When Netflix (NFLX -0.63%) reported its first-quarter 2022 financial results on April 19, it showed that the business lost 200,000 subscribers in the quarter. To make matters worse, management expects to lose 2 million customers in the current quarter. The pandemic surge that it experienced in 2020 appears to have come to a screeching halt; shares are down 67% this year alone.
Slowing growth for the streaming pioneer has forced Reed Hastings, Netflix's co-founder and co-chief executive officer, and his team to publicly mention for the first time that the business will explore a lower-priced, advertising-based subscription option. Let's look at why this announcement by Netflix has actually caused me to buy more Roku (ROKU -10.29%) stock.
Netflix will explore a cheaper, ad-supported tier
Netflix's management had long turned down the idea of ever making this move, deciding to serve its users with the best viewing experience, something that ads would ruin.
Now, the leadership team's tone is focused on providing different choices. It's surprising that management changed its strategy. But when the business isn't adding 25 million subscribers a year, as it did for the past few years before 2021, achieving growth by any means is the goal.
I think it makes sense, though. Another popular streaming service, Walt Disney's Hulu, already offers consumers a cheaper tier with ads. eMarketer estimates that Hulu will generate $3.1 billion in ad revenue this year. That's impressive for a service that only counted 45.3 million members as of Jan. 1.
Image source: Getty Images.
Therefore, it's not difficult to see the incremental revenue opportunity for Netflix. Plus, as the business starts to crack down on password sharing (it says that 100 million households use other people's accounts), Netflix could offer a cheap option to capture these new customers instead of losing them.
It's worth mentioning that Netflix has said it plans to use a third-party ad-tech platform to pursue this initiative. "We can be a straight publisher and have other people do all of the fancy ad-matching and integrate all the data about people," Hastings said on the first-quarter 2022 earnings call. Netflix plans to launch an ad-supported tier within the next year or two.
Roku makes money off ads
This announcement by Netflix immediately puts Roku in the most powerful position in the entire streaming industry. Roku's platform business segment, which represented 88% of total revenue in the first quarter and carries a 58.7% gross margin, includes sales mainly from advertising on its platform. In other words, if a consumer sees an ad while watching a show or movie on a Roku device, Roku gets paid.
Currently, Roku can only make money from Netflix if someone signs up for a Netflix membership from a Roku device. However, if Netflix ultimately launches a cheaper ad-based version of its service, Roku's revenue opportunity with the world's biggest streaming-content provider skyrockets. That's because the typical contract Roku enters into with content companies is to take 30% of any ad revenue. The potential ad inventory with Netflix could be massive.
Furthermore, the majority of streaming time takes place on a TV. And for Roku, as the No. 1 streaming platform (by hours streamed) in the U.S., Canada, and Mexico, this is clearly beneficial.
As you can probably tell, my opinion is that Roku's competitive position in the streaming landscape is poised to become stronger as Netflix plans to introduce a lower-priced, ad-supported subscription tier in the face of a major slowdown in membership growth. And because Roku's stock has gotten absolutely hammered and is down 81% since last July, buying shares recently was a no-brainer decision for me.
Roku now looks like the best pure-play streaming stock investors can own.
