Netflix could be ‘looking for an exit’ through ad partnership with Microsoft: Analyst

Needham Senior Analyst Laura Martin joins Yahoo Finance Live to break down the pros and cons of Netflix’s ad partnership with Microsoft.

Video transcript

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- Netflix has signed on Microsoft to help support its lower priced subscription plan that's going to have ads. For more on where Netflix sits in this competitive space, let's bring in Laura Martin, Needham's Senior Analyst. And in a new note, Laura, you basically say Netflix is sort of doing this out of order, right? And that maybe Microsoft wasn't necessarily the best partner on this. Let's take that last part first. Why do you think they picked Microsoft? And what are the sort of advantages and disadvantages?

LAURA MARTIN: So let's start with the disadvantages. So Microsoft actually just bought an ad tech platform a month ago. It bought Xander from AT&T. It has never been in the third party ad tech business. So it's got to build a lot of capabilities in its SSP, it's supply side platform, in order to actually represent Netflix. Whereas, if Netflix had picked Google, or Roku, or FreeWheel, or Magnite.

Those are all third party SSP, supply side platforms today. Some of those have direct sales forces. So Netflix could have been in market much faster, probably by the end of this year. But there's going to be a lot of tech build required over at Microsoft, which just adds time.

So maybe Netflix can have more impact, and what the tech build ends up looking like, and what capabilities it has. But Wall Street really wanted ad revenue to come to Netflix faster. And it looks like Netflix doesn't have time to market as a core priority with this choice.

- Laura, you certainly caught my attention by what you wrote in your note down here, you say, quote, "A hidden agenda at play here may be that Netflix wants Microsoft to buy them." And you also point out, of course, that Reed Hastings, the Co-Ceo of Netflix was on the Microsoft board from 2007 to 2012. What's the probability of that happening?

LAURA MARTIN: Well, I mean, it could be that Netflix is looking for an exit. And all those other players that would have gotten them into advertising sooner can't buy them. They're either too small, or regulators wouldn't let Google take over Netflix, because regulators want Google to be smaller, not larger. So it could be here that really the play is that Netflix is trying to get closer to Microsoft in hopes that after Microsoft digests its Activision acquisition, it turns next and buys Netflix, which would be a complementary kind of video content, premium video content, like Activision is in the video game space.

- But again, I just want to press this point a little bit. How realistic is this scenario? I mean, particularly, in what I think we could argue is not a super friendly administration in terms of antitrust, in terms of approving deals, the Activision deal isn't even approved yet, right? So do you think that this would be something that would be realistic?

LAURA MARTIN: So I mean, I think time passes. I think that they won't even have a tech stack built out till the end of next year. So this would be more of like a five year play of Reed Hastings. And it's just this is a $100 billion company, Netflix. So sort of who can buy you is really limited. So it may not play out.

But yeah, he couldn't have sold himself to other players that would have been actually better for him to select for ad tech. And I'm just trying to scratch my head. And to your point, so one of the points I want to make about earnings, because Netflix is doing earnings this Tuesday, is that Netflix announced three months ago on their earnings call that they were getting an ad business. They still haven't hired a head of ad sales.

So the notion that you have no one in the empire that's an expert in advertising yet, and yet, they've picked an ad partner for the technology stack is backwards. Like, you should hire your advertising expert first who knows everything about the business. And then he/she should have input into what ad tech stack you're going to go to market with.

So that makes me feel like they were in a rush to announce this before earnings, which makes me cautious on their earnings, because they felt like they had to do something before Tuesday and they just haven't. So I think all that suggests that Tuesday's earnings are going to be light. And I do feel that they will continue to have weak subscriber adds until they have an ad driven tier that is lower cost.

- Laura just staying in that potentially weak earnings report from Netflix, that would be another one. And Netflix shares are down about 70% year-to-date. I mean, is another bad quarter from this company fully priced in?

LAURA MARTIN: No, it is not fully priced in, in part because I believe that Wall Street thinks they're going to have ad revenue by Q4. And this announcement to me says, speed isn't a priority for this company, that they're looking at fourth quarter of next year. Wall Street does not have that priced in yet. They will not like that, especially if the sub numbers are bad, and they don't have a revenue stream called advertising.

- Well, you certainly gave us a lot to think about ahead of that earnings report. Laura Martin Needham, Senior Analyst. Always good to see you. We'll talk to you soon.