Motley Fool Hidden Gems Investing - Netflix’s Promising Next Act

Episode Date: June 14, 2023

Netflix’s is aiming to return to growth by cracking down on password sharing. (00:12) Jim Mueller and Dylan Lewis discuss: The encouraging data behind Netflix’s password crackdown and ad-supported membership.  Why it still might be a bit early to bank on those growth levers for Netflix. How Disney, Apple, Amazon are eying advertising, and how it could reshape streaming tv.  (14:45) Asit Sharma catches up with Sasan Goodarzi the CEO of Intuit to talk about how his company is using artificial intelligence to grow and Intuit's data advantage. Companies discussed: NFLX, AAPL, AMZN, DIS, INTU Host: Dylan Lewis Guests: Jim Mueller, Sasan Goodarzi, Asit Sharma Producer: Ricky Mulvey Engineers: Tim Sparks, Rick Engdahl, Kyle Carruthers Learn more about your ad choices. Visit megaphone.fm/adchoices

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I'm Dylan Lewis, and I'm joined in the studio by Motley Fool analyst Jim Mueller. Jim, thanks so much for being here! Jim Mueller. Thanks for having me, Dylan! We are talking streaming today, and we are kicking things off with Netflix. Last month, Netflix began its crackdown on password sharing. Jim, the early indications based on what we're seeing from subscription firm Antenna is that that crackdown is working and we are seeing a surge in subscriptions. This is certainly good news for Netflix. When they announced that they were going to have to do this back in 2022, they said, at

the time, 220 million subscribers, 100 million of them worldwide were sharing their passwords. This is something they needed to do. I mean, when they were growing fast, who cares, right? They had the luxury of being able to say, that's OK. This is a perk of membership. And they were growing at 20% a quarter, year over year, for like six, seven, eight years. But then the pandemic happened, and their subscription growth, their subscriber growth, the number of people signing up, fell off a cliff.

From 20% a year, it fell down to 10% a year in 2022, in 2021, and down to 5% a year for each quarter on average last year. So, they need to do something, because subscribers are still the engine that drives the company. Yeah, this is a business that needed to find growth. I think we were watching this story and we were wondering, OK, a lot of people are sharing passwords. Does the value of the service live up to having to pay for it if you can't share it? What we're seeing so far is, these notifications started going out in late spring, they really began ratcheting down in May, and Netflix had its four best days of U.S. customer signups

in late May, hitting nearly 100,000 daily signups and setting new records, Jim. I don't know that I was expecting that level of a reception for this. Well, it kind of follows what the company's discovered worldwide. Back before it was not in the entire world, piracy was pretty common in areas that it was going to move into. They found that when they moved into an area, most people went off the piracy and started signing up for them and paying for the content. So, most people are pretty honest.

Sure, people are going to take advantage of the company, of the policy, when the company is not cracking down, but when they say, hey, you really need to start paying for the content you're watching, most people are willing to do that, I think. There were two major growth drivers I looked at for this business for the year. One of them was the crackdown on passwords and being able to grow users by forcing those folks who are sharing to pay. The other one is exploring that ad-supported tier for this company, because it gives them a little bit of flexibility in pricing, and this is a business that has raised its prices

pretty consistently over time. Yeah, they had been raising prices by about $1 a month roughly every one to two years, say 18 months on average, and then they ran into a wall during the pandemic, and they saw a sequential drop in subscribers when they pushed the last price hike through. They were already the most expensive. The idea that they could raise prices forever went out the window. It was gone. And so, they have to come up with, if we can't raise prices and our subscriber growth is slowing down, which it was, they have to come up with another way of revenue, because that

content is not getting any cheaper. And Netflix is spending $6 billion, $7 billion a year. I can't remember what their latest guidance is, but it's on that order of new content. and that is the majority of their revenue. They don't have a lot of reserves like other companies have, like Amazon and Apple, for example. Even Disney has more cash in the bank than Netflix does. They have to come up with another way to generate revenue, and advertising seems to be it. Early indications are that that is successful. I believe we've seen statements from management saying that 5 million monthly active users

are in some element of an ad-supported experience with Netflix. There are some puts and takes with that number, but I think that's a number that is big enough to show that there's traction here. There is traction, but we don't have any real hard data yet. What is a monthly active user? Is that a subscriber or is that a viewer in the household? One of those profiles. And remember, you can have several profiles on your account. What analysts really need, what investors really need, is the actual numbers. How many subscribers are going on that ad-based tier, and how much revenue are they generating, and how much ad revenue is the company generating to make up for the lower-priced tier.

