As most investors are probably already aware, Netflix Inc. (NFLX, Financial), the leading content streaming platform globally, came under pressure last year with the company losing millions of subscribers in the first half of 2022.
Things took a turn for the better in the second half of 2022 with Netflix adding just over 2 million subscribers in the third quarter, followed by more than 7.6 million subscribers in the fourth quarter. The company, in a bid to revive subscriber growth, unveiled a new ad-supported content tier last November, a decision that was widely praised by both analysts and investors. Although Netflix is facing short-term challenges, I believe the company seems well-positioned to grow thanks to its strategic changes.
After surging to more than $360 earlier this year aided by the improving market sentiment toward growth stocks, Netflix stock has declined to around $305. I think this presents a potential value opportunity for those bullish on the stock.
Setting up a platform to grow profitability
For the best part of the last decade, Netflix’s focus has been on revenue growth. Now that growth has slowed down considerably due to size and market saturation, the company is undergoing a business transformation with profits at the center of the strategy, which is a welcome sign for long-term-oriented investors.
Netflix has recently rolled out three major decisions to squeeze out more profits. The first is to charge extra fees for shared accounts, a plan which it is rollng out in several regions including the U.S., Canada, New Zealand and Spain. It does this by tracking users' locations and barring them from accessing the account if they try to log in away from the main account location - unless they pay the extra fees. The successful launch of this service should improve the revenue per user of its primary markets in the coming quarters. Commenting on this decision, JPMorgan analyst Dough Anmuth wrote in a note to clients:
"We expect NFLX to continue down the path of transitioning users away from widespread account sharing, making select policy & customer service tweaks along the way to reduce friction. Ultimately we expect NFLX to generate more revenue through the combination of Extra Members and new standalone accounts, especially as Paid Sharing is paired with the low-priced Basic With Ads tier."
The second move was that it slashed the subscription prices across all categories in more than 100 global territories last month, a move that was not welcomed by many investors. Although these price cuts will impact ARPUs, Netflix’s strategy is to lure more customers to its platform, since it will undoubtedly lose some from the restrictions on account sharing, which could lead to higher revenue and earnings in the long run. These price cuts will also help Netflix compete better with its many emerging rivals in the global market. Maintaining its competitive strength in key global regions should help Netflix’s earnings potential in the long term.
The third new move is the ad-supported tier. The expected growth of the ad-supported tier is a reason to be optimistic about what the future holds for the company. For many years, Netflix failed to gain traction in strategically important markets such as India due to the threat from lower-priced, ad-supported streaming platforms. By embracing a similar operating model, Netflix now is well-positioned to gain traction in India and other emerging markets.
The company is expanding into new content categories as well. Last year, Netflix ramped up the availability of original games on its mobile app powered by characters from original content produced by the company. This year, the company plans to release new games every month, and over 100 new games are expected to hit the platform in 2023 alone. Netflix’s aggressive push into gaming is a move to keep subscribers entertained and engaged.
Long-term macroeconomic trends are favorable
Netflix and many of its peers benefited from the accelerated growth of the streaming industry at the height of pandemic fears and mobility restrictions in 2020. In the post-pandemic era, Netflix initially struggled to gain momentum as years of expected growth were pulled into 2020 numbers already. The streaming market continues to show sluggish growth with consumers cutting down on discretionary spending due to recession and inflation. Short-term challenges have deteriorated the investor sentiment toward entertainment giants, including Netflix, but these dark clouds are unlikely to be obstacles in the long run.
In February, streaming viewership remained strong in the U.S., and the market share of streaming increased to 34.3% while cable and broadcast viewership declined. The continued strength of streaming viewership underlines a long-term shift toward content streaming. In the next few years, cable TV popularity is expected to decline further, enabling streaming giants to aggressively take market share. Out of the streaming pie, Netflix remained the number one platform with a share of 7.3%, followed by Hulu and Amazon (AMZN, Financial) Prime Video with viewership shares of 3.3% and 3%, respectively. Netflix, as evident from these numbers, remains the top streaming platform in the country by far.
The rising middle-income society in emerging nations will be a boon for Netflix as its addressable target market will expand with a new generation of consumers in populous countries such as India, Brazil and Malaysia embracing digital solutions including content streaming. The internet penetration rate is trending higher in many developing nations already, and this trend is expected to gather momentum in the next five years, aided by infrastructure investments to support the rollout of 5G technology.
Takeaway
Netflix may not be growing fast anymore, but it trades at a forward price-earnings ratio of 26, which is cheaper than in the past. The company has a long runway for growth and is experimenting with a few different ways to more effectively monetize its massive user base. The company’s renewed focus on profitability makes it an interesting stock for growth investors shopping for bargains in this volatile market.
