The Evercore ISI analyst’s key takeaway: “The low price of the offering ($6.99 versus $9.99 for Netflix’s basic plan), its simplicity (one ad-supported tier) and its differentiation (one supported device at a time, no download capability and HD versus two supported devices, download capability and full HD for the standard $15.49 plan) will likely materially boost the value proposition of Netflix to consumers, help reduce churn and expand gross subscriber adds by addressing one of the biggest challenges the service has faced over the last couple of years – rising price sensitivity, as tracked by our relentless surveys.”
And, Mahaney argued, his Wall Street peers and investors may not yet give the streaming giant full credit for the move. “We don’t believe this is correctly captured in Street estimates or in the company’s current valuation,” the analyst noted. “Overall, we view this offering as having a very compelling value proposition for consumers and a distinct positive for the stock.”
How does the pricing of the ad tier compare to rivals? “This is a very competitive price point, compared to peer ad-supported services of $7.99 for Hulu and Disney+ and $9.99 for HBO Max,” Mahaney offered. But he also suggested that “the limit on simultaneous streaming (basic plans allow just one) and limited video quality should act as a deterrence to tradedowns.”
Others also discussed the subscriber impact. “We believe that the new tier could drive an incremental approximately 4 million subs in the U.S. alone and should drive further sub penetration,” Cowen analyst John Blackledge, who has an “outperform” rating and $325 price target on the stock, wrote in a first reaction in a note to investors on Thursday.
He cited a “proprietary analysis” from June that “suggests that if Netflix introduces an ad-supported tier in late ’22 and around 8 percent of non-member households sign up (33 percent of ‘somewhat likely’ and 85 percent of ‘extremely likely’), Netflix could add around 4.3 million incremental U.S./Canada members in ’23 and drive a blended U.S./Canada ARM (average revenue per member) that is about 8 percent above first-quarter 2022 levels.”
A September Wall Street Journal article cited an internal company document targeting roughly 40 million global “unique viewers” for its ad tier by the third quarter of 2023. “This figure would likely be higher than paid subs, in our view, due to multiple viewers per household,” the Cowen analyst wrote. “The article also cites a Netflix goal of 13.3 million ad-supported viewers in the U.S. by the third quarter 2023.”
Overall, Blackledge on Thursday spoke of a “significant opportunity to unlock member growth among price-sensitive customers.”
Guggenheim analyst Michael Morris, who in his report maintained his “buy” rating and $265 price target, highlighted the streamer’s initial ad focus on markets with proven ad appeal. “We believe that Netflix focused its initial ad-tier launch strategy primarily on countries with established video advertising markets and those with the most incremental opportunity for market penetration,” Morris wrote before also emphasizing the streamer’s potential subscriber upside. “Nine of the 12 launch markets have membership penetration of broadband homes at levels below the 54 percent U.S. rate. In combination with the continued development and release of local-market content, we believe the lower-priced ad-supported tier offers an outsized potential for membership growth in these countries.”
Morris then cited estimates from S&P Global that projects total advertising spend on video, across pay TV, free to air, desktop and mobile video, in the markets where Netflix is launching its ad tier will grow 7 percent over the next four years from an estimated $161 billion this year to more than $170 billion. “We view Netflix as well positioned to capture share in this market as advertisers seek to reach its diverse audience including younger viewers who spend less time with traditional TV,” he concluded.
Meanwhile, MoffettNathanson’s Michael Nathanson, who has a “market perform” rating and $220 price target on Netflix’s stock, focused on answering this question in his report: “Did we get the key ad assumptions right?” After all, he had in an Oct. 4 report estimated Netflix’s ad opportunity, projecting it would reach $1 billion in 2023, including $700 million from the U.S. and Canada, plus $300 million from international markets.
Nathanson had assumed that the ad tier in the U.S. would be “initially priced at $7.99,” he noted. “In fact, the ad tier price came in $1 lower at $6.99 per month in the U.S. The international price assumptions for the ad tiers are essentially in-line. On the flip side, Netflix plans to initially have 4-5 minutes of commercials per hour versus our initial assumption of 4 minutes per hour.”
Nathanson then analyzed the amount of content that will be part of the ad tier. “Another variable that was bit better than expected is the percentage of content viewership that is cleared for commercial monetization,” he wrote. “We assumed 80 percent of minutes in 2023 would be cleared for ad exploitation versus the company’s estimate of 90-95 percent.”
How does it all ad(d) up? “Net-net, the lower-than-expected price is largely offset by a higher-than- expected ad load and slightly more monetizable minutes,” the MoffettNathanson expert concluded. “Netflix expects the ad tier to be neutral to positive on a revenue basis compared to its ad-free offering. This is consistent with our own analysis suggesting the ad tier will be modestly accretive to revenue per user.”
Nathanson’s takeaway for Netflix shares: “We see this pivot as an incremental positive to Netflix’s financial operations. However, we find ourselves below Street estimates for the first time in a while as other forecasters may be overly optimistic on the impact of this pivot while ignoring the foreign-exchange headwinds to near-term profits and revenue per user.”
Meanwhile, U.K.-based PP Foresight analyst Paolo Pescatore told THR that the ad tier launch changes the Netflix narrative. “The move to offer an ad service of some kind was not part of the company’s script. Clearly, it has been forced upon it,” he argued. “It is apparent that the streaming pandemic party is well and truly over. During this time, we saw a rapid increase in consumer adoption fueling subscription revenue. Conversely, during a recessionary period, users will be forced to make some tough decisions regarding the need to keep on paying or signing up to a slew of services. Adding an ad tier, helps Netflix diversify its business model further, offering something for everyone which should resonate with a broad range of users.”
While “users are accustomed to getting something for free with an ad-based service, without paying for a subscription,” its approach “does allow Netflix to retain its proven subscription formula, and the entry point of £4.99 (in the U.K.) is enough to entice users to sign up, more so when you consider the huge catalog of programming,” Pescatore said.
The analyst also sees the appeal for marketers. “Netflix’s growing subscriber base of more than 200 million will be an attractive shop window for advertisers and brands,” he said. But there could also be jitters ahead. “All key stakeholders will need to work more closely to ensure users are not bombarded with spam,” Pescatore said. “Also, consumers will need to brace themselves for putting up with ads on a service that has been ad-free; this will be a cultural shock.”
His advice to the streamer: “Managing expectations will be important by ensuring the right ads are served, otherwise users will cancel.”
Wells Fargo’s Steven Cahall on Friday addressed the fallout from Netflix’s ad tier on the broader ad market. “The launch of Basic with Ads shows impressive speed to market for consumers. However, we think it may take a little while to scale impressions, build audiences and ultimately deliver a platform that can take in major advertising dollars that satisfy frequency and reach requirements, so we think Netflix will be a disruptor in the 2024 (but not ’23) TV upfronts,” he wrote. “We also think Netflix might eschew programmatic sales for some time to drive more scarcity around impressions, supporting higher (ad rates). The growth in premium content AVOD led by Netflix remains a major risk to linear TV ads going forward, and especially the linear scatter market in our view (around 50 percent of cable network ad sales and 30-40 percent for broadcast).”