On Tuesday, Netflix Inc. (NFLX, Financial) announced that it is in the “early stages of further expanding into games,” following its previous experiments with a handful of interactive programs such as "Bandersnatch" in 2018 and "Stranger Things" in 2019.
Shares of Netflix dropped slightly in response to the news, losing 3% to trade around $509.67 by Thursday:
This move comes after Netflix has repeatedly disappointed investors in terms of its subscriber growth numbers in recent quarters. Following a large “pull-forward” of subscribers during the Covid-19 pandemic as well as a whole host of other content creators with deep libraries making their own entrances into subscription streaming services, including The Walt Disney Co (DIS, Financial) with Disney+ and Comcast (CMCSA, Financial) with Peacock, it’s no wonder Netflix’s growth has slowed.
Analysts are torn over what to think of Netflix’s foray into video games. On the one hand, if Netflix’s games could become a draw for customers in their own right, they could help the company continue reporting strong growth numbers. However, Netflix’s stellar growth so far has stemmed from it being the first (and for a while, the only) major subscription streaming player, and for the time being, its games seem to be more aimed at keeping subscribers rather than attracting new ones.
Can an expansion into video games really help the company maintain its historical growth trajectory, as some investors are hoping, or is this a signal that Netflix is slowing down and could begin seeing its premium valuation multiples shrink?
Growth or safety net?
Those who have been following Netflix closely will know that the company has been planning its foray into video games for years. However, up until this point, it’s mainly been planning and a few projects such as the "Bandersnatch" interactive film and the "Stranger Things" games on PlayStation.
After all, Netflix’s specialty is video streaming. Video games are a big industry, but there are only a few big-name players due to the difficulty of creating the highest-quality content. Many smaller players can make a hefty profit, but what might be a decent amount for a small developer wouldn’t necessarily make any difference to a company with Netflix’s revenues. In order for video games to become a valuable source of growth, Netflix would need to become one of the top video game companies.
For the moment, the company does not appear to be targeting growth via this expansion. Perhaps it might in the future, but for now, the company’s announcements suggest it is still testing the waters. It will mostly be expanding into mobile games, for which there is a broader audience and less of a learning curve. This also allows the company to bundle its games into its mobile app, increasing their discoverability.
The company thinks the main value of its games will not be in driving growth but in keeping existing subscribers more engaged with its content and less likely to unsubscribe. More in the spirit of internet games based on TV shows, its gaming content won’t be made to top the charts so much as to cater to fans looking for more interaction with their favorite shows, with the potential to discover new shows via the gaming platform as well.
On the other hand, much like Netflix’s expansion into original content, this could be a move that pays off in the long run rather than the short run. If the games prove popular, the company might expand into offering third-party or even original games on consoles.
Sticking to its model
Netflix claims that its plans for its video game offerings are in line with the same business model it has always practiced. This claim may seem a little off if we think of it in terms of movies and TV versus video games.
However, when the company adds new titles to its content library, it does so at no up-front cost to users. The subscription price covers the entire content library and does not change based on how much content is available at the moment. This is a large part of what has made the company’s business model so profitable; customers are more likely to subscribe when things are simple, and further complicating the revenue model with tiered content subscriptions could drive people away.
As long as video games remain a supplementary part of Netflix’s business model, they will likely continue to be a part of the normal subscription fee. On the other hand, much like when the company made the transition from DVDs to streaming, there is the potential for video games to become their own separate subscription if Netflix is successful enough in its video game endeavors. This transition would all depend on whether or not Netflix can someday make its video game content attractive enough to bring in its own following, rather than simply having it as supplementary content to go with its shows.
Even if Netflix’s video games someday become attractive enough to be competitive on their own merit, though, the video game market is hardly a new one. Netflix tapped a huge unaddressed market when it began its streaming service, so comparing this to the opportunities currently available for video game market share would be like comparing apples to oranges. That’s not to say the video game market has bad growth prospects – analysts’ forecasts for this industry place its compound annual growth rate anywhere between 7% and 10% over the next five years – but there are many established players and smaller studios to compete with.
Conclusion
For most of its history, Netflix has been the forerunner in the markets it has entered. Competitors have come along ever since then trying to take a slice of Netflix’s pie, with varying degrees of success. The competition has heated up recently as companies with deep content libraries such as Disney and Comcast have introduced their own subscription streaming services.
Now that subscriber growth is slowing down, Netflix is looking to expand into other markets, but the key difference between this expansion and the company’s original move to streaming is that the markets it is trying to enter now are not new. This time, Netflix is the one trying to get a slice of the pie, so investors who expect the foray into video games to drive growth on the same levels as streaming back in the day will likely be disappointed.
When it comes to historical fast growers with valuation multiples as high as Netflix’s, even continued growth can cause the share price to drop if the numbers don’t meet expectations.