They aren't revealing those numbers yet. I'm still staying out of the stock because my original model broke, and I don't have the data yet to build a new one, but a lot of people are very excited about the company. The story for this business has changed so dramatically over the last year. Shares of Netflix up 150% over the last 12 months. Still well off the 2021 highs. I could see how you may want to see some of these things materialize a bit more because the company is off highs, but this is still a relatively expensive and growthy name given how much uncertainty is around this business. Definitely. I sold my shares, unfortunately,

down near that low. I mean, still made good money on the company, no doubt about that, because I'd held them for a long time. But yeah, the share price has gone up a lot since that decision. And I'm still maintaining, don't use the share price as the judgment for your decision-making process. You want a good process, you'll make mistakes now and then. But if you have a solid process, you'll do better in the long run. Yeah, I've missed out that 150% recovery. I wish I had. But there are other ways to make money off the company, and I'm doing so. We start off the show talking Netflix, I think the reason for that is, this was the innovator in streaming.

Because they were the innovator, they also ran into the slowdown in streaming before so many other players in this space. I think a lot of what we're talking about here is probably in the future for the likes of Disney, for the likes of Amazon, for the likes of Apple. Right. Netflix was, for years, the leader of the streaming. And then Disney came in, and Amazon started up, and now we have Paramount. We have whatever HBO is called nowadays.

Is it Max? Max. It's so catchy. And Warner Brothers Discovery has their set. Everybody is streaming. Hulu is streaming. Crunchyroll, my anime. I love every anime.

My wife and I watch it a lot. I mean, everybody is streaming, and so there's all this competition. And so now, with so many places for viewers to put their dollars and how that translates into a much lower ability to raise prices, all these guys are going to have to find out ways to get more revenue. And that, unfortunately for those of us who got used to Netflix, being ad-free means advertising. And certainly, Amazon is thinking of, you could get your Prime video with your annual subscription, and it's ad-free, but now they're throwing some ads in at the beginning, and now they're asking you to pay up for an ad-free experience. I can't remember what Disney's doing, but I think they're thinking the same thing.

Apple hired a big advertising exec last February. Lauren Frye, I think was her name. They're getting into the game, so all the big players are on this. I think we're going to go back to advertising, or you pay more out-of-pocket to avoid it. Cable with slightly more steps, right, Jim? Yeah, right. I think it's interesting and it makes sense when you think about the economics of this business. You can only continue to raise prices for so long. One of the interesting things with advertising here is, there seems like there's a way for this business to find growth and maybe be able to find growth without

necessarily passing that cost along to the customer, but instead switching who the customer is and having it really be advertisers. Right. So, everyone's discovering that as there's more demand for the content, the content becomes more expensive. And Netflix's idea was, OK, we're going to grow our subscribers faster and get more revenue, and then we'll be free cash flow positive and it'll work out. But as that content gets more expensive, you keep having to get that content, you keep having to have the unique content for yourself, to keep the subscribers in your business. You have to find some way to pay for it if you want to keep on growing. Given that the entire industry seems

to be moving this way, Jim, I want to talk a little bit about some of the tradeoffs that come with an ad-supported model. We've been in a period where subscribers have basically footed the bill for content, and that's meant that creative control has been very high, and that these platforms have been able to really control the relationship with the user. I have to imagine that's going to change. Do you expect that to change? I totally expect it to change. And it's one of the things that I was, what it was part of my thesis on Netflix was that

Netflix controls everything and they give the content creator free license, okay, saying you can do whatever you want. You can have a 45 minute show. You can have an hour 15 show instead of what is now 42 minutes for per hour or whatever it is on network TV. And you don't have to put in timed breaks. You don't have to have miniature cliffhangers to make sure the person comes back after the ad break to continue watching the show. That gave a lot of free license to the content creators, and they loved it.

They loved working for Netflix because of that. But now that Netflix is going back to ads and everyone else is too, I think the content creators are crying a little bit in their beers because they're losing that or potentially losing that. How much will the advertisers dictate? Not only the breaks of where the ads are, but the content itself. Does a brand want to be recognized or affiliated with a particular show that might not be very good or have a negative connotation? Netflix had some controversial stuff come out. I don't think we're going to see as much of that going forward. When we're talking advertising, we can't help but also talk a little bit about data here, Jim.

And I think one of the things that I'm wondering with this is, is there going to be a point where we get a little bit more from Netflix? Oh, of course. Because they have to. Of course. I mean, you're spending millions of dollars for a placement in a show, and you want to know what your return on that investment is. How many people watched it?

What were the demographics? Are they the target audience we thought they were? And so Netflix is going to have to start sharing that, and everyone else, of course. is going to have to start sharing that. That also is something that Netflix is having to give up with this new reality that they're entering at their beginning. To get particularly meta here, Jim, I'd love to talk more, but we have to take a break. It's time for us to head into the mid-show read. Stick around, though, listeners. I promise, there'll be good stuff. Jim Mueller, thank you so much for joining me!

