Here’s what it really means when Netflix tries to buy Roku

Shandle video service Netflix (NASDAQ:NFLX) could try to acquire a Connected TV (CTV) platform roku (NASDAQ:ROKU)according to rumors that have surfaced in recent weeks.

It’s just a rumor for now, but Netflix has good reasons for making such a deal. Video content is becoming increasingly commercialized, and Netflix’s recent moves suggest it recognizes the need for a quick transition.

Here’s what’s happening on CTV

Something monumental happened recently in the CTV space. According to Roku’s first-quarter letter to shareholders, 65% of U.S. adults ages 18 to 49 streamed video content in March, compared to just 63% in that age group who watched traditional pay-TV like cable and DVRs. For the first time, there were more streamers than non-streamers.

The switch to CTV is a major secular growth trend investors should pay attention to. But there are two types of streaming: paid subscriptions and ad-supported channels. And while streaming in general is the future of the industry, paid streaming services like Netflix are facing real headwinds.

According to a recent report by market researcher Parks Associates, 32 million households in the US can be described as service hoppers. They frequently switch services and re-subscribe to services they had previously discontinued.

This suggests that there was already a limit to how much consumers would pay for streaming overall. And now discretionary income is being further squeezed by inflation. According to Yardeni Research, the average consumer is spending about $180 more per month on gas alone this year than last year. So consumers have to cut spending somewhere, and maybe the money will go to paid streaming services.

In fact, research group OnePoll conducted a poll for ad-supported streaming service Tubi. The survey found that the average consumer has five streaming services but plans to discontinue three of them soon. Around 70% of respondents indicated that changes in their personal finances were the main reason for the change.

The challenge for Netflix

Netflix started the streaming revolution and shareholders enjoyed life-changing returns while it was the only show in town. But with more competition, it’s harder to get subscribers. And in the last quarter Netflix has lost subscribers for the first time in over a decade.

You need more compelling content than the rest if you want to attract and keep subscribers. But generating quality content comes at a price; The company already spends billions annually on original films and series. As an 800-pound gorilla in space, Netflix needs to spend more than most of its competitors, but it may need to spend even more to stay on top.

Dispensing more varieties weighs down on the bottom line. That’s fine if a company can raise prices at the same time, but it’s fair to question how much pricing power Netflix still has to preserve margins. There’s no denying that the company announced price increases in January, just ahead of a slight drop in subscribers. For service hoppers, it might have been time to jump ship from Netflix.

This is what happens when something is commercialized: pricing power decreases and profits eventually dwindle. That’s the challenge Netflix faces now.

Why I (still) love Roku stock

To reiterate, the shift to CTV is real and is still happening. But it is becoming increasingly difficult to benefit from the change with paid services. Netflix acknowledges this, which explains why it suddenly announced plans to explore an ad-supported tier for its service. When discussing financial results for the first quarter of 2022, management said it plans to add an advertising tier within the next year or two, despite previously rejecting the idea.

An ad-supported layer helps retain more subscribers and monetize the original content that billions of dollars have already been spent producing. After all, Netflix subscribers who are service hoppers are more likely to hop down to the cheaper version than cancel altogether.

But this model still requires Netflix to acquire subscribers in the first place. In contrast, Roku can capitalize on CTV’s growth by better monetizing it distribution of the content and not the content itself. There are over 61 million active Roku accounts streaming from a variety of services. And Roku can at least benefit a bit from it instead of relying on original content.

If Netflix is ​​seriously considering acquiring Roku, it’s because distribution can be more valuable than content — which is why I love my Roku stock.

Rocus market capitalization is about $11.2 billion as of this writing, while Netflix alone has $6 billion in cash, suggesting a deal is more than feasible. I think it would be a great move for Netflix shareholders.

However, as a Roku shareholder, I hope that doesn’t happen. As a standalone company, Roku has a tremendous runway for market-beating returns, and I hope to ride it for years to come.

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jon quast has positions in Roku. The Motley Fool has positions in and recommends Netflix and Roku. The Motley Fool has one confidentiality policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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