For years, Netflix (NFLX -0.63%) surged higher as the streaming service faced little direct competition and had a wide-open growth opportunity.
More recently, the stock has become much more volatile as the company has seen slowing subscriber growth and new competition from legacy media companies.
Netflix has looked to a number of new revenue streams to make up for flagging subscriber growth such as advertising and paid sharing. Paid sharing, or what some refer to as Netflix's crackdown on password sharing, has already begun to show results.
After testing paid sharing in a few countries in Latin America, the company rolled it out to more than 100 countries, representing more than 80% of its revenue base. That helped drive subscribers up by 5.9 million the second quarter, a huge spike for a seasonally slow period, and management said it would roll out paid sharing to all the remaining countries it operates in. With the help of paid sharing, management expects revenue growth to accelerate in the second half of the year.
At a recent investor conference hosted by Bank of America, Netflix CFO Spence Neumann shared some details that show how much of a runway Netflix still has in front of it.
Image source: Getty Images.
A new lever to pull
Netflix had long tolerated password-sharing, seeing it as a form of marketing for its service, and the company believed that password sharers would pay for a subscription when they were ready to do so. Referring to family members sharing passwords, former CEO Reed Hastings said back in 2016: "As kids move on in their life, they like to have control of their life, and as they have an income, we see them separately subscribe. It really hasn't been a problem."
However, as Netflix has matured and faced more competition, it's changed its tune on password sharing and found a massive base of potential users who are borrowing passwords from friends and family.
Neumann said at the investor conference that Netflix has over 100 million viewers that it could convert to paid members through paid sharing.
It's hard to understate the potential windfall from doing so. The company finished the second quarter with nearly 240 million paid members globally, but freeloading viewers present a huge monetization opportunity. In the U.S., Netflix is charging $7.99/month for paid sharing, paid for by the account owner who can add extra members. Alternatively, the password borrower can sign up for their own account, paying $6.99 a month for a basic plan with ads, $15.49 a month for a standard plan, or $19.99 a month for a premium plan.
Netflix only needs to add a small fraction of that base of more than 100 million free users to move the needle on the bottom line, especially since converting password borrowers to paid users is essentially all profit as Netflix is monetizing its existing base of content. If it added 10 million new members at $7.99 a month, that would equal $960 million in straight profit. If it can bring in 50 million new paid users at that price point, that would equal $4.8 billion in profit. By comparison, the company finished 2022 with $4.5 billion in net income.
While it might seem farfetched that paid sharing could double Netflix's net income, the leverage in its subscription model and the huge pool of unpaid users make that a very real possibility.
Neumann explained at the conference that the paid sharing rollout is taking place over the next few quarters, meaning it should continue to drive growth in the user base as it progresses.
The long-term opportunity
Netflix shares might seem expensive trading at a price-to-earnings ratio above 40, especially considering what's happening in the broader streaming industry, but the company still has significant opportunities for profit growth. In addition to paid sharing, the advertising business is just starting to gain traction, and has tremendous potential, given the size of Netflix's audience and its ability to target ads. Neumann described the ads business as being in the "crawl" stage of the "crawl, walk, run" progression.
The company should also benefit more than its domestic competitors from global growth in streaming as it's now well established around the world with a large volume of local-language content. While management expects an operating margin of 18% to 20% this year, similar to last year, Neumann said there's potential for that to go much higher, especially as content spending now seems to have plateaued and it even declined last year. If the company can hold its content spending more or less flat going forward, the revenue from every new subscription will essentially flow straight to the bottom line, and that could send Netflix stock soaring over the coming years.
