Wedbush Securities Managing Director Michael Pachter joins Yahoo Finance Live to discuss Netflix's ad-supported tier as well as the outlook for Netflix, Apple, and Facebook in the metaverse and gaming.

Video Transcript

- Netflix's new ad-supported tier could cost between $7 to $9 a month. That's according to a new report from Bloomberg. The report says Netflix would also play about four minutes of ads for every hour of content.

Joining us to discuss this is Wedbush Managing Director Michael Pachter. I don't know, Michael. Four minutes seems like an eternity when you're watching a Netflix show. I mean, how much do you think-- number one, there's a lot riding on this. But how big of a bump is Netflix likely to get out of this?

MICHAEL PACHTER: Oh, I mean, broadcast TV is 12 minutes. Cable TV is 18. So four minutes is kind of the model that Roku and Hulu have been using. And Hulu has been ticking up. Most consumers will tough it out.

And I think what's interesting about ad delivery in advertising video on demand is you can't fast forward through it. So it's actually a more valuable ad to the advertiser. The trick here is to convince a subscriber who's churning out, who's quitting, that they can go from $15.49 down to $7.99. And if they just put up with some ads-- take $8 a month for 12 months. You know, it's only $96 a year, as opposed to the $15.49, which is $185, $186 a year.

So you're telling these people, you're going to cut your cost in half. You don't have to join for six months and quit for six months just to keep it as a subscription and deal with it. I think that will slow churn. I really do. And I also think Netflix is fully penetrated above median income households in the US and Canada. They have about 70 million subscribers, and there's only 130 million households. So kind of by definition, everybody who's above median income who wants it has it.

So their last remaining untapped market is below median income. And people making less than the median have to think about whether they subscribe to multiple services. So by making Netflix go from the most expensive service to one of the least expensive, they're likely to attract more subscribers. I think this is going to work. I think it's a pretty smart idea.

- Michael, so on that point, I mean, the subscriber numbers aren't as important for Netflix as the margins are right now. And I guess, if consumers that are paying higher per month are going to trade down, what does that do for Netflix's margins? Because they could counteract that from the revenue they're getting from the ads, right. So is it kind of a one-for-one?

MICHAEL PACHTER: Yeah, so we'll find out when it happens. But Hulu does about $10 per household that watches ads. That's about the monthly. My expectation is that Netflix subscribers will watch more content. So the ad revenue could actually be even higher. I don't think people watch Hulu as much ad-supported as they would watch Netflix ad-supported.

So let's go with $10. The norm for a company that has to go outside for advertising is that they split the revenue 70-30 to the company. So Netflix will get at least $7. So if they charge $7.99, and they get $7, it's pretty much a wash.

They cut this deal with Microsoft presumably because Microsoft gave them beneficial terms. So probably Netflix is going to keep more like $8 of that. And they really are dead even. So if people trade down, Netflix will be about dead even. If people don't churn, Netflix is net gaining subscription dollars.

So I actually think it's a mild positive. But I think more important than the revenue impact is that it's going to limit churn. You're going to see subscriber growth start back up. And then investors are going to be confident that this is a growth company. Slow growth, but growing. And slow growth is worth more than where the stock is trading right now. So I see the share price going up.

- Michael, this comes at a time when we've seen a pullback in ad spending broadly. And we saw some of that in the results that Disney put out, specifically with Hulu, which has really been using this ad model for some time. What do you think the ad demand is going to look like?

MICHAEL PACHTER: Well, we have to start with the premise that advertisers are stupid. And they really are. And that they don't actually know anything about anything. And they don't know how to target, which is why Facebook and Google are so successful.

Second, you have to recognize that advertisers are slow to adopt. So it took them a long time to give up on commercial broadcast TV, and billboard advertising, and drive time radio and print. And it took them years and years to embrace Google and Facebook. They're now beginning to see social media as being saturated. So the next untapped market is advertising video on demand, video streaming.

And as you get more subscription services-- Netflix, and Hulu, and HBO Max-- that don't have advertising, you're shifting eyeballs from commercial broadcasts to pay subscription with no ads-- the advertisers have to go somewhere. If Netflix is successful with this, I think they're going to find this audience. The very last bastion of eyeballs is mobile games. And they haven't even begun to start advertising there.

But advertisers have to go where people are and where your eyeballs are. And your eyeballs are going to be on Netflix ad-supported. So I think this is going to be wildly popular and wildly successful. It may take two or three years for advertisers to figure it out. But once they figure it out, I love advertising video on demand.

I think that's a real reason to own Roku. There's a company we don't cover. Chicken Soup for the Soul, same model. There's lots of companies getting into this market. And I think Netflix is actually a late entrant. But they're going to be very successful, because they're so huge.

- Michael, let's talk about, lastly here, the gaming aspect of things. Some reports that Netflix is testing gamer tags, which would really be the next step in terms of turning this into more of a gaming experience. We've talked with the likes of Exploding Kittens for their strategy there. This is obviously something they're going hard on. What is the significance of that in terms of the future of Netflix?

MICHAEL PACHTER: I'm glad you guys got me on early, so I could watch your metaverse report. Netflix is going to fail as miserably in gaming as Apple is going to fail in virtual headsets. There's just no basis for either of these companies to be in those markets. Facebook's going to fail with its metaverse aspirations. They all suck.

And the reason is that there are better companies out there who are chasing the same pie, who are not going to put up walls and try to restrict access. So Netflix getting into games is like McDonald's getting into groceries. Or people that go to McDonald's eat, therefore they want to buy their fresh groceries there. That's just stupid. It'll never work.

Netflix can try, but the games they're going to offer are free to play. You can find them elsewhere. You don't need Netflix to be the aggregator of free games. Netflix can try to get into premium console games. They will fail miserably.

And I'll change my tune if they buy Electronic Arts, sure. But if they don't have the know-how to make these games, they have no chance of succeeding. So it's a nice to have little bolt-on. But they add no value by putting free to play games behind a Netflix paywall. It will not work. It will be an abject failure, as will Apple's headsets.

- Well, if that's the case, I'll stick with my Nintendo Switch then, in that case. Wedbush Managing Director Michael Pachter. Thanks so much. Appreciate it.

- Well, let's turn our attention to my favorite--