Thanks, Dylan! When you take business advice from a chatbot, Sazan Ghadarzi, the CEO of Intuit Business Software Company that owns QuickBooks, TurboTax, and Credit Karma, is hoping you might. Asit Sharma caught up with Ghadarzi to talk about how his company is using artificial intelligence to grow and Intuit's data advantage. So, the last time we spoke, which is about a year and a half ago, you were really emphasizing the role of artificial intelligence, both into its internal development and its strategy for its customers.

So, maybe take us back to that point and bring us forward to today. Yeah, sure. I love talking about AI, but maybe if I could zoom out for a moment. You know, one of the things that we did about almost been five years now was to focus on shifting the company from a tax and accounting platform, solving two very, very important problems for our customers to really being a platform where we solve daily meaningful problems for our customers and truly being a platform that you rely on us on a daily basis, both as a small business and as a consumer. consumer because that really helps us with what we have ultimately set out to do, which is to power prosperity around the world. That was one element of our strategy that we've declared almost five years ago. The other element of the strategy was that we wanted to get to a place where we are actually doing the work for small businesses and consumers when it comes to their

money automagically, meaning that we're delivering insights, we're providing perspectives, we're providing suggestions so we can eliminate the work and the drudgery, but that they ultimately can find ways to get more money in their pocket and do it, you know, with a lot of confidence. So at a big picture, the ultimate intent of our strategy was what I just described. And, you know, we have a $300 billion TAM that really entails customers spending a lot of their time on Google Sheets, Excel, receipts and shoeboxes, manually, you know, connecting with bookkeepers and accountants. And that's really important because as we've been building out our platform, we're not trying to get people to switch from another platform. It's really to deliver something that's

better than doing things manually. Data and AI have been key to achieving that outcome. So when we declare our strategy five years ago, what we said was the most important thing that we have to focus on is getting 360 view of the customer's data and focus on AI. Now, back then, five years ago, when we talked about AI, it was really in three areas. It was machine learning, It was knowledge engineering, and it was natural language processing. And a lot of our innovation in the last four or five years has been accelerated because of our investments in data and AI. And in fact, our two major acquisitions that we've made have really been about enriching our data platform and enriching our AI platform. both MailChimp and Credit Karma brought an incredible amount of customer data and AI

capabilities to help us sort of leap forward five to 10 years. Now, I'll tell you, I have been on the record to say a few things. One, five years ago, what I said was, I believe AI is going to be a platform that will ignite innovation across the globe, across every industry that will only be in line with what electricity did and the internet did. Now, I remember when I said that five years ago, people kind of rolled their eyes and thought I was just trying to be dramatic. But I and we truly feel that AI is revolutionary. And I tell you, I think we are now in the most exciting times because what is amazing about what's possible with generative AI is that it can humanize things. It can personalize things. It can truly help us at least achieve what we

set out to achieve five years ago, which is as a small business, I can actually propose to you based on all the data that we have, what to do to grow your business and run your business and actually share with you very specifically what you can do based on what we know about your business to be able to win and thrive. And so therefore, I'll just end answering your question with the following, which is we've been investing heavily in generative AI for the last couple of years. And in fact, most recently, we announced the Intuit generative AI operating system. Because at the end of the day, it really does come down to being clear about two things, the customer problem you want to solve and the technology. And with our generative AI operating system, it entails a few things that are essential for us to continue to ignite innovation.

One element of it is what we call GenStudio. It is a development environment that will allow our developers to move with high velocity and natively use the capabilities that they need to solve the customer problem. The other, and I would say probably the most important part of the infrastructure that we've built out, is what we call Gen AI Runtime. It's really the brains. It's the orchestrator. And this orchestrator really leverages all of our data platform capabilities that we have. So very specific data about a customer. It leverages, it decides which large language models to leverage because we've built our own Intuit large language models that are being trained by all of the specific data that we have for each of our customers, which in itself is a discussion. we could have. And then when we focus on doing things like helping a customer improve their credit score, helping a customer with how do I double my cash flow in the next few weeks, this orchestrator reaches out and uses relevant data, leverages the right relevant large language models to then come back to the customer with a specific answer that's humanized and personalized

for them. So that's a big part of what we released. And then we also released what we call Gen AI UX. These are ultimately user interface capabilities so that we're building things once and all of our engineers can leverage them across the company. So that's what we've been working on for a couple of years. We just announced it because it is ultimately the infrastructure that we are using to release and reimagine a number of big changes in our customer experiences that we believe will ultimately help us achieve our mission of powering prosperity around the world. And I can share some of the things that we are focused on, but I think it's very exciting times. I think it's exciting times for

the world in terms of what's possible with AI. And I think now things are possible that frankly, in the past, never were. So, I'm very excited. We're very excited about it. Sassan, all that's fascinating. And this is where I think this leap in technology really favors companies like Intuit, which have access to so much data. With the transformer model, those limitations that might have been there four or five years ago, in terms of memory, slowly, we're finding solutions for. I find this fascinating. I wanted to just point out, This feels very Intuit to me, in that Intuit has always built an ecosystem approach to its customers. We always have third parties coming in.

