NFLX: Higher Estimates/Target as Dust Settles on a Flurry of Advertising Changes

What’s New: We have refreshed our advertising model and adjusted ad-supported members/users, CPMs, and fill rate in the UCAN segment, resulting in higher estimates and a higher target for NFLX.

Below, we review the short- and long-term implications of the current aggressive CTV pricing environment, how NFLX’s recent changes (NFL games, more ad tech partners, management changes, etc.) may impact its competitive positioning, and review our revised ad model in detail.

Context on the CTV pricing environment, both short and long-term

As Upfront negotiations worked through the summer months, a variety of news outlets reported aggressive pricing from AMZN (see HERE), DIS (see HERE), and NFLX (see HERE), all of which came after AMZN entered the season with significantly more inventory to sell following its expansion of advertising across Prime Video. While some companies like SNAP and PINS reported pockets of softness in brand advertising, we think pressure on CTV ad pricing is largely driven by the burst of new supply available in the market, both at Amazon Prime and growing ad-supported viewership on other major services (including YouTube continuing to win view share on CTV).

As such, there’s no reason to suspect that the pricing pressure won’t last through the end of 2024 and into early 2025, barring some inflection in macro-optimism that drives incremental demand into holiday season, or an unexpected increase in political ad spending on CTV, which of course will cease to exist after the second week of November.

Put simply, the market must absorb both the AMZN glut, but also the continued growth of inventory from the likes of DIS and NFLX, combined with their sales teams’ efforts to maximize revenue with aggressive pricing. Barring a change in macro, the effect likely lasts into 1Q25 until the market anniversaries the rollout of AMZN Prime ad inventory that began in late January 2024. We think the market properly appreciates this dynamic and embeds it into near-term expectations for those that sell ads on CTV.

The more interesting questions have been about what this implies about the mid to long-term trajectory for CTV ad pricing, with many expecting a bounce-back in 2025 as the shift from linear brings more demand to CTV, helped by continued improvement in targeting and ad performance.

We wouldn’t be so confident. While the short-term supply shock of new Amazon Prime inventory will have passed, we expect long-term convergence with premium linear TV pricing to continue. While CTV may ultimately hold a slight premium for targeting/measurement efficiencies, increasingly integrated CTV + linear ad packages should continue to drive CTV CPMs (now typically in the mid $20 to low $30 range) closer to linear TV (typically in the teens or low $20 range for broadcast and major cable networks’ primetime lineups).

While CTV certainly brings better targeting, and direct response/shopping strategies on CTV are evolving, the platform ultimately remains a branding medium focused on awareness and dominated by a relatively small group of large advertisers. As such, we think “top-down” supply dynamics (i.e., shift of viewers to CTV, ad load creep over time, etc.) should be expected trump “bottom-up” improvements in ROAS for a given campaign executed on CTV versus linear TV.

As detailed below, we’ve lowered CPM expectations for NFLX, and don’t expect them grow again (in fact, our generally flat pricing expectation could prove too optimistic).

How NFLX’s recent changes set it up to face this environment

We think the most consequential changes made by NFLX are those that address the long-term, specifically:

1. Injecting more “Netflix culture” into the ads business under company veteran Amy Reinhard (after parting ways with both Jeremi Gordan and Peter Naylor).
2. Expanding both ad tech partnerships and formally building in-house tools, starting with an ad server, as detailed prior to Upfronts HERE.

Company culture and technology are fundamental to NFLX’s success, and with co-CEO Peters and Advertising President Reinhard having rolled up their sleeves on advertising in recent years, we think the company is ready to put its own stamp on the business. While management hasn’t used the “crawl, walk, run” analogy as much of late, this appears to be the beginning of a light jog.

The two changes we believe impact the near-term more include:

1. The addition of Christmas day NFL games
2. Moving ad-supported membership tiers into major bundle partnerships, combined with the slow and steady elimination of the Basic with Ads tier in the 12 countries where NFLX features advertising.

