Netflix, Inc. (NFLX, Financial) remains one of the few entertainment giants to keep an eye on, in my view, as it plans to diversify its business into video gaming and merchandise. The entertainment juggernaut has long been a winner in the streaming video market, and the global lockdowns in response to the Covid-19 pandemic helped the company boost its subscriber base in 2020. Although government restrictions have halted film production in many parts of the world, Netflix has been relatively unaffected because of its deep library of already-produced content ready for global consumption. This content advantage has helped the company gain an edge over its competitors, and Netflix is still the dominant player in the video streaming industry.
Despite the decline in global production, the company managed to gain more than double the subscribers it planned for in 2020. However, after the huge pullforward of subscribers, membership growth has slowed in 2021, and Netflix has guided for lackluster growth in the next couple of quarters as well. I think this temporary weakness just provides another reason to believe that the company is well-positioned to reward shareholders handsomely in the long run.
From video content to video games to selling merchandise
Netflix has been a streaming-only media company for many years now, and premium subscribers to its platform are the company’s major source of revenue. However, the company's phenomenal success has attracted a lot of competition from billion-dollar entertainment giants, and investors are now expecting the company to come up with additional monetization methods to grow earnings. A few Wall Street analysts have already made their concerns clear by claiming that Netflix's best days are already behind the company.
With the easing of lockdowns and the successful vaccination rollouts allowing people to spend time out of their homes, Netflix is likely to be challenged to report strong subscriber growth in the next 12 months.
Exhibit 1: Weekly global paid net subscriber additions (millions)
Source: Netflix shareholder letter
Another threat to Netflix is the rapidly evolving video content market and the innovative competitors the company is having to deal with. Although these alternatives do not provide the same level of quality content as Netflix, many users have turned to these less expensive options rather than paying a premium for Netflix programming (either that, or they might like other providers' content better). In addition, short-form video content is gaining traction as well, and Netflix is yet to embrace this developing macroeconomic trend. Social media platforms are also dabbling in streaming media, with Instagram aiming to become a video-focused platform. All of this suggests that Netflix is required to diversify its business sooner rather than later as it is operating in a market where there are numerous possibilities for accessing video content at a cheaper price tag.
Netflix's planned move into video games, as well as its launch of an online store, highlights the streaming giant's need for new revenue sources to accomplish growth. By opening Netflix Shop in June, the company decided to enter the e-commerce market with its own store to sell high-quality, limited-edition apparel and other products based on its content catalog. The website currently offers streetwear, action figures based on “The Witcher,” “Yasuke” and “Eden," and decor products based on the hit French series “Lupin.” The company will not only bring in new revenue by selling this merchandise but will also benefit from a boost to its brand value because of this decision to sell products inspired by Netflix characters.
In addition to the merchandise business, the company is also planning an expansion into video games. Netflix's entry into the gaming industry appears to be one of the company's trump cards in attracting new customers and retaining existing ones. The company has already started advertising job openings for game development positions on its website and hired Mike Verdu, former Facebook, Inc. (FB) Vice President of game development, to manage its video games division. It has previously licensed rights to games based on its shows "Stranger Things" and "La casa de Papel,” and the idea is to develop games in-house in the future. This presents a unique opportunity for the company as none of its closest competitors have entered this market just yet.
Video gaming industry outlook
According to Research and Markets, the global gaming market is expected to reach a value of $287.1 billion by 2026, growing at a compounded annual growth rate of 9.24% between 2021 and 2026, driven by the increasing popularity of online video game competitions, simulation games and multiplayer games. According to a report prepared by Accenture, the number of gamers worldwide is expected to reach 2.7 billion in 2021. The report also says that gamers spend 16 hours a week playing, eight hours per week watching or participating in game streams and six hours per week engaging in game-related forums and groups. Given the favorable outlook for the industry, Netflix's decision to enter the video gaming market seems to be an opportunistic move that could help the company secure strong revenue growth in the next decade.
Takeaway
After a successful run for over a decade, Netflix is finally facing challenges as a result of the saturating streaming video market and the increasing competition in the industry. In the United States, the company does not have a lot of room for growth, and in Europe, costs of content production are rising as local language original content is required to gain market share. Elsewhere in India, the company has a market share of just 7%, and Netflix has introduced discounted subscription options to lure viewers to its platform. This does not bode well with the company’s plan of improving operating margins.
One opportunity for Netflix is to diversify its revenue mix by making a strategic move into consumer products which will offer Netflix a more stable cash flow stream, allowing it to fund its content production. Right on cue, the company seems to be interested in following this path, and the company has also decided to pursue growth opportunities available in the video gaming market as well. These strategic decisions are likely to help the company cover the cost of producing original content with internally generated cash in the near future, which should lead to a higher return on invested capital. Considering these initiatives, it seems reasonable to conclude that the recent pullback in Netflix stock price presents a good investment opportunity for growth-oriented investors.
