🍿 Netflix: Ad Tech Focus

The streaming giant is sowing the seeds for future growth

App Economy Insights

Jul 19, 2024

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1. Netflix Q2 FY24

Netflix's revenue growth depends on two main factors:

👨‍👩‍👧‍👦 Paid Memberships: Number of users paying for the service.
💵 ARM (Average Revenue per Membership): How much revenue they generate per subscriber.

Metrics shift: Starting in 2025, Netflix will stop sharing membership and ARM and focus on revenue and operating margin as its primary success metrics. New initiatives like tiered pricing, paid sharing, and advertising make subscriber numbers less indicative of the company's performance.

Membership surge:

Since May 2023, Netflix has cracked down on password-sharing in the US and parts of EMEA, leading to a surge in new sign-ups.

278 million paid memberships at the end of Q2 FY24.
8 million added in Q2 (~5 million beat) and +17% Y/Y.
North America now accounts for 30% of memberships, down from 45% five years ago. It illustrates the successful international expansion. Q2 growth was fastest in APAC (+24% Y/Y) and EMEA (+18% Y/Y).

ARM growth:

ARM was up 1% year-over-year, or 5% in constant currency (impacted by Argentina's inflation). This growth is relatively soft, given the price hikes in October last year. It’s partially explained by the ad inventory not being filled yet (more on this in a minute).
Still, the continued rise in ARM illustrates that the recent membership infusion is happening without sacrificing pricing.

Income statement:

Revenue grew +17% Y/Y to $9.6 billion ($30 million beat).
Revenue grew +22% Y/Y in constant currency.
Operating margin was 27% (+5pp Y/Y) (in-line).
Earnings per share (EPS) was $4.88 ($0.14 beat).

Cash flow:

Operating cash flow: $1.3 billion (14% margin, -4pp Y/Y).
Free cash flow: $1.2 billion (13% margin, -4pp Y/Y).

Balance sheet:

Cash and short-term investments: $6.7 billion.
Debt: $14.0 billion.

Q3 FY24 Guidance:

Revenue: +14% Y/Y (or +19% Y/Y in constant currency).
Operating margin: 28% (+6pp Y/Y).

So what to make of all this?

Revenue and margins were ahead of guidance. Revenue grew +22% in constant currency, accelerating for the fifth consecutive quarter. Paid membership additions (+17% Y/Y) were the main driver.
Netflix's guidance for Q3 FY24 shows continued growth, with a forecasted 19% Y/Y revenue growth in constant currency.
The outlook for FY24 is 14% to 15% revenue growth (up from 13% to 15% previously). Growth is partially affected by FX headwinds. Management anticipates a slowdown in the back half of the year. Paid sharing started in Q2 2023 in the US, making the second half a harder comp.
Operating margin guidance was raised to 26% (from 25% previously), implying more margin expansion. Netflix has a very scalable business model with no near-term margin ceiling.
Free cash flow in Q2 FY24 was $1.2 billion (vs. $1.3 billion last year). Management still expects $6.0 billion in free cash flow in FY24 and a cash content spend of $17 billion (unchanged).
Management bought back $1.6 billion worth of NFLX shares in Q2, slightly less than the $2.0 billion in Q1. The repurchase plan has $5 billion remaining.

2. Ads, Live Sports, and Content.

📢 Ad-supported tier: A winning formula?

Ads are going to make up an increasing part of the business:

Ads tier membership grew 34% quarter-over-quarter (after 65% in Q1 FY24 and roughly 70% quarter-over-quarter growth in Q3 and Q4 FY23).
The ad plan accounts for 45% of sign-ups in available markets (+5pp Q/Q).
Netflix is building an in-house ad tech platform to launch globally in 2025. This platform will allow Netflix to have more control over its ad operations, optimize ad targeting and measurement, and potentially increase ad revenue.
Ad monetization is still lagging. This is primarily due to the rapid growth of ad-tier membership outpacing the company's current ability to sell ad inventory. A meaningful revenue contribution from ads is not expected until after 2025.

Management expects the $6.99/month ad-supported plan in the US to generate more revenue than the standard $15.49/month plan. Ad revenue should more than make up for the lower subscription price—a win-win for both Netflix and budget-conscious viewers. Now it’s all about execution and filling the ad inventory.

