Is Netflix Stock a Buy After Its Deal With Microsoft?

In 2007, Netflix (NFLX -0.51%) upended the entertainment industry when it launched the first streaming service, challenging traditional paid television with a less costly and more convenient alternative. Early on (and somewhat ironically), many industry executives failed to see Netflix as a threat, including the CEO of the now-defunct video rental chain Blockbuster.

Everyone knows what happened next. Broadcast and cable television have slowly lost market share, while Netflix has become a global phenomenon. At the same time, patient shareholders saw life-changing returns as Netflix stock skyrocketed more than 4,600% over the past 15 years.

However, Netflix lost 200,000 subscribers on a sequential basis in the first quarter -- its first subscriber loss in more than a decade -- and the company expects to lose another 2 million  in the second quarter. Investors are worried Netflix has hit a saturation point, and those concerns have sent the share price tumbling. Despite tremendous returns over the last one-and-a-half decades, Netflix stock is still down 75% from its high. But the company just made a potentially game-changing deal with Microsoft (MSFT -1.84%).

Here's what you should know.

The details of the deal

In April, Netflix announced plans to introduce a cheaper ad-supported service as a way of reinvigorating subscriber growth. The company has since met with several potential marketing partners, including Alphabet's Google, Comcast, and Roku. But Netflix ultimately selected Microsoft to help power its ad-supported offering.

That move caught some investors by surprise, but Microsoft has quietly built a robust ad tech platform. Of particular note, it acquired Xandr from AT&T last year in preparation for a post-cookies world. That move added a number of tools to Microsoft's portfolio. For instance, Xandr Invest is a demand-side platform that helps advertisers buy inventory and run data-driven campaigns, and Xandr Monetize is a supply-side platform that helps publishers sell ad inventory. Going forward, those tools will facilitate ad transactions on Netflix's ad-supported tier.

In hindsight, the decision to partner with Microsoft makes a lot of sense. Google, Comcast, and Roku each operate their own ad-supported streaming services -- YouTube, Peacock, and The Roku Channel, respectively -- which naturally creates a conflict of interest. Microsoft doesn't have that problem. More broadly, Microsoft is a reputable brand with plenty of experience in the ad industry, and its technology could prove to be a significant asset to Netflix in the long run.

Is the stock a buy?

Netflix is the most popular streaming service as measured by total subscribers. That success stems from its first-mover advantage and its growing library of original content. Case in point: Netflix currently owns eight of the top 10 original streaming series, according to data from Nielsen, and it received more Academy Award nominations than any other studio in both 2021 and 2022.

However, that competitive edge only goes so far. Consumers have a finite amount of time and money, so headwinds like increasing competition, rising membership fees, and high inflation have caused subscriber and revenue growth to decelerate in recent years.

Data source: Netflix SEC Filings.

As a point of clarification, all businesses eventually reach a point of maturity where growth slows down. But streaming still accounts for less viewing time than cable television, according to Nielsen, which suggests that Netflix still has plenty room to grow its business. But to realize that potential, the company needs to do something different.

With that in mind, an ad-supported offering could be the game-changing feature that reenergizes Netflix's business. Ad-support video on demand (AVOD) services are expected to generate $260 billion in revenue by 2025, according to Omdia. However, there is still execution risk. Netflix pioneered the streaming industry, but the company is a latecomer in the AVOD space.

While the partnership with Microsoft is a good start, Netflix still has a lot to prove and investors should pay attention to management's commentary surrounding its ad-supported streaming service, which could launch as early as this year. The company is set to release its second quarter financial report on July 19, and I bet management will have more to say on the Microsoft partnership.

For what it's worth, I plan to stay on the sidelines until I see some evidence that Netflix can reaccelerate growth in key metrics like subscribers and revenue. But with the stock trading at 2.8 times sales, it's cheaper today than it has been since 2013. So I think it's OK to buy a few shares right now.