Streaming pioneer Netflix (NFLX 4.17%) successfully brought movies and television to its streaming platform, which has grown to serve a massive worldwide audience of 230 million paying subscribers.
Netflix also recently launched over 50 mobile games, its first effort to enter into a massive gaming industry that is ripe with opportunity. Will gaming become a core pillar of the company's long-term growth?
Answering that requires understanding some challenges facing Netflix that are unique to gaming. Here is how the company's gaming efforts could impact investors now and over the coming years.
An opportunity to level up long-term growth
The gaming industry is one of the largest and fastest-growing media formats. It's worth an estimated $180 billion, with roughly half of that on mobile devices. It's second only to television in size, surpassing movies, books, and music. You're starting to see gaming's growth in mainstream media through television and movie adaptations (the Last of Us series on HBO is a recent example). According to Grand View Research, the global gaming market could hit $500 billion by 2030.
Investors hope that Netflix's strong foothold in streaming is a direct gateway to penetrating this lucrative market. The company's Co-CEO and Chief Content Officer Ted Sarandos recently discussed Netflix's gaming segment at a conference, noting that the company believes consumers will spend a lot of time and money on gaming as part of their entertainment package moving forward.
Gaming doesn't contribute to the business at this point, so what's the takeaway? Investors should look at gaming as an avenue to intellectual property. Popular games have built entire corporations (Call of Duty, anyone?) like top-tier movie franchises, and Netflix wants exposure to this upside.
But making inroads could be challenging
It's a great theory that could pay handsomely if Netflix succeeds, but it's not as straightforward as plunking games in front of subscribers. A report last summer used app-download tracking data to estimate that less than 1% of Netflix's user base was playing its games daily.
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Gaming is far more competitive than television or movies, which require large budgets and specialized talent. However, anyone that can write code can make a simple game (more complex games can take years and teams of programmers), which is why there are more than 15 million game developers today. The average iOS game costs developers $5.28 per install but only pennies in revenue per user. It's a top-heavy industry where a few games make most of the money.
A possible workaround would be to acquire a game studio with established content and bring it into the Netflix app. However, Netflix is advertising that its games are free of traditional monetization methods used by mobile games, like ads and in-app purchases, instead offering them as part of a Netflix subscription. The early lack of traction and willingness to lean on subscriptions could mean that games are a money-loser for Netflix for the foreseeable future, something investors should monitor moving forward.
How should investors proceed?
For now, investors should focus on Netflix's core streaming business and consider gaming a lottery ticket for the long term. Today there's enough fundamental value to consider buying shares for the company Netflix already is. The stock trades at a price-to-earnings ratio (P/E) of 33, comfortably below its average over the past five years.
NFLX PE Ratio data by YCharts
Analysts believe the company can grow earnings at a 25% growth rate, so there's long-term appeal -- Netflix could quickly outgrow its valuation if investors are willing to hold for at least the next few years. Gaming is exciting, but don't put the cart before the horse. Instead, buy Netflix for its attractive valuation and solid core business.