According to Antenna, ad-supported streaming is booming. Streaming services are seeing more new subscribers choose ad-supported plans. In May 2024, 39% of new Netflix sign-ups in the US opted for the cheaper plan—a big jump from 22% the year before. The adoption rate was even higher for competitors. This shows that consumers are increasingly embracing ads for a better deal.

🏅 Live Sports After All

“We're not anti-sports, we're just pro-profit.”

This now famous quote from co-CEO Ted Sarandos in 2022 reminds us that Netflix has shunned live sports until recently. But with the success of the ad-supported tier, live events have become a natural fit.

Netflix's foray into live sports now includes:

🏈 Christmas Day NFL games in 2024, 2025, and 2026.
🤼 WWE's Monday Night Raw starting in 2025.
🥊 The upcoming boxing match between Mike Tyson and Jake Paul.

This significant shift in strategy has the potential to attract a wider audience, boost advertising revenue, and drive subscriber growth.

The NFL deal is likely worth hundreds of millions. This investment could put upward pressure on subscription prices, especially as Netflix continues to invest in premium live content.

👀 ‘What We Watched’ (H2 2023)

Netflix recently released its What We Watched report for the second half of 2023, giving us a glimpse into the most popular titles on the platform.

Here's a quick rundown:

90 Billion Hours: Total Netflix content devoured in just six months.
Top Film: Leave the World Behind, starring Julia Roberts and Ethan Hawk, was the most popular film, with 121 million views.
Top Series: One Piece led the charge with 72 million views, more than doubling viewership for all Netflix anime titles.
Returning Favorites: Wednesday, Red Notice, and Squid Game continued to draw massive audiences long after their debuts.
IP Boost: The spin-off Squid Game: The Challenge boosted the original Squid Game's viewership by 34%.
Global Appeal: Non-English content is a major hit, representing nearly a third of all viewing, with Korean, Spanish, and Japanese leading the way.
Diverse Tastes: From The Witcher to Virgin River, viewers indulged in a wide range of genres, with sports documentaries and kids shows also gaining traction.
Licensed Hits: Licensed series like Suits (144 million views) and Young Sheldon (88 million views) remained incredibly popular.

This report offers a fascinating glimpse into the diverse viewing habits of Netflix's massive audience and underscores the platform's ongoing commitment to delivering content that resonates across borders and genres.

🎮 Netflix Games keep pushing

Since November 2021, Netflix subscribers can download exclusive games on the App Store at no additional charge. The Netflix catalog reached 100 games in June, including 13 released in 2024 alone.

Appfigures estimates that Netflix games reached roughly 6 million downloads in May. If you remember, the GTA Trilogy launched in December 2023 and has since boosted monthly downloads. Nearly a third of the 6 million May downloads were from GTA San Andreas. Most gaming catalogs are top-heavy, and Netflix is no exception.

Looking forward, Netflix plans to launch a multiplayer game based on the Squid Game universe during the launch of season two later this year.

3. Key quotes from the earnings call

Co-CEO Greg Peters on ad tech:

“We hear lots of enthusiasm for […] increasing ads relevancy, targeting personalization, better measurement, incrementality, all these things that we'll be building over the next several years. […] So we have the hard work ahead of us of building those as quickly as we possibly can and closing that gap as soon as we can.“

Netlfix will test its new in-house ad tech platform in Canada later this year and expand in 2025. On the programmatic side, the company is also partnering with The Trade Desk Google DV 360 and Magnite to fill the slots. Greg Peters candidly admits the company is playing catch-up. But once these features are in place and deemed good enough by the largest ad spenders in the world, the ad inventory will likely fill in a heartbeat.

On iteration for games:

“We've launched over 100 games so far. We've seen what works, what doesn't work. We're refining our program to do more of what is working with the 80-plus games that we currently have in development.“

By making baby steps with small investments and iterating on its formula, Netflix is positioned to eventually find success with games. But it will take time.