We think NFL games act as an important wedge opportunity for NFLX’s ad sales team, starting with committed league sponsors that always support those dollars with ad commitments around games and shoulder program. This isn’t an overly innovative idea, but we think it helps, including helping secure a 150% increase in Upfront commitments this year (see HERE), which was in line with expectations.

NFLX has long partnered with hardware OEMs, cable/wireless providers and other platforms to distribute its service, so participating in more bundles that feature the Basic with Ads offering (e.g., Comcast/Xfinity’s StreamSaver, T-Mobile’s Netflix on US transitioned to the ad tier earlier this year) is a new twist on a long-used company tactic.

Combined with continued password sharing restrictions and elimination of the Basic with No Ads tier in advertising markets, we think this multi-pronged strategy continues to support strong growth of ad-supported memberships and viewers over the near-term.

Higher estimates driven by more ad members, higher fill and lower CPMs

In summary, our 3Q24 and 4Q24 ad-supported net adds, ad revenue, total revenue and FCF move higher. This flows through to higher revenue and FCF estimates in out year periods, except 2025, where we also increased cash content spending leading to lower 2025 FCF.

Estimate Changes Summary

Source: Company reports, New Street analysis, and FactSet for consensus.

Ad-supported member and Monthly Active Users (MAUs)

As a result of these strategies, we raise our ad-supported net membership additions in the UCAN segment, and our 2024 total net adds rise to 24M in versus 22M previously, with 4M in 3Q24 versus our prior 2.5M (still below consensus of 4.2M) and 2.6M in 4Q24 versus our prior 2.1M (and also below consensus of 7.1M). We further raise net adds estimates in the out years by 1-2M annually.

The ad-supported member additions are an important vector in Netflix’s overall net adds algorithm comprising 19.8M of our estimated 24M total net adds in 2024E, but with the impact tapering off in our our-year estimates.

Annual net member additions: NSR Total, Ads and Non-Ads vs Consensus Total

Source: Company reports, New Street analysis, FactSet for consensus

We see 40.6M total ad-supported members by 2025E bringing total year-end members to 300.8M including 260.2M non-ad-supported members.

Ad-Supported and Non-Ad-supported members

Source: Company reports, New Street analysis

With slightly over two viewers per ad-supported membership on average, this results in just under 75 million MAUs by the end of 2024 and slightly greater than 100M MAUs by the end of 2025.

Ad-Supported Monthly Active Users (MAUs, aka viewers) by Region

Source: Company reports, New Street analysis

Pricing and Fill Rates

We lower CPM estimates in our UCAN model but see this as a reasonable strategy and not something that alarms us about the prospects of the business. Netflix is still in the early stages of helping advertisers get accustomed to purchasing its inventory, but we think the continued maturation of NFLX own sales team efforts, and a successful Upfront help set the stage for better integrating new programmatic demand sources like TTD and Google DV 360 more fully in 2025.

Specifically, we lower our UCAN CPM estimate to $28 in 3Q24E but raise our fill rate to 65% in 4Q24E versus our prior 55% to reflect better ability to draw in advertiser demand. While management doesn’t expect the contribution of new ad partners to be a material contributor until 2025E, we see the potential for the impact of new demand/ad tech partners to begin earlier if testing and integration go well into 4Q24E.

Updated UCAN Advertising Model

Source: Company reports, New Street analysis

Content Spending, FCF and FCF Margins

Higher members/ad revenue/total revenue flows through to our FCF estimates, however we raise 2025 cash content spending slightly. We had previously forecast a slight decline year-over-year owing to catch up spending in 2024 after the Hollywood strikes in 2023, but now see more consistent content spending in 2025.

Annual FCF and FCF margin

Source: Company reports, New Street analysis

Target Price: Raising to $625 from $590 owing to higher estimates

New Price Target

Prior Price Target