Video streaming platform Netflix (NFLX 0.28%) has been around for almost 20 years. The company was a pioneer in both the on-demand video rental business and content streaming. However, over the years, several other media outlets have invested heavily in rival streaming platforms, rendering Netflix a thing of the past.
But unlike its burgeoning competition, Netflix was still one of the only streaming platforms that avoided using advertising as a revenue stream and was widely known to be lax with password sharing by its users. While the company has invested significant capital in producing its own original content, which has reaped benefits in the form of more subscribers, more often than not, Netflix has had no choice but to increase its subscription fees in an effort to grow revenue.
During the Q3 earnings call, investors learned about management's playbook for bringing Netflix to the next level. And while not everyone might be a fan, the company is clearly laying the groundwork for becoming a maturing business. Let's dig in and analyze how Netflix might have unlocked some further value.
Do people even click on those?
Advertising might be one of the oldest yet most successful methods of generating sales. Whether you are in a grocery store, in a restaurant, or online, marketers have savvy ways to attract your eyeballs and, more importantly, your money.
Digital services, however, present some extra barriers when it comes to advertising. For example, in a retail setting, a shopper can move around freely and direct their attention to whatever sign, poster, or promotion attracts them most. Moreover, shoppers have the luxury of walking away with the advertised item right on the spot.
By comparison, when streaming content on a television or computer, users have little choice but to watch the ad that is pushed their way. On top of that, should the viewer actually make a purchase after watching the ad, there is a lag between when the order is fulfilled and when the item arrives. For these reasons, only a handful of technology companies seem to have really unlocked the power of advertising.
While Netflix has long avoided including commercials and ads within its content, it seems as if most of its major competitors have been doing so for quite some time. For example, Disney-owned Hulu offers a basic plan that includes ads. The primary benefit of this approach is that Hulu can now attract a new demographic of subscribers: those who are unwilling or unable to pay for a premium subscription (without ads). Furthermore, Hulu is able to command lucrative deals with its advertising partners who want access to the platform and its many viewers. As a result of the extra revenue, competitors like Hulu are able to reinvest in building their own content to compete with that of Netflix.
During the Q3 earnings call, Netflix management made it clear that it has seen enough. The company began rolling out a basic plan that includes ads for $6.99 per month. This is significantly less expensive than Netflix's highest tier, which runs $19.99 per month. While the company is only rolling out this plan in the U.S. and 11 additional markets to begin, it seems confident that it will be able to acquire an entirely new cohort of viewers.
This could benefit Netflix greatly, as the company will increase its subscription revenue and now have a secondary source of revenue from advertising partners. It's not surprising that the company believes it will add more than 4.5 million subscribers just in Q4 alone, which would be nearly double what it added during Q3.
The crackdown we all knew was coming
For several years, many Netflix viewers accessed the platform by sharing a password with someone else. Netflix knew about this but did not seem overly concerned about it. Beginning in early 2023, however, the company will begin cracking down on password sharing via a two-pronged approach.
For starters, if a single account has multiple users affiliated with it, the company will allow the nonprimary members to transfer their viewing histories, watch lists, and other data to their own separate accounts. Additionally, Netflix will permit primary account owners the option to pay for borrowers' subscriptions if they choose.
This means that if you allow friends or family to use your Netflix account, either they will need to create their own account or you will need to pay an extra service fee on top of your subscription price. Either way, Netflix is going to monetize account-sharing, which will likely cause an uptick in both subscription fees and the number of subscribers.
Keep an eye on valuation
Since the company began hinting at its ad-tier and a paid sharing crackdown over the summer, Netflix stock has enjoyed a nice uptick on the speculation that the company will be rolling out these features to generate more growth.
During the Q3 earnings call, this hypothesis was verified when management commented at length about the advertising rollout and paid-sharing timeline. Given the clear visibility into higher subscription revenue growth, and therefore increased profitability, from these two catalysts in Q4 and going into 2023, Netflix stock soared more than 14% immediately following the earnings release.
Yet despite these upward movements, the stock is still trading at roughly 23 times its price to earnings. For reference, Netflix was trading over 60 times price to earnings during the same period last year.
As Netflix shows signs of becoming a maturing business, the current valuation looks appealing. Now could be an ideal time to lower your cost basis or initiate a position.