After months of speculation regarding the details, streaming-video service Netflix (NFLX -1.58%) is officially ready to launch its ad-supported tier. According to the company, users from multiple countries, including the U.S., can subscribe to the new "Basic with Ads" plan starting on Nov. 3.
Netflix's move toward ads is the most anticipated move from the company in years. And yet, this might be an anticlimactic event for shareholders. Here's why I wouldn't buy Netflix stock based solely on the launch of its ad-supported tier.
What ads will look like on Netflix
Here's the context for the company's move toward ads. After years of rapid growth, Netflix's user growth stalled in 2022. Peak membership occurred in the fourth quarter of 2021, with 221.84 million paid memberships worldwide. In the first half of 2022, it lost roughly 1.2 million accounts. And that's a big reason Netflix stock is down about 60% year to date.
Early in 2022, Netflix management shocked investors by saying it was exploring an ad-supported streaming tier -- something co-founder and CEO Reed Hastings historically opposed, due to its complexity. But faced with slumping user metrics, Hastings changed his tone, saying he was a fan of "consumer choice."
Netflix is now presenting consumers with the following choices: pay $9.99 monthly for the most basic Netflix subscription without ads, or $6.99 monthly for the same quality video resolution with ads. The company says consumers can expect between four and five minutes of ads per hour of streaming.
It's worth noting that Netflix is beating The Walt Disney Company to the punch in two ways. Disney's most basic plan for Disney+ doesn't launch until Dec. 8 -- a month after Netflix. And Disney's ad tier will cost $7.99 per month, compared to Netflix's $6.99.
The impact ads will have on Netflix's business
Netflix stock jumped 5% immediately after announcing the details for its ad-supported subscription tier, suggesting the market is bullish on the plan. Wall Street is bullish, as well. According to The Fly, JPMorgan analyst Doug Anmuth believes this lower-priced ad tier could attract 7.5 million users in 2023 alone.
Similarly, Atlantic Equities analyst Hamilton Faber believes the move will be "extremely material" to Netflix's financial results and consequently upgraded Netflix stock, also according to The Fly. Anmuth and Faber aren't alone -- many analysts and investors think ads are a big deal for Netflix.
But there's something important for Netflix investors to consider: The company will give up $3 per month in revenue when subscribers opt to watch ads instead of paying for the comparable ad-free experience. Therefore, it needs to make at least that much in average ad revenue per user (ARPU) just to offset this.
That'll be easier said than done for Netflix, at least initially. The company's COO Gregory Peters all but said as much by saying, "We're quite optimistic that the sort of unit economics work to make that monetization sort of equal or maybe even better than" comparable non-ad tiers [emphasis added].
Therefore, it's likely Netflix's move will have a neutral effect on revenue in the near term, as streaming subscribers trade down from paid tiers to its ad-supported tier.
Buy Netflix stock?
Some might argue that Netflix's ad-supported tier will attract new users. And perhaps an entirely free version would, too. But a CivicScience survey in July found that only 26% of non-subscribers to Netflix would even be interested in an ad-supported paid plan, let alone actually sign up when it's available.
That said, Netflix's decision to have ads has its merits, nonetheless. For starters, it's hard to measure the value of keeping existing users happy by offering them greater choices, but it's surely important. Moreover, Netflix does have valuable ad space. For example, the fourth season of Stranger Things racked up 1.3 billion viewing hours in the first four weeks it was available and generated buzz on social media. Brands would love to put their products in front of an audience like that and would pay up for the opportunity.
However, the takeaway for investors is not to buy Netflix stock because of its new ad-supported tier. The move doesn't hurt but appears to have a low chance of improving the business fundamentals.
Netflix's new ad-supported tier merely acknowledges that this is a feature its customers want. If ads offered a fundamental improvement to the company's financials, management would have done this long ago.
Therefore, if you buy Netflix stock, it should be for other reasons, like the company cutting down on password sharing and focusing more on profits. It will be a long time before Netflix's ad-supported tier potentially moves the needle, giving investors plenty of time to wait and see how ads perform before making it part of a Netflix investment thesis.
