The Update Issue: What to Make of the Netflix Price Hike

Binging your favorite show on streamer Netflix (NFLX) is about to get a little pricier... Last Friday, Netflix announced that subscription prices in the U.S. and Canada would rise by between $1 and $2 per month, depending on the plan. For the most popular Standard plan, the price goes from $13.99 to $15.49... For the […] Not rendering correctly? View this e-mail as a web page [here](. [Empire Financial Daily] The Update Issue: What to Make of the Netflix Price Hike By Berna Barshay Binging your favorite show on streamer Netflix (NFLX) is about to get a little pricier... Last Friday, Netflix announced that subscription prices in the U.S. and Canada would rise by between $1 and $2 per month, depending on the plan. For the most popular Standard plan, the price goes from $13.99 to $15.49... For the Premium plan, a $2 hike takes the monthly cost to $19.99... And the Basic plan is up $1 to $9.99. Applying an average monthly price increase of $1.50 to Netflix's 74 million subscribers in the U.S. and Canada equates to around $1.3 billion in revenue on an annualized basis. And because of the staggered rollout of the price hikes across the existing customer base, some of the price increase-driven revenue growth will fall into the 2023 fiscal year versus this one. A price increase could however lead some customers to churn off the service in the face of a higher monthly nut. Any customers that choose to quit would be an offset to the more than $1 billion of potential incremental revenues from the increase. It's always the million-dollar question when any company hikes prices whether or not it will destroy demand... But in the case of a recurring payment subscription service like Netflix, where so much of the corporate value derives from the sub count – and the stickiness of it – any increase in churn could have a meaningfully negative effect on the company's valuation. The price hike shouldn't have been a major shock to anyone... With penetration of around 60% of U.S. and Canadian households, the law of large numbers is catching up to Netflix in these markets... the rate of growth of subscribers in these countries has really slowed down. Last quarter, the streamer added just 70,000 net subs in the region. To continue its top-line growth – and fund its soaring content costs – Netflix needs to increase pricing. The price hike comes on the heels of increases of similar magnitude in a number of European countries last fall. The price bump is also a sequel to price hikes in the U.S. and Canada back in 2019 and 2020... Simply put, the U.S. and Canada were due for a hike. So while the exact timing was uncertain, the directional move was not – which is probably why the announcement was met with a bit of a shrug last Friday, with NFLX shares closing up only a touch over 1%. Assuming no big pick up in churn, on an annualized basis, the $1.3 billion in increased run-rate revenues would represent a 4% bump to 2021's estimated company revenues of $29.7 billion. If investors believed that Netflix would take in that money and not spend it, the stock might be up a lot more. Keep in mind that $1.3 billion in extra revenues would theoretically translate to almost $2 in incremental earnings-per-share ("EPS") power... if Netflix didn't spend any of that extra money it took in. But that's a big "if." The price action on Friday and since then tells you there is no way that investors think that Netflix just pockets that incremental revenue. An extra $2 of EPS would be very meaningful versus the $10.76 of EPS Netflix is expected to have earned in 2021. Even half that amount would equate to nearly a 10% bump to earnings power. The fact the stock didn't move much just confirms that no one believes that this price hike doesn't get re-invested into content, as the streamer searches to find the next Bridgerton, Ozark, or Squid Game. Netflix had indicated earlier last year that its content budget in 2021 could hit $17 billion. Based on three quarters of reported financials, analysts see that number tracking closer to $14 billion... But even at the low end, that would represent about 25% growth from 2020 levels. --------------------------------------------------------------- Recommended Links: [Four Gurus... Four Predictions... Four Ways to Get Rich]( On Tuesday, January 25, at 8 p.m. Eastern time, four living financial legends will take the stage for the first time ever... And they're going to reveal their biggest predictions for 2022 (as well as their No. 1 stocks). Don't miss it. [Click here to register today](. --------------------------------------------------------------- [This tech might already be in your home (and it could make people rich)]( For months, Whitney Tilson has been investigating a controversial new technology... one that might already be in your home. [He also reveals a surprising way this tech could make people rich in the coming months](. --------------------------------------------------------------- The big questions for Netflix are clear... While consensus seems to be that churn will be minimal to non-existent from these latest hikes, the price increase raises some bigger, longer-term questions... First, is subscriber growth pretty much over for the U.S. and Canada? I would say yes. With 74 million subscribers and roughly 60% household penetration, it's unclear that there are that many new subscribers left to sign up. Some households just aren't candidates to become customers, either because household income is too low or because of connectivity issues that prevent streaming. Also, the sharing of passwords reduces the addressable market. Second, with probably a billion-plus