Netflix (NFLX -3.92%) crushed Wall Street's expectations, delivering a solid set of numbers for the third quarter. Most notably, it added an impressive 2.41 million net new paid subscribers while analysts were anticipating an increase of just 1 million, but there's a bigger story cooking in the background that investors may want to take a closer look at.
The video streaming specialist seems all set to dive into a new market that could unlock a huge long-term growth opportunity. At tech-focused online publication TechCrunch's Disrupt event, Mike Verdu -- Netflix's vice president of gaming -- said that the company is "seriously exploring a cloud gaming offering." Verdu added that Netflix is opening a new game development studio in Southern California.
It is worth noting that Netflix also set up a gaming studio in Finland last month. The latest addition will take its total number of gaming studios to five.
Fortune Business Insights estimates that cloud gaming generated $1.7 billion in total revenue last year. But the market research firm expects that the niche will clock annualized growth of 43% through 2029, when the forecast points to $40 billion in annual revenue. So it's not too surprising that Netflix is putting serious thought into its plans to tap that explosive market.
Netflix believes it can succeed in cloud gaming
The cloud gaming market is taking off thanks to the advantages it enjoys over the traditional modes of delivering games -- such as eliminating the need to purchase high-end hardware and expensive gaming titles. Yet, not many companies have cracked this market so far.
Technology giant Alphabet (GOOG 0.74%) (GOOGL 0.55%), for instance, recently announced that it will shut down its Google Stadia cloud gaming service in January. Though Alphabet says that Stadia is "built on a strong technology foundation," the lack of traction among users is what's led the company to pull the plug on this service.
Netflix believes it can succeed where Google Stadia failed. At the TechCrunch conference, Verdu explained that Netflix plans to offer cloud gaming as an additional service -- one that won't require subscribers to replace their gaming consoles.
The digital media veteran aims to deliver its cloud games to subscribers on the same devices where they are already consuming its streaming video content -- personal computers, smartphones, and TVs. Netflix had 223 million paying subscribers as of the end of the third quarter. That's a huge customer base to whom it could cross-sell a cloud gaming service.
Since cloud games are run on remote servers and are delivered to gamers via fast internet connections, all Netflix needs to do is create a healthy library of games and sell the gaming service as an add-on subscription. After all, cloud gaming doesn't require customers to upgrade to expensive hardware as data centers do all the heavy lifting.
However, that will be easier said than done. Another tech powerhouse has already become the dominant player in this nascent space.
An Nvidia-sized obstacle is waiting for the streaming giant
Graphics card specialist Nvidia (NVDA -3.33%) is leading the cloud gaming market in terms of both revenue and subscribers. On its August earnings conference call, it pointed out that its GeForce Now cloud gaming service has more than 20 million members. It is also worth noting that Nvidia has a massive cloud gaming library of over 1,350 titles thanks to the company's consistent efforts to bring more games onto the GeForce Now platform.
This is where Netflix pales in comparison to Nvidia. The company has just 35 gaming titles on the market and 55 games in development for its cloud platform right now. And Nvidia's expertise in critical gaming hardware such as graphics cards gives it another advantage. Its platform -- run on servers powered by RTX 3080 graphics cards -- streams titles at high resolutions and rapid refresh rates.
That's another area where Netflix will need to come close to Nvidia to cut its teeth in cloud gaming and give its growth rate a shot in the arm. The video streamer's revenue increased by just 6% year over year last quarter to $7.9 billion, while its earnings contracted to $3.10 per share from $3.19 per share a year earlier.
Analysts aren't upbeat about Netflix's prospects. They anticipate annualized earnings growth of just 3% for the next five years. So, a new catalyst such as cloud gaming could give Netflix a much-needed boost, but the company will have a long way to go to make a name for itself in this market, especially considering that it is going up against a video gaming giant that is already making the most of its first-mover advantage.
