Netflix Stock: Advertising Holy Grail (NASDAQ:NFLX)

Investment Thesis

Netflix’s (NASDAQ:NFLX) shares are down substantially so it ”has to” be undervalued. Investors are ready to race in a buy the dip. Any story from any of the FANG stocks that are going to turn around gets all investors positively excited.

Everyone is on their marks, ready to buy the dip. But I suggest that investors could perhaps do well to wait a moment.

I Don’t Do Macro, Macro Does Me

I believe that Wall Street has gotten caught in one theme, largely driven by anchoring. Investors have become so acclimatized to higher share prices, that when a stock is down 60% in 12 months, investors are tripping over themselves to buy the dip. And this doesn’t make any sense to me.

There are three aspects that are weighing down Netflix.

• High inflation runs through consumers’ household budgets.
• Higher interest rates are impacting mortgages.
• Higher energy costs.

And I’ll address these topics in turn. Here’s what we know from Jamie Dimon’s comments yesterday. The consumer was very strong in the past year, but today the consumer isn’t quite as strong.

Even though a substantial proportion of households had already fixed their mortgages, anyone that is being forced to move is having to embrace higher mortgage payments.

What’s more, outside of the US, this impact is more serious, because mortgage rates are typically not fixed over further than 2-years.

Next, we know that energy costs around North America and Europe have been going up. This is not an unknown factor. Indeed, we know that the consumer is going to have less disposable income in the coming 6 months.

Accordingly, the Fed is telling you, the investor, that they are going to have to crush demand, to bring inflation down. And this whole bullish thesis that the Fed will have to pivot, I find it ludicrous. If the Fed has to pivot on its interest rate hikes it’s because the economy is breaking! That’s why it will pivot. That’s not a positive business environment.

Advertising Business to Save Netflix?

I have a ton of respect for Netflix. They’ve always been extremely entrepreneurial and not happy with the status quo. Netflix pushes boundaries. And consumers love them. But do they love Netflix not to churn out if they are having to cut back on household expenditure? That’s where opinions diverge.

Today there’s a lot more competition. To illustrate my point, note that Disney (DIS) launched Disney+ in 2019 and now has 221 million subscribers in a few short years. While Netflix, as of its latest quarter also has 221 million subscribers, despite rolling out its streaming platform in 2007.

Simply put, Netflix was clearly the winning streaming platform. But in this upcoming quarter, we might see Netflix starting to slip into a clear second place.

Hence, given all these considerations, Netflix is being forced to rethink its strategy to drive revenue growth. Thus, Netflix has entertained the idea of rolling out a cheaper ad-supported option for customers. This has clearly got investors from all walks of life very excited.

For both retail investors as well as large institutions, this is a narrative that everyone can get behind. What’s not to like? Advertising has clearly worked very positively alongside TV.

Also, we know that part of the justification for Amazon’s (AMZN) valuation is that its advertising business went from essentially non-existent, to one of the biggest advertising platforms in the world in approximately 3-years.

The problem, I argue, is that Netflix’s advertising tier will not be a large needle mover.

Analyst Doug Anmuth described yesterday, how in 2023, Netflix will see around $600 million from its ad-supported tier. Think about this figure for a moment. We are talking about 2% of Netflix revenues coming from its ad-supported tier. That’s it!

The Advertising Industry Is on Its Knees

Here’s what we know from everything we can see in the market right now. The biggest advertising platforms in the world from Alphabet (GOOG)(GOOGL) to Meta (META) and all the ad tech companies are struggling to find much strength. The advertising industry is on its knees.

And for those advertising platforms that’s what they do. That’s their bread and butter. That’s the core of their business. And to think that Netflix will waltz into this sector and get brands to open up their wallets strikes me as too optimistic.

Next, consider this, it takes a significant capex to get the necessary adtech infrastructure going. Even with Netflix outsourcing the bulk of the heavy lifting to Microsoft (MSFT), this is still going to burn substantial cash and not be a considerable thesis mover in my opinion.

Now, in the next section, we’ll talk about reasons why advertising could work.

Limitations to This Line of Thinking

On the other side of the equation, the advertising business could make a lot of sense for artists and production companies looking to promote their content. This wouldn’t be all that different from what Amazon is already doing with its own paid-sponsored items.

Also, the huge advantage for brands to reach consumers on Netflix is that it bypasses a lot of hurdles that exist today in a cookieless world. Brands will be able to leverage Netflix’s programmatic inventory and retrieve consumer insights such as the type of demographics that are watching which programs and the potential downstream ability to launch an e-commerce offering that leans into the advertising side of the business.

This is an avenue that Pinterest’s (PINS) new CEO Bill Ready (from Google) appears to be keen to explore with potential e-commerce livestreams.

The Bottom Line

I argue that down significantly does not mean undervalued.

Investors are clamoring to buy the dip on Netflix stock. Why? Because it’s a beautiful story of a compounder. It worked so incredibly well in the past decade, that investors ”believe” that it will work again.

And all that is needed is a story to get investors excited. Investors are on their marks, ready to buy Netflix. But I suggest a tiny bit more patience.