Most of the time in Netflix's history, investors did not care much about how long users watched video, focusing instead on whether users signed up and whether they stayed. On retention, Netflix has long been the envy of its peers: its churn rate has stayed low for a long time.
But as user growth peaks, simply keeping subscribers is no longer enough. Netflix's growth increasingly depends on advertising, and ad revenue is heavily tied to how long users watch. Yet watch time has recently fallen into a slump. This makes Netflix look less like a growth stock and more like a mature, profitable company.
This also explains a contradiction in the market: by most earnings data, the company is operating well, margins are expected to hit a record annual high, and its churn rate remains the lowest in the industry. Yet the stock has nearly halved from last year's peak. Investors are now watching two other sets of metrics: user watch time and advertising growth.
According to Wells Fargo, combining Netflix's disclosed viewing-hour data with its own subscriber estimates: the average Netflix subscriber watches about 9% less than three years ago. Ironically, this scrutiny of watch time was invited by Netflix itself. Last year Netflix stopped disclosing new subscriber numbers and told investors that user engagement, or how long users watch, is the best measure of customer satisfaction. Now that core metric has stalled, and Netflix plans to reduce disclosure of that data from twice a year to once a year starting next year.
Netflix has faced business downturns before. When user numbers fell in 2022, it launched a cheaper ad-supported plan and cracked down on password sharing. That combination worked and the stock rebounded strongly. Netflix's forward price-to-earnings ratio is now back to its 2022 low. Bullish investors believe the stock is already cheap and are looking for the company to find a new growth driver. But the easy growth gains are gone. Management acknowledges that in mature markets like the United States, future growth will mainly rely on price increases and advertising. Wells Fargo predicts advertising will contribute more than one-third of Netflix's revenue growth next year.
But Netflix has just cut its 2026 advertising revenue forecast from $3 billion to about $2.7 billion, with management attributing the change to delays in rolling out ad technology. Regardless of the reason, as advertising becomes a bigger part of the business, user viewing time becomes key to the outlook. And winning viewing time is getting harder. Nielsen data shows YouTube has become the most popular platform on American television screens, with U.S. viewing share roughly twice that of Netflix. Barclays analyst Kannan Venkateshwar said the industry has moved from an era of content scarcity to an era of attention scarcity. Netflix can keep producing quality series, but every title must compete for user time with other streaming platforms, free services, TikTok, YouTube, and an endless supply of short videos.
Netflix has several options, but each has a cost: it could increase the amount of advertising per hour, since Netflix currently has far less ad time per hour than competitors. According to BMO Capital Markets, Netflix inserts about 2.4 minutes of ads per hour, while Hulu and Disney-owned platforms run about 8 minutes. But Brian Wieser, CEO of advertising consultancy Madison and Wall, points out that adding more ads can hurt the brand. Netflix was originally positioned as a replacement for traditional television, and too many ads could annoy viewers, undermining the goal of increasing watch time. The safest way to raise watch time is to spend more on content, but that would erode margins. (It previously failed in a bid for Warner Bros.; success would have achieved a similar effect, but at a much higher cost.) Another path is continued price increases, but each hike pushes some users toward the $8.99-a-month ad-supported plan; if ad sales fall short of expectations, the ad-supported tier actually generates less revenue per user.
Netflix's response is to reorganize its content team, hoping to produce more quality series and films. Next year, the Narnia film and new seasons of Bridgerton and Wednesday will launch. But a business driven by hit content has a very different valuation logic from one with a continuously expanding audience. Needham analyst Steven Cahall believes Netflix should trade at a valuation similar to hit-driven media companies like Disney, at about 15 times earnings; Netflix currently trades at about 17 times earnings, already close to that level. But Wieser argues Netflix is not the same as Disney. As the streaming leader, it may have more room to raise prices than investors expect. Still, growing simply by raising prices on the same set of households year after year is exactly the path the cable television industry followed for decades. That model can deliver stable profits, but it is hard to earn a growth-stock valuation. In an optimistic scenario, the P/E could approach 20 times, but it will be hard to return to the roughly 30 times seen earlier this year, when the market still treated it as a high-growth tech stock.
Needham analyst Laura Martin raised a bigger risk: nearly all of Netflix's revenue still comes from its core streaming subscription business, which has already matured. Traditional media giants squeeze every bit of value from a hit IP: theatrical releases, merchandise, theme parks, and licensing; Netflix mainly has only streaming playback as a monetization path. She also warned that artificial intelligence will help YouTube creators make better-quality, longer videos at the same cost, further narrowing the competitive gap with Netflix's original content. For years Netflix has proven that users are willing to keep paying. Now the harder question is: how to keep users willing to keep spending their time watching.
Comments