Private Note to Premium Members:

It will be interesting to discuss someday how Netflix’s share price dropped 35% following the news of an ad-supported tier. The stock price took a historic hit after the company reported a subscriber miss of 200,000 and a guide of 2 million subscriber losses for the next quarter. Meanwhile, the company has a surplus of 100 million viewers sneaking passwords that the company can monetize. In my opinion, the market has lost perspective of the bigger picture.

There are two analysts who have started to crunch numbers on the opportunity and they believe it will add a base case of $12 billion in annual revenue and up to $25 billion to $35 billion in annual revenue by 2030. 

“Assuming a domestic launch in the first quarter of 2023 and a global rollout over the following two years, Morris has layered in an advertising-supported tier to his multi-year forecast for Netflix and now sees total company revenue approaching $75B by 2030, he tells investors.”

Currently, Netflix is at $29 billion in annual revenue. So, wow — a doubling of Netflix’s revenue in 8 years compared to the nearly 25 years it took to get to the first $30 billion in revenue (Netflix launched in 1997). 

There’s been plenty of rumors around who Netflix might choose as an ad server and supply side partner. One reason we think Roku is a candidate is because of its strong positioning with first-party data that can augment Netflix’s publisher data for enhanced targeting. Roku can also make deals around promoting Netflix on its platform, which it did for Disney, since Roku’s ad platform is the primary product compared to The Roku Channel. We think this is a strong possibility because Roku has the richest first-party data in the industry due to owning the operating system where it hosts many applications.

On the other hand, Google is not a good choice as it’s a major publisher itself. YouTube TV happens to be Netflix’s closest competitor in terms of total US TV time at 5.7% and 6.4%, respectively. It’s rare to see Big Tech competitors’ partner with one another, which can result in helping the competitor become stronger. Even though there are rumors that Netflix and Google are meeting about ads at Cannes, those events usually have meetings between all major players without any guarantee of an outcome.

Pictured Above: YouTube is Netflix’s biggest competitor 

Magnite has been floated around, and this could be a strong choice for its global exposure and its ad server, SpringServe, helps put the company on par with Roku’s ad server. Comcast’s FreeWheel could also make a good partner for Netflix as the company focuses more on live broadcast and is not in direct competition to Netflix’s premium content. 

We think it’s less likely that Netflix goes with The Trade Desk as a publisher, — although certainly anything could happen. However, The Trade Desk will benefit from the increased ad inventory from a demand perspective. 

Truly, no matter what ad platform Netflix chooses, more than one CTV ad stock will participate as programmatic allows bidding across many sources to increase fill rates. Due to Netflix’s premium inventory, however, the company may go with a private marketplace where only two or three sources are allowed to bid. 

In regards to timing, I foresee Netflix wanting to take full advantage of next year’s upfront season, which means testing and rollout will need to happen by this time next year. Otherwise, Netflix risks losing out on contracts from premium advertisers due to timing and will need to wait until the following year Q2 2024. It’s certainly feasible that strong ad partners can get Netflix’s global rollout accomplished in a year’s time – which is why I believe we will hear who Netflix has chosen as soon as Q2 earnings or by Q3 earnings. I don’t think we will need to wait until Q4 2022 as testing is likely to happen sooner.

Why is that important? Because the global juggernaut has the ability to raise the tide of all boats on CTV ads. This is the biggest news to happen to the CTV ad industry – ever, really, due to the sheer size of audience that Netflix is capable of bringing to the CTV market. There will be a compounding effect as Netflix’s entry will also more ad budgets, more premium advertisers, — and really marks the moment when CTV ads are being taken seriously even by subscription services. 

I wrote an article on Netflix published in Forbes below. Of course, the real angle here is that we own Roku and Magnite and we hope one of these two is chosen as the premiere partner. It’s not speculation to say so, rather it’s taken quite a bit of conviction in the face of a fickle stock market to repeat that CTV ads have a large runway ahead of them. Four years and two years later, respectively, from our first analysis and we now have Netflix agreeing with the CTV-ads thesis. I think we should take a moment to let that sink in – as there is no company bigger or more important to agree at this juncture.

