Last week, the streaming – and advertising – world woke to the news that Netflix had partnered with Microsoft to launch the former’s new ad-supported subscription plan. To put it mildly, this came as a surprise to many who assumed that Netflix would partner with the likes of Google or YouTube to launch its service, and it would have been interesting to have been a fly on the wall of either of those organisations when the news came through.
However, what perhaps is more interesting is both what the deal says about both parties and what it means for the future.
Firstly, this looks like one of these deals that – in hindsight – was obvious from the get-go. Unlike NBCU or Google, Microsoft does not have a conflict of interest when it comes to CTV advertising money, which is presumably where Netflix will look to tap into. Perhaps a more interesting question is whether this then feeds into a wider strategy of looking to grab a share of the overall digital video ad budget. There is a case for arguing that the boundaries between all video categories are becoming increasingly obsolete as the boundaries blur.
For the two parties, there are obvious advantages. For Microsoft, the deal is an obvious plus and is a coup for Xandr, burnishing its credentials as well as its appeal to other streaming platforms that face a similar dilemma (want to sell advertising but no in-house platform). It also embeds itself more into the advertising ecosystem where its efforts have not always been successful (Bing still languishes as a very poor second player to Google Search). By winning such a flagpole client, Microsoft is setting out its stall to other players, not only in streaming but potentially the broadcasting space in general.
For Netflix, the deal represents a good enough solution for what it needs. It also provided a boost to the share price, which was further boosted the news that Netflix had lost “only” 970,000 subscribers in the quarter versus a predicted two million loss. Netflix’s share price has recovered more than 20 percent since the deal was announced (although it is still down nearly 60 percent over a year).
More importantly, it means it can bring its product relatively speedily to market – important given the Disney+ / Trade Desk deal – and it provides breathing space while it works out a longer-term strategy. Netflix said on its Q2 earnings call that its advertising product in several years’ time is likely to look different from when it launches, and it’s clear that this will be a voyage of discovery for the platform. Having Microsoft lessens the risk of this voyage, especially as Microsoft will be keen to demonstrate that it is a serious player in the space.
One obvious question is whether that voyage leads to Netflix building up its own sales team to handle sales. If it does, it is likely to be over the medium to longer-term. Netflix is coming from a place where, unlike Disney+, it cannot lean on an ad sales infrastructure. Having two major hurdles to overcome – inexperience at selling ads and the introduction of adverts on a previous ad-free platform – will require time and patience.
However, the formation of an internal sales house may only be an interim stop on the final destination. One question this deal has raised is whether Microsoft will be a buyer of Netflix at some point. My view is that, over the long-term, the answer is probably yes. For both parties, it would make sense. Netflix is increasingly outgunned on a Free Cash Flow basis, especially against the likes of Amazon and Apple. And unlike Comcast and Disney, it does not have an extensive back catalogue that provides protection. If Netflix wants to move into sports, as is rumoured, a significant cash pile is going to be critical when it comes to acquiring rights packages.
For Microsoft, there are also clear advantages. The acquisitions of businesses such as LinkedIn and particularly Activision Blizzard demonstrates its desire to diversify its traditional B2B weighting of revenues, and acquiring Netflix would make it immediately one of the major players in the global streaming market, with a reach of over 220 million subscribers. As the acquisition of Activision has also shown, Microsoft is also not afraid to bid big when it comes to strategic moves.
In the short term at least, a deal is unlikely, given the questions raised by the Activision Blizzard deal. In the long term however, given an increasing interest in advertising/consumer facing businesses, it makes sense.
Who will move next?
All thoughts and comments welcome. As usual, this is not investment advice.