Netflix (NFLX -9.09%) expects advertising to be a big part of its business.
On its fourth-quarter earnings call, outgoing co-CEO Reed Hastings asked CFO Spence Neumann how many years it'll take the company to surpass Hulu's advertising business. The Hulu streaming service, controlled by Walt Disney (DIS 0.16%), had a 15-year head start on Netflix in advertising, and it has grown to become a leading seller of connected TV advertising in the United States.
"We're not going to be larger than Hulu in year one," Neumann said. "But, hopefully, over the next several years, we can be at least as large."
Here's what a growing advertising business would mean for Netflix and its investors.
How big could advertising be for Netflix?
Hulu's advertising head start will be tough to overcome.
It generated $3.1 billion in ad sales from connected TV alone in 2021, according to an estimate from eMarketer. The advertising market cooled in 2022, though, and Hulu saw a decline in ad revenue in Disney's fourth quarter.
Still, connected TV remains one of the best areas for growth in advertising, and Hulu is the market leader in the U.S. eMarketer sees Hulu's total ad revenue growing to $4.25 billion this year.
Netflix expects its advertising business could grow from $0 to around $5 billion in just a few years. Neumann said: "[W]e wouldn't get into a business like this if we didn't believe it could be bigger than at least 10% of our revenue and hopefully much more over time in that mix as we grow." Management's expectations are roughly in line with an estimate from Ampere Analysis last summer that saw Netflix taking in $5.5 billion in total ad revenue in 2027.
But Hulu could be generating well over $5 billion in ad revenue by that time. Disney is combining its ad-buying platform with Disney+, which could attract more advertisers and cross-service targeting, not to mention the secular growth in connected TV advertising fueling revenue. So, overtaking the leader in the space could take quite a bit longer for Netflix.
Still, even if Netflix doesn't overtake Hulu, it'll be integral to its plans to reaccelerate revenue over the next few years.
Getting back to double-digit revenue growth
Netflix's medium-term goal is to return to double-digit revenue growth after growth slowed significantly in 2022.
For the full year, Netflix grew revenue 6.5%, but that slowed throughout the year after it lost subscribers to start off 2022. Fourth-quarter revenue grew less than 2% year over year. Management expects 4% revenue growth in the first quarter this year, but that number should accelerate over the course of the year. However, the company could face some hiccups as it develops the ad tier and cracks down on password sharing.
Over the next five years, Netflix may be able to reach a compound annual growth rate of 9% to 10%, owing to the slow growth in 2023. That translates into revenue of $48.6 billion to $50.9 billion in 2027. Again, that puts estimates for Netflix's ad revenue in line with the 10% of total revenue target.
It also suggests advertising will account for more than a quarter of Netflix's total revenue growth in that time. And when you consider the incremental subscription revenue from the ad tier, the entire shift in strategy will account for an even greater effect on revenue growth, proving essential to Netflix's return to double-digit growth.
So far, Netflix is pleased with the results: Strong engagement, strong take rates, and minimal downgrading from premium plans. It says the plan is attracting incremental subscribers, and sign-ups for the ad tier should grow over time. While the team still has to execute, the potential management sees in the ad tier should make investors optimistic about a reacceleration in growth.
