) is launching the ad-supported version of its service Dec. 8, priced at $7.99 a month, a dollar higher than Netflix. (It’s also raising the price of ad-supported Hulu (DIS) (NASDAQ:CMCSA) to $7.99.)
There are also earlier (and smaller) entrants to the ad-supported service game. Peacock (CMCSA) Premium with Ads tier comes at $4.99 per month; Paramount+ (PARA) (PARAA) also comes at $4.99 with ads; and HBO Max’s (NASDAQ:WBD) ad-supported version is priced at $9.99 per month.
The simplest business look at Netflix’s plan suggests the company saw incremental opportunity in creating a version of the service for more price-conscious consumers; why else would CEO Reed Hastings go back on a seemingly solid early-days promise not to bring advertising to the streamer? So the question is just how big the opportunity is in adding ad revenue to make up for the lower subscription price, and what it does to the company’s average revenue per account.
Citi’s Jason Bazinet says of the pricing “We like it,” adding it looks like Netflix (NFLX) management is pursuing a “bifurcated” strategy. In the U.S., where Netflix is deeply penetrated, “we believe Netflix has set its pricing so it generates far more in ad revenue than it will lose if consumers spin down to the ad tier. Outside the U.S., we believe Netflix has set ad tier pricing so the firm is agnostic about consumer’s preferences,” he says.
“That is, the anticipated ad revenues have been fully reflected in lower ARPUs (average revenues per user). This should help drive deeper penetration outside the U.S.” The company is discounting the U.S. plan by $3 per sub per month when it should generate some $10 of ad revenue per ad-tier sub per month, he says. The upshot is “material upside” to Netflix free cash flow.
The pricing seems right, UBS analyst John Hodulik agrees, but it will take time to scale, and limiting users to a single stream could “limit the plan’s attractiveness.” Management’s suggestion that the plan will be ARPU-neutral to -positive vs. the basic tier implies advertising ARPU of a conservative $3-plus in the U.S., he notes.
Evercore’s Mark Mahaney says Netflix’s ads addition is “the biggest catalyst across the Internet sector.”
The low price of the offering, its simplicity (one ad-supported tier), and differentiation (one device, no download and HD, vs. 2 devices, download and full HD for the Standard plan) are likely to “materially boost the value proposition of Netflix to consumers, help reduce churn, and expand gross subscriber ads by addressing one of the biggest challenges the service has faced over the last couple of years – rising price sensitivity, as tracked by our relentless surveys. And this can be done with improved unit economics, per our competitive Streaming ARPU analysis.”
The company reportedly wants to reach 40M viewers with the ad plan by the third quarter of 2023.
Netflix (NFLX) reports its upcoming earnings after the closing bell on Tuesday; it’s expected to post earnings per share of $2.17 on revenues that grow nearly 5% to $7.84B.
Seeking Alpha contributor Livy Investment Research did a dive into the numbers and expects the ad-supported launch is generally a good thing – adding some $1.8B in annual revenues – but not enough, with the best-case scenario still resulting in a stock price close to where it is now.
Take Seeking Alpha’s Weekend Bite poll: Would you watch Netflix with ads?