If we enter Netflix, it would be above the $450 price target outlined below. The majority of our bullishness resides with the companies we already own and our research is more about the effects on our current positions.

Netflix Stock Could Rally with Ad-Supported Content

Forbes Article Forbes Article 

Netflix’s stock is down a staggering 71% year-to-date. The stock’s fall from grace includes dropping its FAANG-status as the company’s market cap has decreased from $300 billion to $75 billion. This was partly due to the company reporting it lost subscribers for the first time since 2011, with a loss of 200,000 subscribers in the most recent quarter. The company also forecast a decline of 2 million paid subscribers for the second quarter. 

The earnings report caused the stock to immediately lose 35% of its value. Bill Ackman sold his Netflix shares for a loss of $450 million in three months, with some goading him for his decision while others congratulated Pershing Capital for being bold and walking away from a losing position.

Meanwhile, our focus was elsewhere. In our Netflix coverage following its earnings report, we had stated “we can’t help but salivate” over which ad platform Netflix might choose to power ads to hundreds of millions of viewers. Primarily, this is because we have consistently discussed why the trend of CTV ads has plenty of runway even during an epic market selloff. 

The key point is this: the global juggernaut in media is essentially stating that CTV ads are the future for streaming.  

Below, we discuss why a new perspective is needed as the 200,000-miss last quarter and the 2 million miss this quarter pales in comparison to the 100 million viewers who are sharing passwords that Netflix intends to monetize. In other words, I would argue the day that Netflix’s stock price dropped 35% was consequently one of the most important days in the company’s history in terms of its chances for a boost in revenue and a renewed uptrend. Patience, though, will be required, as Netflix has a lot of work to do (minimum one to two years for full global roll-out). Yet the path to adding more subscribers is finally clear for Netflix and will pay off long-term especially during times of inflation or muted consumer confidence as it drives down household costs across fragmented subscriptions. 

Netflix’s Q1 Earnings

The company reported revenue of $7.9 billion, up 10%. Excluding FX headwinds, the revenue growth in the quarter was 14%. The company guided for 10% growth in the upcoming quarter for $8.05 billion in revenue. Net cash from operations was up from $777 million to $923 million.

Netflix has maintained a healthy operating margin above 20% for most quarters and EPS beat estimates at $3.53 compared to $3.75 EPS a year ago. However, the issue with Netflix has been the lumpy free cash flow since the company began producing original content with the majority of the company’s history being deep in the red on cash flow. The recent quarter was positive $802 million, yet the company still holds gross debt of $14.6 billion on the balance sheet and net debt of $8.6 billion.

Netflix reported a subscriber miss of 200,000, yet excluding Russia, the company had net adds of 500,000 as Russia contributed to a miss of 700,000. Regardless, it’s the upcoming quarter that has the market concerned as Netflix is guiding for a loss of 2 million subscribers. 

Notably, Netflix has moved towards staggered releases of hits such as Stranger Things, which could reduce churn and help renew subscriber strength. 

Netflix Entering the Ad-Supported Market

We had written an editorial a year ago on Forbes called the Crucial Difference between Netflix and Roku Stock. At the time, we pointed out that: “we believe first-party data for connected TV ads is a significant trend moving into 2021 and an important distinction from subscription-video on demand (SVOD) […] Ad-Video on Demand (AVOD) has an approximate ten-year runway as the trend began taking shape when Roku launched its ad platform in late 2018/early 2019. There were AVOD players in the space before this, but the budgets were negligible.”

