Netflix New ad-supported tier; A new Catalyst?

1) Company Background

Founded in 1997, Netflix is a popular streaming service that offers a wide selection of television shows and movies with an accessible online subscription. In the early days, Netflix was found to be a leader in innovation in the traditional movie rental market as they introduced the online subscription service with a personalized recommendation system. As of 2022, the company has a high market position with a large consumer base of over 222 million subscribers. Netflix’s dominance started to slow as rivals such as Disney Plus, HBO Max and Amazon Prime have cut its share of viewers. With the fast growing streaming market, investors are questioning the future of the Netflix stock through the competition with its upcoming rivals. With its competitive advantage, content exclusivity and worldwide expansions, Netflix maintains its leadership in the market.

2) Investment Thesis

Competitive Advantage As of early 2020, Netflix had three tiers of monthly subscription prices: $8.99 for basic plan, $12.99 for most popular HD-quality service and $15.99 for a premium plan. As of November 2022, Netflix details a new cheaper ad-supported tier which is delivered in 12 countries. The ‘Basic with Ads’ will present five minutes of commercials every hour for $6.99 a month, which is 20-40% below the current starting price. With this competitive pricing strategy to appeal to price-sensitive customers, it could withstand subscriber churn and act as a customer retention tool. Netflix estimates that these 12 markets account for approximately $140 billion of brand advertising spend across TV and streaming and over 75% of the global market. In fact, analysts estimate that this approach will bring in between $2 billion to $2.5 billion annually because of this generated new source of revenue from advertisement. Netflix is diversifying their streams of income, where membership will only be one component of their revenue growth. Over the next five years, analysts predict that Netflix will earn 8.5 billion in advertising revenue from its ad tier, as $3 billion will come from subscription fees and advertisers will pay $5.5 billion to run their ads. Similarly, other companies, such as Google’s owned video platform Youtube, have proven successful in implementing this advertising revenue delivering $28.8 billion in the year 2021.

As well, Netflix is currently the most expensive streamer in the US compared to its competitors, this offers an opportunity to be a leader with low-priced subscriptions and compete in this untapped market. As Netflix offers additional varieties in plans, it offers flexibility to the consumers which allows them to purchase a tier that best suits their needs. In fact, 92% of non-Netflix subscribers watch ad-supported platforms according to Samba TV. Therefore, this can be an opportunity to appeal to an entirely new audience base.

Content Exclusivity

Netflix focuses on building a strong pipeline of new content to drive subscriber growth and high retention rate with the anticipation that competitors would stop licensing their content. In 2012, Netflix launched its original content strategy which is an aggressive venture into the production of feature films in multiple different languages and across multiple genres. As the company was faced with its prime programming becoming more available on different platforms, they started to invest in production to differentiate from the consumer content. By producing their own content, Netflix offers first window availability, global rights, carry films on stream in perpetuity, copyright ownership, and intellectual property. These advantages have led the original content to have been a key source of Netflix’s success and the appreciation of its stock price. In fact, a P/E ratio of 24.75 as of 2022 means investors view the company profitable in future growth. The 2022 debt to asset ratio has also improved from Q1 to Q3 from 0.32 to 0.29. As of 2022, this strategy is still a continuous innovation as Netflix is investing more to build content exclusivity on their platform. This year Netflix has reported an improving gross profit margin from 2019 to 2021 from 38.28% to 41.64%. In March 2022, originals and exclusive titles accounted for 50% of all available content, a figure ahead of competitors such as Amazon Prime with 9% and Hulu with 4%. Since 2013, Netflix has consistently increased its yearly investment on content creation and peaked in 2021 with $US 6.2 billion invested, which is double competitor Disney+’s investments of $US 2.8 billion. In the Q1 of 2022, the exclusive content accounts for 12% of the 100 most popular titles in the US. Analysts are estimating that this streaming service will continue to be a prominent distributor of unique content in the years with 75% of movies and shows being exclusive or originals by the end 2024.

World Wide Expansion Opportunities Based on the Q3 results, Netflix published that its revenues grew 19% as average paid membership rose 23% in Asia-Pacific. In Latin-America, revenues increased 19% year-over-year and average revenue per membership grew by 16%. In the US and Canada, average revenue per membership grew by 12%. In Europe, Middle-East and Africa, revenue grew by 13% and average revenue per membership grew 7%. Although Netflix operates in a highly competitive industry, it is still small to the global market and has a large opportunity for growth. For instance, it only occupies approximately 8% of total television time in the US and UK which are countries that reside Netflix’s biggest consumer base. As of 2018, overseas members accounted for 58% of the customer base. Analysts are predicting that international markets will eventually account for as much as 90% in the years to come. In fact, Netflix plans on focusing

on an increase in commissioning internationally for its original titles. Analysts are predicting that this strategy will be successful in outstripping international competitors due to its maturity. This showcases Netflix’s plans for global expansion and potential untapped audiences.

3) Investment Risk

As Netflix introduces its new tier system, investors may consider potential risk associated with this new launch and the impacts on its future revenues. By researching other industries, such as the gaming industries, investors may investigate the consequences of the release of a new tier system. Sony had made a similar launch with ‘PS Plus’ in the gaming industry in 2022 which led to great amount of confusion among its players and customers. As a result, this failure negatively affected their subscriber count which is reflected in their quarter 2 report, showing a loss of nearly 2 million subscribers. According to their 2022 official earning results, PlayStation Plus maintained 45.4 million subscribers in quarter 2 compared to 47.3 in quarter 1. The Netflix tier launch is subject to this potential risk, albeit at a reduced level because Netflix marketed its clear and direct intentions to target a certain consumer group prior to the launch, which minimizes uncertainty among subscribers and investors.

As the US dollar has strengthened against most other currencies, it becomes expensive for foreign consumers to purchase memberships. This causes a failure to attract new consumer bases and increase in cost of production of its original content. Therefore, Netflix forecasts a sequential decline of 9% of revenue growth due to the continued strengthening of the US dollar. Netflix believes that they are capable of adjusting pricing and cost structure to adapt to the appreciation of the US dollar in the medium term. In the long term, Netflix aims to sustain double digits growth, increase operating profit faster and deliver growing positive free cash flow.