Netflix Flying High – Can It Last?

Source: WGME

Netflix (NFLX) is in an interesting place because two recent developments have the company soaring from $ 177 per share on October 2 to about $ 195 per share as I write.

The two catalysts have been the announcement by some analysts that they see the company exceeding new subscriber expectations domestically and internationally while the company communicated it’ll be raising streaming prices for its customers with different plans.

That combination, assuming the increase in costs doesn’t generate more churn than expected, will continue to give the company momentum, which should remain in place at least until the end of 2017.

I draw that conclusion because the fourth quarter tends to be a good one for the streaming giant.

Also, we are not likely to see what the impact of the increase in pricing plans will be until the first quarter of 2018, which won’t be reported until April. If there is a meaningful decline in subscriptions, it’s probable the company will release that before the second-quarter earnings report so investors aren’t caught off guard.

For now, it looks like Netflix investors are going to enjoy a nice ride, although high expectations could turn to a negative if they fail to be met in the upcoming earnings report.

Subscriber outlook

The outlook for Netflix’s subscriber growth was upwardly revised by two analysts, which boosted optimism for the stock earlier in the week.

One came from UBS analyst Doug Mitchelson, who raised his 12-month price target, and the other from Piper Jaffray analyst Michael Olson, who focused on the third quarter, saying he sees domestic and international subscribers exceeding expectations.

Mitchelson said this in a note to investors:

“A strong third quarter performance this year without a big content release slate or new market launch should increase investor confidence in the size of the ultimate total addressable market, Netflix’s potential market share and its speed in getting there.”

Mitchelson could be correct, at least for the fourth quarter, where Netflix has waited to release a strong slate of original content.

Among them are season 2 of “The Crown,” “Bright,” season 2 of “Stranger Things,” “Mindhunter,” and “The Meyerowitz Stories (New and Selected).”

“The Crown” and “Bright” will be released in December 2017, with the rest scheduled for release in October.

All of this is in preparation for the historically robust holiday season where Netflix has enjoyed solid subscriber gains. With the new shows and looser wallets, Netflix obviously hopes consumers won’t pay too much attention to the fact they are now charging more than rivals Amazon (NASDAQ:AMZN) Prime and Hulu.

As for Olson, he said he drew his conclusion from “analyzing Google search trends.” Data showed domestic growth climbed about 16 percent in the third quarter while international subscribers soared by 71 percent over the same reporting period last year.

Olson said “the consensus outlook is 10.7% for U.S. subscriber growth and 42% for international subscriber growth.”

Streaming price increases

Netflix is increasing its streaming prices in several markets, including the U.S., the U.K., Germany and France. Earlier in the year it boosted prices for Scandinavian countries, Latin America and Canada.

In the U.S., it’s increasing the monthly charge from $ 10 for its most popular plan to $ 11 per month. This is the plan that allows programs to be watched on two different devices connected to the Internet at the same time. The plan that won’t be changed is the one that doesn’t include high-definition, and allows only one screen to be watched at any one time. That will remain at $ 8 per month.

The high-def or 4K plan in the U.S. is being increased from $ 12 to $ 14 per month.

Overall, Netflix has approximately 53 million U.S. subscribers.

In the U.K., its prices are being increased on standard and premium plans. The plan there for watching on two Internet-connected devices simultaneously has been increased from £7.49 to £7.99 per month, while its Ultra HD plan has been increased from £8.99 to £9.99 monthly. The increases for existing subscribers will start in November.

The company is also increasing prices in France and Germany for its standard and premium plans.

Major competitors of Netflix will have a price advantage for now, with Amazon Prime subscribers paying around $ 8.25 per month, or $ 99 annually, and Hulu subscribers paying $ 10 per month.

That leads me to wonder if Netflix may be trying to some degree to position itself as a premium streaming service to differentiate from its rivals, at least with its Standard and Premium plans.

Differentiation

One of the challenges from the beginning for Netflix and other streaming companies has been how they’ll differentiate in a market that in the beginning was primarily a commodity market, meaning companies were streaming old content from traditional media with little to set them apart from legacy companies and from one another as they made content streaming deals.

That of course meant there was little in the way of pricing power. That of course changed with the transition to paying for the production of original content. This is a major reason Netflix is increasing prices, as it wants to defend margins and earnings even as it commits more to original production projects.

