Netflix’s Next Phase of Growth Hinges on Pricing, Paid Sharing and the Ad Tier

Wall Street still feels bullish about Netflix’s growth prospects heading into the release of its first quarter earnings results on Thursday afternoon.

But while analysts agree that the company has devised the right formula of balancing global content creation with costs, while increasing profitability, much of the streamer’s growth going forward will depend on how far it can push pricing and paid sharing, and how quickly it can scale the ad tier. 

“The big challenge is accepting that they aren’t going to be a high growth company. They’re going to be a low growth, extraordinarily profitable company,” Michael Pachter told TheWrap. “They still trade at a big price because they’re so profitable and we believe they can be more profitable.”

Analysts surveyed by Zacks Investment Research currently expect the streamer to report earnings of $4.49 per share for its first quarter of 2024, in line with Netflix’s guidance, and revenue of $9.26 billion, up slightly from the company’s $9.24 billion revenue guidance. Shares are up 85% in the past year and 31% year to date as of Tuesday’s close.

How much longer will the paid-sharing benefit last?

With the paid-sharing initiative coming up on the one-year mark in the second quarter of 2024, one of the biggest questions from Wall Street will be how much longer its subscriber and revenue benefits will last. 

Citigroup analyst Jason Bazinet told clients that most investors the bank has spoken with believe the benefit will remain strong in this quarter’s numbers, but will start to fade over the next two.

Out of the estimated 100 million households sharing passwords, Bloomberg Intelligence believes 60 million to 70 million could be potential Netflix subscribers. 

“A lot of industry watchers as well as people tracking the stock feel that most of the low hanging fruit has been captured,” analyst Geetha Ranganathan told TheWrap. “The big concern there is if they say we’ve already captured 50% or 70% or we don’t think it’s going to go beyond a certain level. If management comes out and says ‘No, we really don’t see more than 30 million,’ I think that’s a huge problem.”

Netflix has already captured roughly 20% of the estimated 100 million households sharing passwords, Oppenheimer Research analyst Jason Helfstein estimates.

“By 2026, we think a 60% capture rate is more likely, given NFLX’s increasing content advantage and content/advertising spend pull-back by competitor streaming platforms,” Helfstein said in a note to clients. The 60% recapture rate over three years would represent an upside of around 14 million subscribers, he added. 

In the fourth quarter, Netflix added 13.1 million subscribers for a total of 260.28 million globally — its second-best quarter ever for sign-ups since the COVID-19 pandemic-related surge during the fourth quarter of 2020. It expects a sequential decline in the upcoming quarter, but with additions above the 1.8 million net adds in the prior-year period. 

When will the ad tier reach an inflection point?

The ad tier is not expected to become a substantial revenue stream for the company until 2025. But analysts will be listening for any color on a potential timeline for the scaling of the offering, especially as it faces increased competition from Prime Video’s new ad tier. 

Netflix’s ad tier, which is available in 12 countries, has surpassed 23 million monthly active users globally and now accounts for 40% of all sign-ups, the company says. The offering’s base grew by nearly 70% quarter over quarter in Q4, supported by product improvements and the phasing-out of its Basic plan for new and rejoining members. 

“Despite the growth over the last few quarters, it appears the scale of the ad-tier is lagging expectations,” Piper Sandler analyst Matt Farrell told clients. “We continue to wait for the pivot to ‘walking’ from ‘crawling,’ but as the ad-tier competitive landscape intensifies, we suspect scale needs to happen sooner rather than later.”

In order to scale the offering, Netflix has said it plans to retire its ad-free basic plan in countries where the ad-supported offering is available, starting with the United Kingdom and Canada in the second quarter. The company also partnered with T-Mobile in January to offer the Standard with Ads plan in the mobile provider’s packages.  

Wedbush estimates that Netflix needs the ad tier to reach at least $9.66 monthly per user in ad revenue to be accretive and that it expects the offering to do so in the back half of 2024. They estimate that the United States and Canada make up at least 9% of global ad subscriptions and that raising the domestic percentage where the ad market is strongest is the key to reaching accretion.

“We think the average ad-based subscriber watches less than Netflix’s average premium subscriber, so at optimum, we think it will reach a steady state of [about] 55 hours on the ad tier,” analysts Alicia Reese and Michael Pachter wrote in a note to clients. “The more content and features that Netflix adds to this tier, the faster it can achieve this.”

