Will Netflix’s Advertising Strategy Work?

Netflix (NASDAQ:NFLX) is doubling down on its plans to offer ad-supported plans after two straight quarters of subscriber losses.  The success of the new plan will be important for Netflix, as it needs to bolster subscriber additions and monetization in order to fund its massive content investments and shore up its stock price, which has declined by 61% year to date. Below we take a look at how the new offering is expected to impact Netflix.

With continuous price hikes, Netflix services have become pricey versus the competition.  The company’s most popular high-definition plan is priced at over $15 per month. In comparison, Disney+ costs about $8 per month. This is proving an issue for Netflix, given that rising inflation is hurting household budgets and consumer spending, just at a time when people are relying a bit less on streaming as a means of entertainment post the Covid-19 lockdowns. With the new ad-supported tier, which is likely to be priced well below $10 per month, Netflix should be able to target more price-sensitive customers, helping its subscriber growth. Netflix is likely to differentiate the plan from its standard offering, with the lower-priced tier not expected to offer the company’s full content catalog, potentially helping to keep ad-free customers from moving to the lower-priced service.

Netflix has indicated that its monetization on the new ad-supported plans could be similar to, or even better than, non-ad, subscription-only plans. While the new plan is likely to have a monthly subscription fee of under $10 per month, Netflix is likely to bring in considerable advertising revenue. The company is apparently positioning itself as a premium option for advertisers and is likely to charge as much as $60 and $65 for ads to reach 1000 people, per the Wall Street Journal, while eventually charging as much as $80 per 1000 impressions. This would put it almost at par with top NFL programming. This is quite possible, as Netflix services cater to a younger demographic and are generally skewed toward more affluent households, making them attractive to marketers.

Now, Netflix has been building out its advertising capabilities in recent months. It hired Snapchat’s top advertising sales executive to build out an ad team while partnering with Microsoft to use some of its technology, such as the Xandr demand-side platform that enables marketers to buy programmatic ads. That said, there are challenges as well. Competition for streaming advertising dollars is also set to mount, with other players such as Hulu and HBO Max offering ad-supported tiers, and Disney+ slated to launch an ad-supported plan of its own. The ad market is also seeing a slowdown, with the U.S. GDP contracting over the last two quarters and marketers getting more judicious about spending, considering surging inflation.

We think that Netflix stock appears compelling at current levels. The stock remains down by roughly 61% year-to-date, due to the recent subscriber losses and the broader market rotation out of Covid winners. With the stock priced at about $234 per share, Netflix is trading at levels last seen in early 2018, prior to the global Covid-19 pandemic. However, Netflix has made considerable progress since then. For example, the company has doubled its subscriber base since 2018, despite hiking prices multiple times over the period, with its churn rates remaining the lowest in the streaming business. The stock now trades at just about 21x projected 2023 consensus earnings, down from levels of over 90x prior to the pandemic. Considering this, we remain positive on Netflix stock, with a price estimate of $317 per share, which is 36% ahead of the current market price. See our analysis Netflix Valuation: Expensive or Cheap for more details on what’s driving our price estimate for Netflix. Also, check out the analysis of Netflix Revenue for more details on how Netflix revenues are trending.

With inflation rising and the Fed raising interest rates, Netflix has fallen 61% this year. Can it drop more? See how low can Netflix stock go by comparing its decline in previous market crashes. Here is a performance summary of all stocks in previous market crashes.

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[1] Month-to-date and year-to-date as of 9/12/2022
[2] Cumulative total returns since the end of 2016

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