RBC Capital Markets’ Mark Mahaney recently wrote this in a research note:

“We believe that Netflix’s pricing power has increased materially over the past few years as their content slate and technology has improved.”

If Netflix in fact does have pricing power, which has yet to be proven, it would suggest its original content is superior to Amazon’s and Hulu’s. While it has done all the politicking in Hollywood to secure awards, it’s not a given that it will translate into consumer acceptance of higher prices, or that consumers consider it must-have TV.

A factor in whether or not Netflix considers itself to have pricing power or a premium service in comparison to its major rivals is in how Amazon Prime and Hulu in particular respond. If they raise prices as well, it would mean they consider their content at least as good as Netflix’s. More importantly, it would signal to the market they’re confident in those assumptions.

I don’t see Amazon raising its Prime subscription price in response to this, although its commitment and focus on customer service for Prime members gives it the potential to raise prices without enduring significant churn. The problem for Amazon is the way it prices its plan, where the $ 99 per year has a psychological element to it, if it were to be raised above $ 100.

Amazon’s size and willingness to work with low margins could position it as a low-cost alternative that is perceived as at least equal to Netflix. Amazon Prime is more than only a streaming service, so it’s not really comparing apples to apples, although the market in general still uses Amazon’s streaming business as a key metric to compare against Netflix.

Where Netflix could get hurt by this, if its rivals keep their prices where they’re at, is if the economy starts to slow down and consumers are forced to make a decision on which services to use or keep.

If Netflix isn’t considered a premium service in their eyes and worth the higher price, it could take a hit that would be difficult to recover from if the next recession is a prolonged one.

Conclusion

In the short term, by which I mean the next couple of quarters, Netflix should enjoy some strength. The question is whether or not the robust expectations coming from analysts concerning subscriber numbers are accurate. The market assumes they are, and have bid up the share price of Netflix as a result. If they are overly optimistic, and the earnings report on October 16 disappoints in that regard, the share price will reverse direction, albeit not as much now that the company is increasing prices in key markets.

Netflix as earmarked about $ 6 billion for original programming in 2017, and that’s likely to increase going forward. This is a major reason for the increase in prices and why it is attempting to position itself as a major player with original programming.

Netflix garnered more Emmy nominations in 2017 than any other network, with the exception of HBO. That definitely provides a sense of being a premium network, and I think the company is counting on that perception limiting the amount of churn coming as a result of raising prices. Again, it’s also why it timed the announcement right before the busy holiday shopping season, and why it is releasing so many original shows in the last quarter.

With the addition of relatively new streaming competitors like YouTube (NASDAQ:GOOG) (NASDAQ:GOOGL) and likely Apple (NASDAQ:AAPL), along with streaming offerings from legacy media, it’s becoming a crowded field, and Netflix will have to continue to release original content that resonates well with its subscribers in order to justify its price increases and maintain and grow its customer base.

Momentum should carry Netflix for the next couple of quarters, unless subscriber numbers aren’t as strong as the market is now looking for. Assuming they are, the share price should eventually jump above the $ 200 per share mark, and when it does, that in itself will be a catalyst to push it higher.

One concern I have is that Netflix believes its improvements in service justifies its price increase. I think it’s wrong there. I’ve heard that argument from Comcast (NASDAQ:CMCSA) for a long time, and consumers deservedly consider it among the worst in customer service.

In other words, how customers view the increase in services will determine the level of acceptance. The carnage in 2011 after the price increase shows this isn’t guaranteed to be something its customers accept. That was different because of the changes going on from physical disks to streaming transitions, but it still showed its users weren’t so committed they wouldn’t abandon the service in droves.

That probably won’t happen this time around, but it can’t completely be ruled out.

My view is it’s going to be all about perception, and if Netflix has successfully positioned itself as a premium network in the minds of its customers, similar to HBO, it probably shouldn’t have too much problem with this.

On the other hand, if customers consider it to be similar to Amazon Prime and Hulu in value, there may be more of an uprising and abandonment of the service than the market expects.

Since it’ll take some time before we find out the response of consumers to the price increase, I still think Netflix will do well over the next couple of quarters. Once the numbers come in concerning churn, which probably won’t be significant until after the first quarter of 2018, we won’t really know what revenue will look like for the company going forward.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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