dollars from the hike likely to get directed to content spending, what will Netflix's production budget look like for 2022 and beyond... and how will that affect the competitive landscape? We'll find out tonight when Netflix reports where the 2021 spending level landed. Regardless of where it ends up, it should represent a healthy double-digit increase from 2020 spending levels. We might get early indications from management of what the 2022 content budget will be... My guess is that another year of double-digit growth will take us to the high teens. With media giant Disney (DIS), the No. 2 player in streaming, set to spend north of $20 billion on new movies and TV shows in 2022 – and north of $30 billion when you include sports rights – the battle for the best content shows no signs of slowing. The streaming wars aren't cooling down anytime soon. Finally, with subscriber growth in the home market potentially looking at a ceiling, future growth for Netflix will be heavily reliant on international regions, with Asia leading the way. The average revenue per user ("ARPU") in Asia is on average about one-third lower than it is in the U.S. Take a look at this summary from a Bank of America (BAC) report of where Netflix pricing stands around the world... Source: BofA Global Research The current price disparities make you wonder how quickly rates in developed Asian countries like Japan and South Korea – where prices trail the U.S. by about 20% – can come closer to parity. Also, while the trend in developed markets has been for price increases, those hikes haven't been as prevalent in emerging markets. In India, Netflix even made the rare move of slashing prices in the face of slow uptake. Putting it all together, there are lots of unknowns about Netflix's international growth trajectory. Not only is the pace of growth by region or country something U.S. investors need to guess at, but there's also a little mystery around the pricing power of Netflix in these newer markets. There's no doubt that Netflix is way ahead of the competition in every market, including these less mature ones. Netflix management always asserts that good storytelling is universal – and I tend to think the executives are right. And [Squid Game's global success]( last fall went a long way as an anecdote that proves the point. Netflix will almost undoubtedly be a global streaming winner, if not the winner... but we just don't know yet how profitable these markets will be. So what does this mean for the stock? NFLX shares have taken a tumble since late last year – they currently sit almost 25% below their mid-November all-time high... NFLX shares underperformed the S&P 500 Index substantially last year, up 11% to the index's 27% gain. Down about 13% so far this year, NFLX shares now sit around where they were at the end of 2020. Management had warned us that 2020 borrowed growth from 2021. Management was right, which is why NFLX shares had a tough 2021 after soaring 67% in 2020. I've been on the sidelines with NFLX shares primarily because of the tough comps and decelerating growth, but also because of the very full valuation coming into that slowing growth. With the big pullback, NFLX shares definitely look more interesting. I think the pullback was about 80% due to market forces... tech stocks and other high-growth, high-valuation names have gotten hammered. The rest of the move is more stock-specific: some analysts have warned that Netflix might miss its subscriber guidance when it reports tonight. I actually think the risk/reward is much better into this quarterly report than it has been in a long time, since expectations are muted and the stock has fallen so much. But even after the fall, NFLX shares aren't cheap at an enterprise value ("EV") to earnings before interest, taxes, depreciation, and amortization ("EBITDA") ratio of 35 times and price-to-earnings (P/E) ratio of 49 times. Netflix's recent earnings beats have all come from margins, not from sales growth. With growth shifting to international markets where there is less transparency on the margin trajectory, investors are paying a lot for a fuzzier outlook. A high valuation in the face of uncertainty keeps me on the sidelines with NFLX shares, despite thinking the bar has been lowered quite a bit from recent price action. Turning to the company – and not the stock – Netflix continues to make all the right moves and is the one in the streaming wars that everyone is trying to catch. On another note, tune in on January 25 at 8 p.m. Eastern time to hear from the whole Empire team about our outlook for 2022... Whitney, Enrique, Herb, and I will share our thoughts on the markets, the economy, inflation, and other hot topics to consider for successful investing in 2022. This will be the first time the four of us will have ever appeared on screen together... and it could be the biggest event we've ever hosted. The event is completely free to attend, but make sure to reserve a spot in advance... You can do so [right here](. In the mailbag, another letter about Peloton (PTON) in the wake of its announcement of a looming restructuring... Is there a price where you would have to rethink your Netflix subscription? How high is too high... $20... $25... $30? Would you ever go to the trouble of turning on the service when your favorite show drops new episodes and turning it off when you have finished them? At what price does turning it off and on become worth the trouble for you? Share your thoughts in an e-mail by clicking [here](mailto:feedback@empirefinancialresearch.com?subject=Feedback%20for%20Berna). "Hi Berna, Hahaha with the Peloton spoiler alert for And Just Like That. Trust me, nobody who reads your