Deutsche Bank analysts Bryan Kraft and Benjamin Soff said Netflix’s WWE deal also represents a “potential jump start” for the ad business in 2025. They estimate Raw could provide roughly $225 million in advertising revenue, based on its average linear TV audience of roughly 2 million, combined with an assumed $35 cost per thousand impressions (CPM) and roughly 3.2 billion impressions per week in 2023.

How much pricing power does Netflix have left to bolster growth?

In October, Netflix hiked its U.S. Basic plan to $11.99 a month — an increase of $2 a month — and its Premium plan to $22.99 a month — an increase of $3 a month. It also raised prices in the U.K. and France to £7.99 and €10.99 for Basic and £17.99 and €19.99 for Premium, respectively.

Barclays analyst Kannan Venkateshwar said Netflix’s revenue growth will likely drift into the “high single to low double digit range” in the next year and beyond, citing 2023 as being a slow year for revenue growth despite being one of the best years for subscriber growth. 

As a result, more than half of Netflix revenue growth will need to come from price increases if it remains in the low-to-mid teens range, Venkateshwar wrote. “This is likely to be difficult without unit growth trade-offs, which will make pricing even more important.” 

Licensed content from both Disney and Warner Bros Discovery will allow Netflix to continue to command pricing power, Macquarie Research analyst Tim Nollen said, while Ranganathan sees the ad tier as a “backstop” that prevents churn and offers “substantial pricing leverage.”

“They obviously can increase prices, because they have a very, very compelling content slate. They’ve hit their stride in terms of having a lot of the originals perform really well,” she added, noting that “Fool Me Once,” “Avatar: The Last Airbender,” “Griselda,” “Berlin,” “Love is Blind,” “One Day” and “The Gentlemen” have posted over 200 million hours of viewership.

With its ad tier and paid sharing initiatives rolled out, Nollen believes a price increase on its standard plan may be imminent.

Netflix’s mid-tier ad-free price in the U.S. of $15.49 lags Hulu and Max now, and its base of ad tier users is growing, “which provides more volume and pricing power in a generally improving ad market,” Nollen wrote in a note to clients. 

Will Netflix invest more in sports?

Despite Netflix’s longtime stance that it has “not seen a profit path to renting big sports,” the company has recently been dipping its toes into shoulder programming, such as the docuseries “Formula 1: Drive to Survive” and live events like the Netflix Cup, a golfing tournament, and Netflix Slam, a tennis match. 

Ranganathan argues that if Netflix wants to scale its ad tier, it’s going to have to continue to invest in different types of content – including sports. 

“There is this anticipation that Netflix will be a dark horse and come in a bid for maybe one or multiple NBA packages,” she said. 

Deutsche Bank envisions Netflix licensing the NBA’s in-season tournament, which would be a smaller package that requires less of a commitment than the traditional national package that spans the entire season. They noted it would have to wait for current international media rights contracts to expire before the IST would shift to them. 

“It plays very well with Netflix’s strategy of going after a global, younger audience and would really help them scale their advertising business very, very substantially,” Ranganathan added.

Where does Netflix plan on allocating its capital moving forward?

Lastly, investors will be focused on how Netflix allocates its capital as the streamer anticipates roughly $6 billion in free cash flow in 2024. It plans to spend around $17 billion on content in 2024, compared to $12.6 billion in 2023. 

Macquarie Research argued a key question will be whether Netflix chooses to extend its ad tech partnership with Microsoft, which expires in October 2024, or if it will build its own ad-tech capabilities. Ranganathan anticipates that Netflix will balance content investment with investments in its advertising technology capital returns in the form of share buybacks. 

“We expect share repurchases to continue throughout 2024 but also would not be surprised if the firm considered incremental M&A to either bolster its IP portfolio or move deeper into video games,” Bazinet added. 

When asked about M&A on the Q4 call, Netflix chief financial officer Spencer Neumann reiterated that the company is focused on building rather than buying. The company also emphasized it’s not interested in acquiring linear assets, nor does it believe that M&A among traditional media companies will “materially change” the competitive environment. 

Deutsche Bank believes that Netflix has an opportunity to continue to “optimize its content spend” and drive higher returns on content investment over time through its licensing efforts as well as the recent reorganization of its film division. 

Looking ahead, Netflix said it would continue to invest in its content slate with a “high single digit percentage” year-over-year increase in non-cash content costs. 

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