Co-CEO Ted Sarandos on AI and content:

“There's a lot of filmmakers and a lot of producers experimenting with AI today. They're super excited about how useful a tool it can be. And we got to see how that develops before we can make any meaningful predictions of what it means for anybody. But our goal remains unchanged, which is telling great stories.”

AI will be a double-edged sword for Netflix. It can reduce costs and help improve the content produced. But it elevates the playing field for the entire industry.

CFO Spencer Neumann on the growth factors:

“I'd say that the kind of outsized paid net-adds in the quarter was primarily driven by stronger acquisition, a little stronger than we expected, but also very healthy, continued healthy retention in the quarter and that's across all regions.”

Netflix is often credited with the lowest churn in the industry, and competitors haven’t been able to replicate it.

4. What to watch looking forward

📢 It’s an ad-supported world

According to Antenna, ad-supported plans accounted for the majority of gross additions across all SVODs in Q4 2023 and Q1 2024. This trend could lead to more bundles and consolidation as all services seek scale.

👑 Content is king

Netflix's massive reach, targeted promotion, and personalized recommendations fuel its ability to capture the Zeitgeist. But quality is also critical, as Netflix was the most nominated brand for the 76th Emmy Awards.

From the shareholder letter:

“We’re programming for an audience of over 600M. It’s a huge number and to delight this many people, we need lots of great stories that appeal to many different tastes and moods”

The high-performing titles in Q2 illustrate this approach:

Bridgerton universe (3 seasons plus Queen Charlotte): 172 million views.
Under Paris (French movie): 91 million views.
Baby Reindeer (British miniseries): 88 million views.
Hit Man: 33 million views.
The Roast of Tom Brady (live event): 22.6 million views.

From major hits in France and the UK to a live event tailored for an American audience, Netflix has made its global and broad appeal a critical differentiator.

📊 A new high in US market share

Co-CEO Greg Peters revealed on the earnings call that members spend roughly 2 hours per day on Netflix, a number consistent across all tiers. Engagement is the north star for all streaming services because it bleeds into all performance metrics:

🔒 Improved user retention (commitment to ongoing shows).
💰 Lower customer acquisition (via word of mouth and awards).
📈 Higher revenue per membership (via low churn on price hikes).

Nielsen’s monthly market measurement of US TV time is one of the best proxies for evaluating engagement. It shows how Americans spend their TV time across streaming, cable, broadcast, and other categories (linear streaming, gaming).

According to Nielsen, streaming accounted for 40.3% of US TV Time in June 2024, representing a 2.6-percentage-point increase year-over-year. It’s the highest share of TV ever reported.

In June 2024, Netflix represented 8.4% of TV time—more than Hulu, Prime Video, and Disney+ combined. It was the highest share since Nielsen started providing this measurement. In short, Netflix is still gaining market share compared to other large SVODs.

YouTube increased its market share to 9.9% (up from 8.8% a year ago), excluding linear streaming like YouTube TV. While YouTube is taking an increasing share of US TV time, it hasn’t come at the expense of Netflix. Instead, it’s eating away at Cable, a segment now representing a 27.2% market share, down 3.4 percentage points year-over-year.

From Netflix’s shareholder letter:

“We believe our biggest opportunity is winning a larger share of the 80%+ of TV time (primarily linear and streaming) that neither Netflix nor YouTube has today.”

The streaming market is steadily growing, and Netflix is well-positioned for continued growth as it holds its share of an expanding pie. Critically, Netflix’s ability to expand the life of a show or movie—as illustrated by licensed content like Suits—should not be overlooked. Licensed content could fuel network effects (the most potent form of competitive moat), with more licensed shows bringing more subscribers.

With a thriving ad-supported tier, incoming live sports, and a growing global catalog, Netflix is leaving other SVODs to fight for second place.

Stay tuned for updates on other streaming giants in the coming weeks. 🍿

That’s it for today!

Stay healthy and invest on!

Author's Note (Bertrand here 👋🏼): The views and opinions expressed in this newsletter are solely my own and should not be considered financial advice or any other organization's views.

Disclosure: I am long NFLX, GOOG, AMZN, AAPL, and ROKU in the App Economy Portfolio, where I share my ratings (BUY, SELL, or HOLD) with members.