With Netflix’s subscriber and stock price growth slowing down, analyst Michael Nathanson of MoffettNathanson Research suggests the streaming leader might have to take another look at getting into the advertising and sports businesses.
“Although Netflix management continues to strongly dismiss the idea of advertising, we think that view will be seen as a strategic mistake if future rates of subscriber growth start to fall short of Street expectations,” said Nathanson in a note Tuesday.
Nathanson notes that while once HBO was Netflix’s main competitor, today that rival is The Walt Disney Co., which uses its spending on content to fuels numerous lines of business in addition to its fast-growing direct-to-consumer video brands. Netflix has signaled interest in doing more with consumer products and gaming.
“Of course, having a business that generates $25+ billion in annual recurring revenues growing mid-teens is more than admirable, but we are seeing signs that Netflix is looking to build a new profit pool or two à la Disney,” Nathanson said. “Yet, we don’t think that consumer products or gaming will be enough to change the narrative. Rather, we think that an ad-supported tier or live sports would be the way to go to penetrate harder to reach customer segments and markets, especially in low-ARPU emerging regions."
For Netflix’s video business, Nathanson sees U.S. and Canada revenue increasing just 7% annually for 2022 to 2025. International growth will be stronger, but slowing from 23% in 2021 to 16% in 2025, he estimates. Together he sees a 14% growth rate for 2021 to 2025.
“Is a 14% revenue CAGR over 2021-2025 enough to justify Netflix’s premium equity valuation? Compared to other Internet names, Netflix stands out with lower anticipated revenue growth than peers despite a relatively high valuation,” Nathanson said.
Netflix has been opposed to advertising because it doesn’t want to be involved in privacy issues or have to spend money to track its subscribers' locations and purchases.
But the fast growth of ad-supported video services may force Netflix to change its tune, suggests Nathanson, who estimates that AVOD has ad revenue has grown from $1 billion in 2017 to $5 billion in 2020 and will increase to more than $21 billion by 2025.
With 6% of total TV minute viewing, according to Nielsen (that’s twice Hulu’s total), Nathanson said that Netflix does not need to offer hyper-targeted advertising in order to attract marketing dollars.
“Given Netflix’s popularity, it appears they should be the best positioned to capture the emerging AVOD market if they embrace advertising,” he said.
“While an ad-supported tier may very well boost growth, it may also send a worrisome signal to the market that Netflix’s core SVOD strategy is facing its limitations. Accordingly, we believe another route Netflix could take to spur growth and also gain exposure to the strong advertising market is by adding sports content to the service,” Nathanson added.
NBCUniversal’s Peacock and Paramount Plus are already embracing sports to attract signups.
“Netflix may want to add sports to a more premium tier, helping to boost ARPU, gain exposure to in game advertising and broaden the appeal of its service in an increasingly competitive market,” Nathanson said.
“Although advertising or sports on Netflix is purely conjecture at this point, we believe management will need to consider more aggressive actions to drive growth to support their elevated equity valuation, especially as the core SVOD business begins to slow down. Consumer products appear to be the first step towards broadening the business beyond subscription streaming, yet we do not believe it is enough by itself to change the long-term financial profile for the company,” he concluded.
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