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Focus on ads instead of adds? Netflix‘s subscriber additions are traditionally in Wall Street’s focus when the global streaming giant opens Hollywood earnings season. But this time around, ads could steal the show as investors are all eyes and ears for possible latest commentary on the planned launch of the company’s advertising tier.
Earlier this year, Netflix had said it would introduce a lower-priced service tier with ads in early 2023. But the launch then became widely expected to happen before year’s end, and on Oct. 13 the streamer confirmed a November launch, ahead of the start of an ad-supported version of Disney+. The company has also been working on plans to begin charging people who use its service by sharing the password of a paying subscriber.
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Netflix — which reported in July it had a total of 220.67 million subscribers, down about 970,000 from the first quarter — has forecast it will add a million subscribers when it discloses its Q3 earnings on Oct. 18. Year to date, Netflix stock is down about 60 percent from the first day of trading this year and sits at $230.00 a share.
But there is optimism from some Wall Street corners. Evercore ISI analyst Mark Mahaney, in an Oct. 11 report, added Netflix’s stock to his list of “top picks,” explaining that those are “stocks where we see clear fundamental inflection points.” For the streaming giant, he explained those this way: Netflix has “arguably the single biggest catalyst across the (internet) sector with its rollout of an ad-supported offering.” After Netflix’s outline of its ad tier launch plans, he reiterated that view.
Meanwhile, Morgan Stanley’s Benjamin Swinburne in an Oct. 6 report maintained his “equal-weight” rating and $230 price target on the stock, writing: “We acknowledge a high degree of uncertainty in the impact on growth from both the ad-supported tier and paid sharing, but we do believe some degree of success has been reflected in the stock.” Overall, he now sees the risk and reward outlook in the stock as “fairly balanced.”
Going into earnings season, other analysts have also highlighted an increased ad tier focus among investors. After Tuesday’s market close, Netflix will hit its net subscriber addition forecast of 1 million, in line with management guidance, “reflecting macro and near-term challenges,” Cowen analyst John Blackledge predicted in an Oct. 5 report, adding: “Given investors’ focus on the upcoming ad tier and paid sharing efforts, these new offerings could partially offset any weakness in reported third-quarter member net adds and/or fourth-quarter member net add guide.”
Overall, Blackledge reiterated his “outperform” rating and $325 price target on the stock. “Netflix shares are up 19 percent since second-quarter earnings on July 19 (but down 60 percent year-to-date), with the year-to-date decline likely reflecting a broader trend among tech sector shares as well as Netflix-specific challenges,” the analyst highlighted. “Meanwhile, investors are increasingly focusing on the opportunity ahead as Netflix rolls out ad tier and password sharing efforts, while also working through pandemic pull-forward in demand.”
The Cowen analyst’s team also questioned Netflix users about password sharing and whether they would pay $3 per month for it. “In total, around 51 percent would pay for Netflix to maintain access to the service, underscoring the opportunity as Netflix prepares to roll out a paid sharing solution,” he concluded.
J.P. Morgan analyst Doug Anmuth, in an Oct. 10 report, maintained his “neutral” rating and $240 price target on Netflix shares. “Given Netflix’s recently muted sub growth, advertising is critical to re-accelerating revenue, expanding Netflix’s Serviceable Available Market (SAM) and driving greater profitability,” Anmuth explained. “The Netflix narrative has shifted from slow/no sub growth on the current business to advertising and paid sharing.”
MoffettNathanson analyst Michael Nathanson wrote in an Oct. 13 report that Tuesday’s earnings update and call could yield additional insight or color on the impact of the ad tier. “[O]ne key aspect to this advertising math that we touched on in our last report will be how the Microsoft partnership is structured to help guarantee and backstop Netflix from any underperformance and cloud any of the true cost as the advertising business scales for Netflix,” Nathanson wrote. “Another unknown variable that impacts our estimate is the percentage of higher-paying subscribers from the $15.49 and $19.99 plans that spin down to the advertising tier.”
Meanwhile, Nathanson in an Oct. 12 report on the streaming landscape also highlighted: “Netflix broke its own record for number of original episodes released in a quarter, releasing 1,026 in the third quarter. That’s about five times more than anyone else, with Amazon and Hulu each releasing 223 and 194 episodes, respectively.”
However, not everyone on Wall Street is as optimistic about the upside from the ad tier and password sharing. Pivotal Research Group analyst Jeff Wlodarczak in an Oct. 11 report reiterated his “sell” rating and $175 price target. Citing recent investor “optimism regarding the supposed potential upside of an ad-supported tier to potentially accelerate subscriber and possibly even (average revenue per user) ARPU growth,” Wlodarczak highlighted: “We see the move to offer an ad-supported tier by the global streaming incumbent player as defensive, not offensive, and fraught with ARPU, technological, product perception, results variability risk that continues to be underappreciated as evidenced by Netflix’s current still rich valuation.”
In the core U.S./Canada market “in particular we doubt that an ad-supported tier is going to allow Netflix to return to annual subscriber growth as Netflix appears near fully penetrated,” the analyst wrote, estimating that around 80 percent of U.S. internet households “already subscribe to Netflix when including piracy and highlighting “increasing levels of competition.” He added: “More importantly, we believe there is a significant ARPU risk of existing households churning down to what we believe will end up being a less attractive ad-supported service while making Netflix dramatically more reliant on variable advertising spend into an increasingly likely ’23 recession and putting its ARPU at risk should advertising turn out to be lower than expected.”
The Pivotal analyst also warned that “a lower-cost ad-supported version of Netflix arguably taints the Netflix brand, and the tech behind successful advertising delivery is very difficult (and Netflix seems to have not chosen the strongest potential partner in Microsoft), not to mention Netflix original programming is not optimized for ad breaks.”
Meanwhile, hit content could help Netflix beat a low bar its team had set for third-quarter subscriber expectations, according to Wedbush Securities analyst Michael Pachter. “The beginning of the quarter was driven by the release of Stranger Things (season) 4,” he wrote in a Oct. 14 report. “Not only were viewers excited about the (latest) season, many went back to rewatch prior seasons while others binge-watched the whole series to be part of the cultural zeitgeist that the show manifested. Late in the quarter, Dahmer gained strong viewership.”
Concluded Pachter: “Given the strong viewership over the course of the third quarter, we think subscriber numbers will beat low expectations set by management. We think that management set a sufficiently low bar of 1 million net global subscriber additions.” The former Netflix bear, who now rates the stock at “outperform” with a $280 price target, predicts “subscriber growth of 1.45 million to end the quarter at 222.12 million.”
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