investing emails is ever planning to watch that show. The Sex and the City 15 minutes was over 15 years ago. "I am an avid Peloton user (5x/week) and made a handsome sum on the shares in 2020, when I bought shares a couple of weeks after getting my bike in early 2020. I sold late in 2020. I jumped back in on Friday after the sell-off. I suspect the sell-off was more related to the Mirror sales commentary on the Lululemon Athletica (LULU) call [than] the silly episode that was watched by maybe a couple hundred people max. Sure, social media exploded, but I seriously doubt many people actually watched or are planning to watch the show. This was clearly the case of a tired, old brand ("SATC") trying to be relevant by associating itself with the current, hip brand. The Peloton response over the weekend was great, and now everyone is talking about Peloton. "I am noticing so many more of my friends and colleagues buying Peloton bikes recently. The short lead time is helping them now (versus the long lead time hurting them previously). So while execution has been subpar by the management team, at least now they have inventory to deliver quickly. Virtually nobody churns off the bike, so this inventory situation will help them for the holiday season and beyond. "As an avid user, I am super frustrated with the pathetic product management team at Peloton. It literally took them eight years to add a (hidden?) pause button. I have hundreds of entry level software engineers on my team that could have added that in less than 10 minutes for recorded rides! The big 'innovation' of 2021 was hiring a bike instructor who speaks Spanish. Seriously? But the product is still awesome. The instructors are still the best. The people who ride regularly are in much better physical shape. The churn rate is negligible. New users love it once they get a few rides under their belt. "There are some easy and obvious things the management team can do to increase loyalty. For example, encourage (i.e., pay) the instructors to interact with users on social media. When Kendall Toole likes my tweet(s), I am on cloud 9 for days... and out of breath, 'cause I better show up for next ride! So easy to encourage and promote this to ensure the churn rate stays near 0. "Next, get a real product management team to add sticky features. I ride frequently with friends 100s of miles away. Add some cool, interactive features to increase competition among friends. I have so many ideas here, but won't share for now, but not hard to envision all the cool things that competitive friends could do while riding and racing together. Even adding a couple dollars' worth of hardware to the bikes would enhance future features immensely. At $2400 per bike, there is so much flexibility to be creative and add some Easter eggs for future expansion once they get some software engineers that know how to make stuff happen. "Anyway, I am once again long PTON shares. Product is awesome, management is clueless, and there's so much opportunity to improve the offering with very little investment once the management team gets their heads out of the sand. Keep up the great work Love your emails. Love shopping at Revolve (RVLV) and avoiding the mall too! Cheers." – Dennis F. Berna comment: Dennis, I agree with almost everything you wrote about Peloton. Management is screwing things up and tech innovation should be faster... And yet, the product is fantastic – leading to loyalty that is high and churn that is low. You're also right that social media interactions go a long way to personalizing and improving the customer experience. I'm still on the sidelines with PTON shares, mostly because of my issues with management. Also, I don't think the valuation makes it a screaming buy yet, especially given the growing risk of cultural issues, general disruption, and employee turnover with the restructuring in process. And today, there was a report out that Peloton is temporarily halting production of bikes and treadmills. This news sent PTON shares into a tailspin, down more than 20% in the last hour of trading. They are getting closer to where I might be interested in taking a shot, given all the things in the company's corner than you cite. But today's news is pretty bad... We knew Peloton was in a heavy inventory position, but it seems sales may have cooled off even more than the company guided to the last time we heard from management about it. Right now, PTON shares feel like a falling knife. While we agree on most things Peloton... I think you are extrapolating too much from your own lack of interest in And Just Like That. The show had the biggest debut, as measured by audience, of any new show that has aired on HBO Max. Its 24-hour views put it in the Top 10 of all movies and series to debut on HBO Max, and that of course includes big-budget movies like Dune, Wonder Woman 1984, and The Matrix Resurrections... plus returning hit series like Succession and Curb Your Enthusiasm. The Peloton placement definitely wasn't just a social media thing – millions of people saw that episode. But who knows... maybe all PR is good PR? Regards, Berna Barshay January 20, 2022 If someone forwarded you this e-mail and you would like to be added to my e-mail list to receive e-mails like this every weekday, simply [sign up here](. © 2022 Empire Financial Research. All rights reserved. Any reproduction, copying, or redistribution, in whole or in part, is prohibited without written permission from Empire Financial Research, 601 Lexington Ave., 20th Floor, New York, NY 10022 [www.empirefinancialresearch.com.]( You received this e-mail because you are subscribed to Empire Financial Daily. [Unsubscribe from all future e-mails](