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Netflix’s ad-supported tier ‘a great upside opportunity,’ analyst says

Mark Mahaney, Evercore ISI Senior Managing Director & Head of Internet Research, joins Yahoo Finance Live to discuss Netflix stock, the company's ad-supported tier, and the challenges and opportunities ahead of the streaming giant.

Video transcript

AKIKO FUJITA: Welcome back to Yahoo Finance Live. We've got a new bull on Netflix. Evercore ISI citing the upcoming ad supported tier and password sharing crackdown as reducing user churn. The move comes as Netflix struggles to retain dominance in an increasingly competitive streaming space.

Let's bring in Mark Mahaney, Evercore ISI senior managing director and head of internet research. Mark, it's good to talk to you today. Early on this year, you mentioned-- you were kind of critical of Netflix, saying that they have been slow to pivot in this changing landscape. But it sounds like you see real levers here with this ad supported tier, a crackdown on password sharing. What are you seeing?

MARK MAHANEY: That's right, Akiko. I think that's the right setup. And I also fully agree with what your prior guest, Scott Wagner, said about you need safety. Megacap can maybe help you. I'm looking at names that have been really beaten down. And Netflix is probably at the top of that list, down 70% at one point year to date. Now it's had a 40% rally recently, and it's because of this ad supported business that they're rolling out. So, look, you've got Netflix now that's finally beaten down to a place where you could buy it at a PE multiple, like, 16, 17 times earnings, first time in the company's history.

And then you've got a new revenue stream. One of the big problems that Netflix has had, has created for itself is that they've raised prices consistently over time. They're the leading streaming service globally, but they've kind of painted themselves into this kind of premium price, premium product corner. Offering a lower price ad supported solution gets them out of that corner. I think expectations are still super low. And so I think this is just a great upside opportunity for the company and for the stock. It's the most identifiable catalyst that I see out in consumer tech today.

AKIKO FUJITA: So let's walk through your thesis of it. You said 20% of churn users are likely to return to Netflix with this cheaper ad supported model. That means 10 million incremental subscriber net adds, $1 to $2 billion in incremental revenue. How much of that churn, you think, or return back to Netflix comes from previous subscribers? How much of it is about bringing in new subscribers on board for those who may have said before, this is a little too much for me?

MARK MAHANEY: Well, Akiko, it's almost impossible to know that. And in all honesty, none of us know what the real price point is going to be for Netflix. We don't know how they're going to market it. So there's a lot of what ifs in the analysis. But what was interesting to me is the survey work I've done for 12 years, we have seen since the beginning of 2018, rising price sensitivity amongst Netflix customers. And we've seen declining satisfaction, at least in their most mature markets, like the US.

And then when we looked at what the other streaming companies are doing, they're able to generate $5 to $10 in ad revenue per user. And so the light bulb that went off in our heads was, wait a second, Amazon could-- I'm sorry, Netflix could lower its pricing, its subscription pricing by $2 to $3 and still generate more revenue per user because they can get $5 plus in ad revenue per sub.

So we've got something that kind of addresses the price sensitivity and is positive for unit economics. I don't think that was captured in the company's valuation. I still don't think it is. And I don't think it's captured in Street estimates. That was kind of the upside call for us on Netflix.

AKIKO FUJITA: So Mark, price sensitivity is one thing. And you point to the declining satisfaction among those users. But what about the actual quality of the content? I mean, this is a company that spends about, what, $17 billion in content. Some would argue that they have really gone for quantity over quality. That's at the core of the churn.

MARK MAHANEY: That's possible. Now, that's why we do the survey work. So, Akiko, that we've surveyed 2,000 people in the US and in other countries. And we've done this for 12 years. And we ask people, why did you leave? Why would you leave? What would get you to come back? And what has, and for the first time, just in the last year or two, shown up as the number one factor is price sensitivity.

And then we do also ask people to rank all of the streaming services in terms of the perceived quality of content. I mean, that's really a judgment call for all of us, which where really is the best content in terms of streaming.

But the objective answer we try to get at through surveys clearly shows that Netflix is perceived as having content as good or better than anybody else. And I'm not terribly surprised by that. They've been longer in the streaming than anybody else.

Now there are some wonderful other streaming companies like HBO and Disney+, but Netflix is spending probably about the industry high in terms of $17 billion in cash spend per year. And every once in a while, it produces these mega-hits-- "Bird Box," "Stranger Things," "Squid Games." And I think what's happened to the stock is people kind of forgot about that. There's probably another "Squid Games" out there. The odds are that there is I sometimes think about it is 17 billion shots on goal. Something's likely to go through for Netflix. So that's kind of part of the call.

AKIKO FUJITA: I mean, that's a fair point. I don't think anybody would have predicted the big hit that "Squid Game" would become. You were on with us earlier this year, saying Netflix is no longer a premium growth story. Does that [INAUDIBLE] change, you think, as a result of the potential catalyst you see coming from the ad supported tier, as well as the crackdown on password sharing? Are we still talking about below 20% plus?

MARK MAHANEY: Yeah, Akiko, thanks for pointing that out. No, I don't think that Netflix gets back to premium growth. I don't think it gets back to 20%. As a stock picker or as a potential stockholder, what you should think about is if they were, the stock is going dramatically higher. So why? Because the Street right now is looking for 8%, 9%, 10% revenue growth. I think that ad supported-- particularly ad supported offering, but also some password sharing crackdown, they have to be really careful about that. You have to do that right.

But if they get those out, that could bring growth back up to kind of 15%. So this isn't the go-go days for Netflix. They had them. It was the best performing stock of the S&P 500 last decade. I doubt it will be this decade. It won't be able to generate that kind of growth that they did so consistently over the years.

But this stock can still nicely outperform from here. You want these dislocated stocks that have been beaten down that have got reasonable valuations and are starting to generate real interesting free cash flow stories. That's the setup on Netflix, a stock that's been hated, but starting to turn. And I think this turn could go on for quite some time.

AKIKO FUJITA: Finally, Mark, when you look at the broader streaming space, Amazon has seen a lot of success in the first two weeks of Thursday Night Football. Obviously, that has been a big catalyst to get more on board with Prime. You look at Apple moving aggressively on sports, whether it's MLB or MLS. You think Netflix can continue to stay on the sidelines when it comes to sports streaming?

MARK MAHANEY: It's possible that this gives them the entree in the sports. I talked with the management team about this numerous times over the years. The one pushback they've always had is we're an on-demand streaming service. Like, you come on when you want to watch something, and it's on your schedule, your time, your schedule. And sports isn't built that way. Sports is on the team's schedule.

So it's kind of a different value proposition. It's also extremely expensive. I think Netflix doesn't need to get into sports. I may be wrong on that. And I've seen Netflix pivot. They refuse to get into advertising until they finally did earlier this year. So they've refused to get into sports. It's possible that they change that going forwards. But I don't think we'll see that kind of pivot from them in the next couple of years. I think they're all in on advertising. And they're going to run this and see how well that goes.

AKIKO FUJITA: Yeah, they talked about sports adjacent content, not necessarily live sports. But we'll see if that shift happens. Mark, it's always good to have you on the show. Mark Mahaney, Evercore ISI senior managing director and head of internet research.