I'm asking this only half-jokingly with Gen Studio and Gen UX. When will we see third-party apps in the Intuit store that are tapping into this technology? So we are an open platform. And the most important element of being an open platform is how we leverage the transactional data of a PayPal, of a Square, since I use those as an example. And when I mentioned that data lake that our large language models reach out to you, that data, the customer's data, which was a Square transaction, a PayPal transaction, is all in that data lake. And so there isn't a time in which we will be able to allow that data to be accessed by Gen OS. It's actually part of the infrastructure that we're building. The key and where I led with, it's a very hard problem to solve and why for us everything is about the data, is you got to make sure that data is clean. You got to make sure that data is usable. You got to make sure that Gen OS and particularly machine learning knows how to use that data. So, we invest a lot of time making sure the design and the structure of that data is such that Gen OS can actually use it. But it is already part of what we are launching.

There's no sort of timetable for it because it's the customer's data. Wonderful. So, San, we have just a few more minutes. Love those answers. Give me one risk scenario in which this thesis of everything coming together automatically gets challenged or upended. You know, it really for us comes down to, um, accuracy. Uh, and, um, one of the things that we take very seriously, which is where our knowledge engineering investments over the years become so important. Now our knowledge engineering investments are about completeness

and accuracy. So when you ask me, uh, Hey, how do I improve my credit score? When you ask me, hey, how can I double my customers? We have to have the right level of controls relative to the data that we use, how we apply our technology to be able to give you a proposal, but also say, hey, Seth, this is the confidence factor in what we are proposing to you so that there's full transparency. So for us, the biggest thing is actually about accuracy. And are we making a difference in your financial life. We don't worry as much about a lot of the talk out there, which is like hallucinations, because we have a lot of the capabilities to be able to focus on the task at hand. But our biggest focus and where to your question, things may not pan

out the way we would wish is completeness, accuracy, trust, where you can trust what you're getting from us. And then you continue to come back because we're truly impacting your life in a positive way. That's what we're focused on, and that's what we're going to get right. As we conclude, one more question for you. Give me one scenario or vision in which everything is working according to plan. What are the attributes or maybe metrics or qualitative things that you'll see that tell you, yeah, all this investment in AI, our shift to marry up our machine learning with our expert knowledge and Gen AI is really taking root and we're happy with it? I love that. I love that question. So, um, we have two metrics, uh, that we internally

hold ourselves accountable to, to measure our, our mission. Uh, the, the two metrics are we've set a goal where anybody that's on our platform, we want to be able to double their household savings rate. And we measure that and talk about it, uh, internally every quarter. And we talk about it with the board. Um, the second metric is 50% of businesses go out of business after five years. And the goal that we've set is if you are on our platform, uh, we want to reduce that to 30%. So the two goals are, we want to increase the livelihood, uh, on success of small businesses, and we want to power the financial prosperity of consumers. I'll tell you where we are against both goals, just not to leave you hanging. On the double your household savings rate,

we are at 1.2. So if you are on our platform, your savings rate is 20% better than if you are not on our platform. We're not at the doubling yet, but we are making progress. In fact, during the COVID years, it went up to 1.8, but I don't use that number often because I think it was inflated, not because I think it was inflated by all the stimulus and government funding. So we're making great progress and room to improve on the small business side. As I said, 50% go out of business after five years. If you are on our platform, we have improved that by nearly 15 points. So that 15 points of businesses are less likely to go out of business if they're on our platform versus not.

And our goal is to actually get to being 20 points better than industry. So those are the metrics that matter the most because our view is it's ultimately about the success of small businesses and it is about the success of consumers. And that is what we

hold ourselves accountable to. And actually, we are extremely hopeful that with generative AI, we can now do things that we never imagined possible and are very excited about the possibilities. Sassan Ghadarzi, this has been really insightful for our members,

and I so much appreciate your time today. All right. Thank you so much for having me. Great to see you. Same. As always, people on the program may own stocks mentioned, and The Motley Fool may have formal recommendations for or against, so don't buy or sell anything based solely on what you hear. I'm Dylan Lewis. Thanks for listening. We'll be back tomorrow.