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Netflix ad tier could generate up to $8 billion in revenue, analyst explains

Macquarie Senior U.S. Media Tech Analyst Tim Nollen joins Yahoo Finance Live to discuss the expectations for Netflix's ad-supported tier, reports that it could cost anywhere from $7-$9 USD, ad sales and revenue, and the outlook for the streaming company.

Video Transcript

JULIE HYMAN: Let's switch gears here and talk about a big tech player, talking about Netflix here. Expectations are high for the company's much debated ad supported service with reports it could even be up and running before the end of the year. And these plans mark a big turnaround potentially for the company, as it looks to change its fortunes and fast. Macquarie raised its rating on the streaming giant to neutral from underperform on the opportunities for global ad revenue.

Tim Nollen, senior US media tech analyst at Macquarie, is joining us right now. Tim, it's good to see you. So talk to me about your analysis here, how you're sort of gaming out what this ad supported tier could look like and what data points you're looking at to try and figure out how much revenue it could bring in for Netflix.

TIM NOLLEN: Sure. Thanks for having me, by the way. Well, there are a lot of inputs to the calculations here. I mean, I think our basic premise is that we've seen with other streaming services that the ad supported tiers can generate actually more RPU, more Revenue Per User, than the ad-free versions. And they can attract more users. So the basic premise here is that Netflix launching an advertising tier is probably a good thing for revenue and earnings.

In our note that we put out today, we did a lot of calculations behind what goes into this. So anything from what's the new ad tier price going to be, what's the price you're going to get for the ad impressions on the service, will they add subscribers, how many people on the existing service will switch to an ad supported tier. And all put together, we come to a potential ad opportunity. And I say intentionally potential ad opportunity, rather than our official forecast, because there's a lot that goes into making this work right.

But in 2025, we think in the US and Canada region, Netflix could generate $3 and 1/2 billion in advertising sales. And globally, it could be an ad opportunity of $8 billion, again, in 2025. Now that's everything going smoothly and going well. But in addition, you have to factor in the ad revenue minus the so-called forgone or the lost subscription revenue from the more expensive ad-free tier.

So if you factor that in, we come to about a billion dollars in incremental revenue, both in the US and internationally in 2025. So $2 billion of incremental revenue, which should generate a higher profit margin for Netflix as well.

JARED BLIKRE: And Tim, I'm wondering about the timeline here. You talked about 2025 as a target. As I understand-- I guess I am in the media business here-- advertisers, companies buying ads in large blocks, it tends to happen at one point in the year. And how does Netflix's strategy kind of evolve around the industry's peculiarities when it comes to ad buying?

TIM NOLLEN: Yeah, well, I-- we chose 2025 as a three-year time frame that this thing could be up and running in most or all markets. But yes, you're right. So a couple of things. First of all, Netflix is-- well, the press has indicated that Netflix aims to start this ad supported service in the US, Canada, and I think it's three countries in Europe, starting already November 1, right?

So as a roll-on, a ramp-up phase, you can't assume really much financial impact already this year. But then going into next year and the year beyond and beyond, that's when it starts to really roll on. What you're referring to really is the TV upfront markets in the US. And it's a US specific phenomenon, which is basically where the TV network traditional groups get together with the media buying agencies every year starting in May. And they negotiate basically forward sales of their TV ads for the upcoming year.

Netflix, probably because that's the way the industry works, Netflix will probably be going in that direction as well and geared toward selling its inventory in such a fashion. They may have already done so in the upfront, which took place starting in May and June of this year. So the upcoming upfront season will be important.

But I think what you're basically referencing is the fact that a lot of ad dollar commitments are made once a year. There probably was some of that already in this TV year, which starts kind of mid-calendar year. And in going into next year, that's going to be a very important selling period for Netflix.

JULIE HYMAN: Now, as we know, the ad spend generally in media has been trending lower with what's been going on in the US economy. What's your level of confidence that Netflix is going to be competitive for those ad dollars with some of the other media services that already have those longstanding relationships?

TIM NOLLEN: Yeah, yeah, I mean, in some cases, they'll be competing for ad dollars versus the traditional TV networks, and obviously, versus other existing streaming services that already have ad tiers. And of course, Disney will be coming on with its own ad supported tier in very short order as well. So that's one thing, competing against existing services, both linear or traditional and streaming.

Now, there is a structural move toward streaming TV. Connected TV or CTV is the common lingo in the industry goes. And that's where Netflix really can compete, I think, and make an important difference. In addition, you've got, obviously, a slowing ad market. We'll see what type of an ad recession we might be going into. We don't know. But clearly, the numbers are slowing.

So Netflix is kind of entering into a competitive market, perhaps a difficult cyclical market, and yet, a structurally growing connected TV market where Netflix, just by virtue of its subscriber base, is the largest single player in terms of the number of people on its platform. So the offering that it can bring to advertisers now, we at Netflix can come with X million number of subscribers from day one.

That's very, very interesting for advertisers who want that large audience, and by the way, should have some access-- we'll see what they provide, but some access to good data on what those people are watching, where they live, what their viewing habits are. So there's a very interesting opportunity here, both in terms of the size of the audience and in terms of the opportunity to target them with effective ads.

JULIE HYMAN: And finally, Tim, just quickly, if you look at the revenue that Netflix is going to get from a customer who's using the ad supported tier versus a subscriber, how do they compare?

TIM NOLLEN: So, currently, in the US, the RPU, the Revenue Per User for Netflix, which is all ad-free at this point, is just under $16. That was the number in June. You know, I mean, remember, Netflix has three different ad tiers.

JULIE HYMAN: Right.

TIM NOLLEN: Sorry, three different subscription tiers in the US right now. What we assume is they knock $5 off of each tier price. So that comes to an average revenue in 2025 of $10. So it's not that they're going to offer a $10 tier. It's that in our calculation-- we do this for the sake of simplicity-- the $10 subscription price goes to $5, the $15 price goes to $10, the $20 price goes to $15.

Now, there's all sorts of variables, all sorts of analysis that we've done in our work that you can flex that however you choose. But so we don't know what the actual price will be. We've heard numbers of $7 to $9, which Netflix has apparently come out and refuted. In our analysis, we assume that it's basically about a 35% cut to the total subscription revenue that Netflix will take in from actually three new ad tiers on each of its existing services.

JARED BLIKRE: Tim, it's good to put some numbers to that. I'm sure there are backs of envelopes among your cohorts that are just filling up with numbers right now. Macquarie senior US media analyst Tim Nollen, thank you.