During the most recent earnings call, Netflix’s management team discussed the company’s plan to introduce ad-supported content:

“And one way to increase the price spread is advertising on low-end plans and to have lower prices with advertising. And those who have followed Netflix know that I've been against the complexity of advertising and a big fan of the simplicity of subscription. And those who have followed Netflix know that I've been against the complexity of advertising and a big fan of the simplicity of subscription. 

But as much I'm a fan of that, I'm a bigger fan of consumer choice. And allowing consumers who would like to have a lower price and are advertising-tolerant get what they want makes a lot of sense. So that's something we're looking at now. We're trying to figure out over the next year or two. But think of us as quite open to offering even lower prices with advertising as a consumer choice.”And allowing consumers who would like to have a lower price and are advertising-tolerant get what they want makes a lot of sense. So that's something we're looking at now. We're trying to figure out over the next year or two. But think of us as quite open to offering even lower prices with advertising as a consumer choice.”

Although Reed Hastings stated “the next year or two,” the New York Times later reported that Netflix told employees an ad-supported tier could rollout by the end of 2022. There were also rumors that Netflix may buy Roku, yet upon hearing the news, we quickly refuted this idea on Twitter:

Netflix’s debt load is one reason why it’s unlikely Netflix will buy Roku as the company has a current valuation of $12 billion. This would nearly double Netflix’s debt or the company could dilute shareholders which would weigh heavily on a stock already down 70% YTD. Plus, Netflix has its hands full as a content creator competing with Hollywood, which was referenced on the call: “We've been doing this for a decade. Well, first of all, that's about 90 years less timethat's about 90 years less time than all of our competitors have been at it.”

Here’s One Path to How Netflix Can Make a New High

If Netflix pulls off the feat of making a new high, fundamentally it will need to be correlated to the global roll-out of ad-supported content. I anticipate the company will test an ad-supported tier in lower yielding markets before rolling it out in the United States and Canada where the company has an additional 30 million it can monetize. Due to the testing this is required, UCAN region is unlikely to see a roll-out in 2022. 

On a technical level, Netflix is the only other FAANG, along with Google, that has not made a lower low. There are always two paths a stock can take: going lower or going higher. The probabilities improve that a certain direction is favored once a stock breaks specific price targets. The below chart is tracking the 5-wave move from the 2012 low. 

What we will want to see for Netflix to make a new high is a break above $405. At this point, the odds are in the stock’s favor that the bulls are in control again. Typically, after a stock reaches new highs, it has to be monitored again to make sure the price holds. If this happens, we will revisit our analysis – which is published weekly in our free newsletter. 

Because we deal with probabilities in the sentiment-driven tech sector, it’s also important to point out that below $115 is what we call no man’s land, where a bottom may be particularly tough to form. We call it “no man’s land’ when a stock can potentially be in free fall and we avoid even the best fundamental stories in these zones.

The chart above shows rare, bullish divergences in the chart which would point towards $450 being more probable than a break in support at $115. There are only two other times since 2012 that this pattern has manifested, and they both marked a turning point was close. 

Netflix is also trading at a 10-year record for a low valuation, which sets up the stock for a sizable rebound. In fact, the company has not traded this cheap in terms of PE Ratio for over 10 years.

When you look at top line growth, the company has not traded this cheap since 2012:

Despite the low valuation, Netflix now has a path to monetizing 50% more subscribers (100 million) including 30 million in the United States and Canada that are currently sharing passwords. 

Notably, Netflix must curtail content costs while competing in a market with many big players. However, despite the nominal subscriber miss, Netflix has actually gained market share from 6% to 6.4%.

Conclusion:

Ultimately, the market has read the situation wrong as Netflix is going to monetize nearly 50% more subscribers in the near-term (1-2 years). The ARPU from advertising is unlikely to be as high yielding as the subscription tiers, yet premium CTV content sees $40 in average revenue per user. We think Netflix could set a new record on ad-supported ARPU due to its premium content and captive audience. Despite a clear path to drive record revenue and record active accounts, the stock is trading at its lowest valuation on the top line and bottom line in 10 years.