Netflix Looks to Advertising to Spark Top-Line Growth

Business Strategy & Outlook

Netflix is a pioneer in subscription video on demand and is now the largest online video provider in the U.S. and the world. The economic moat rating of narrow is based on intangibles resulting from the use of data stemming from the firm’s massive worldwide subscriber base. From its origin in the U.S., Netflix expanded rapidly into markets abroad as the service now has more subscribers outside of the U.S. than inside. The firm has used its scale to construct a massive data set that tracks every customer interaction. It then leverages this customer data to better purchase content as well as finance and produce original material such as “Stranger Things.” However, the firm has recently ramped up its production using more traditional methods. Many consumers use, and will continue to use, SVODs like Netflix as a complementary service, especially as SVOD prices increase and pay television bundle prices decrease (due to the shift to over-the-top, or OTT, delivery). With a number of new services from media firms launched over the last five years, many consumers now pay for or have access to multiple services.

One potential issue for these platforms is the potential for consumers to move between the services with minimal friction. This usage pattern and increased competition will constrain Netflix’s ability to raise prices without inducing greater churn. Netflix will trial an ad-supported tier in fourth-quarter 2022 into 2023 as the firm looks to capture potential subscribers that were unwilling to pay the ad-free price. While the potential audience could be large, particularly in emerging markets, management will need to ensure that the lower-priced tier doesn’t cannibalize the full-price subscriber base in more saturated markets like the U.S. Netflix will expand further into local-language programming to augment its offering in many countries. This will generate a competitive response from the firm’s global and local rivals, which will augment their own first-party content budgets. In turn, Netflix’s international expansion will continue to hamper margin expansion.

Financial Strengths

Netflix’s financial health is poor due to its weak free cash flow generation, large number of content investments that require outside funding (primarily debt), and content obligations. Debt has been taken on to fund additional content investments and international expansion. The company’s weak free cash flow due to this spending is a concern, as one doesn’t see the need to spend decreasing in the near future. The net cash burn was over $2 billion in 2017, over $3 billion in 2018, and $3.5 billion in 2019. While the firm generated positive free cash in 2020 due to pandemic-related production shutdown, Netflix returned to a slight cash burn in 2021. As of June 2022, Netflix has $14.2 billion in senior unsecured notes that do not have borrowing restrictions, but a relatively small amount due in the near term ($700 million due 2022, $400 million due 2024, and $800 million due 2025), as the firm generally issues debt with a 10-year maturity. Netflix also has a material quantity of noncurrent content liabilities ($3.0 billion recognized on the balance sheet and $15.6 billion not yet reflected on the balance sheet).

Bulls Say

Netflix’s internal recommendation software and large subscriber base give the company an edge when deciding which content to acquire in future years.
Netflix has built a substantial content library that will benefit the firm over the long term.
International expansion offers attractive markets for adding subscribers.

Company Description

Netflix’s primary business is a streaming video on demand service now available in almost every country worldwide except China. Netflix delivers original and third-party digital video content to PCs, internet connected TVs, and consumer electronic devices, including tablets, video game consoles, Apple TV, Roku, and Chromecast. In 2011, Netflix introduced DVD-only plans and separated the combined streaming and DVD plans, making it necessary for subscribers who want both to have separate plans.

(Source: Morningstar)

DISCLAIMER for General Advice: (This document is for general advice only).

This document is provided by Laverne Securities Pty Ltd T/as Laverne Investing. Laverne Securities Pty Ltd, CAR 001269781 of Laverne Capital Pty Ltd AFSL No. 482937.

The material in this document may contain general advice or recommendations which, while believed to be accurate at the time of publication, are not appropriate for all persons or accounts. This document does not purport to contain all the information that a prospective investor may require. The material contained in this document does not take into consideration an investor’s objectives, financial situation or needs. Before acting on the advice, investors should consider the appropriateness of the advice, having regard to the investor’s objectives, financial situation, and needs. The material contained in this document is for sales purposes. The material contained in this document is for information purposes only and is not an offer, solicitation or recommendation with respect to the subscription for, purchase or sale of securities or financial products and neither or anything in it shall form the basis of any contract or commitment. This document should not be regarded by recipients as a substitute for the exercise of their own judgment and recipients should seek independent advice.

The material in this document has been obtained from sources believed to be true but neither Laverne and Banyan Tree nor its associates make any recommendation or warranty concerning the accuracy or reliability or completeness of the information or the performance of the companies referred to in this document. Past performance is not indicative of future performance. Any opinions and or recommendations expressed in this material are subject to change without notice and, Laverne and Banyan Tree are not under any obligation to update or keep current the information contained herein. References made to third parties are based on information believed to be reliable but are not guaranteed as being accurate.

Laverne and Banyan Tree and its respective officers may have an interest in the securities or derivatives of any entities referred to in this material. Laverne and Banyan Tree do and seek to do business with companies that are the subject of its research reports. The analyst(s) hereby certify that all the views expressed in this report accurately reflect their personal views about the subject investment theme and/or company securities.

Although every attempt has been made to verify the accuracy of the information contained in the document, liability for any errors or omissions (except any statutory liability which cannot be excluded) is specifically excluded by Laverne and Banyan Tree, its associates, officers, directors, employees, and agents. Except for any liability which cannot be excluded, Laverne and Banyan Tree, its directors, employees and agents accept no liability or responsibility for any loss or damage of any kind, direct or indirect, arising out of the use of all or any part of this material. Recipients of this document agree in advance that Laverne and Banyan Tree are not liable to recipients in any matters whatsoever otherwise; recipients should disregard, destroy or delete this document. All information is correct at the time of publication. Laverne and Banyan Tree do not guarantee reliability and accuracy of the material contained in this document and are not liable for any unintentional errors in the document.

The securities of any company(ies) mentioned in this document may not be eligible for sale in all jurisdictions or to all categories of investors. This document is provided to the recipient only and is not to be distributed to third parties without the prior consent of Laverne and Banyan Tree.