Netflix (NFLX) is hiking prices by $1 to $9.99 for new U.S., Canadian and Latin American customers. As a result, Netflix stock has soared higher as research firms react — for instance, Pacific Crest upping its price target from $122 to $140 — due to the effects of the increase in Netflix prices.
However, with a near $50 billion valuation, Netflix prices will have to rise much more if Netflix stock is going to create long-term shareholder value.
Otherwise, Netflix stock is priced for perfection as is.
Netflix Prices Rising Slowly but Surely
Netflix’s latest $1 price hike in core regions marks the second such hike in as many years. The company has been strategically raising prices in recent memory, not too much, but at a steady pace.
Back in August Netflix increased prices in Europe. The services went from $10 to $11, and in Switzerland prices jumped all the way from $13.20 to $15.20. So far, Netflix stock hasn’t seen any backlash from these moves, unlike in 2011, when Netflix stock price saw about three-fourths of its value wiped out after it split DVD and streaming ops, thereby causing a higher price.
Nevertheless, these little $1 and $2 price hikes are great, but if Netflix is going to ever support a $50 billion valuation, then prices need to go significantly higher. Furthermore, Netflix needs to hike prices fast, as it is much harder to hike prices for existing customers than new customers.
Why the Need to Hike Netflix Prices Quickly?
At the end of Netflix’s second quarter, it had 65.55 million subscribers — 42.3 million were in the U.S. and the rest were global subscribers. To no one’s surprise, Netflix’s biggest growth opportunity is its global division, where NFLX expects to add 2.4 million new subs in the third quarter.
However, in NFLX’s recent letter to investors in early October, it already noted international sub growth of 2.4 million since Q2, meaning it is well ahead of expectations.
Nonetheless, subscriber growth isn’t the issue, but rather charging a service price that will lead to profitability and support its near $50 billion valuation. Even if we use a bullish long-term forecast, like Nomura Securities’ outlook for 152 million peak subscribers, it is going to be very hard for fundamentals to support a $50 billion valuation. Right now, Netflix stock is very much speculative, but as growth slows and profits become expected, fundamentals will be taken more seriously.
That said, if we assume an average global service price of $9.99 per month and figure peak subscribers of 152 million, Netflix’s annual revenue could top $18 billion. That means that Netflix trades at 2.7 times peak revenue right now, a fairly high stock multiple for a media/technology company.
With NFLX’s content costs soaring — expected to top $5 billion next year — and essentially all of NFLX’s operating profit coming from a dwindling DVD rental business, NFLX must raise prices to drive both revenue and profit growth long-term.
U.S. Is Key for Netflix Stock
All things considered, international markets may represent NFLX’s biggest opportunity to find new subscribers, but the U.S. is still where Netflix stock has the greatest shot to drive profit and revenue growth. That’s because Netflix prices of even $9.99 per month are still far lower than pay-TV packages, which can range from $50 to more than $100 per month. Even competing services from HBO and DISH Network‘s (DISH) Sling TV charge more than $9.99 per month.
Thus, NFLX should and likely could up prices $15 to $20 in the U.S. without much backlash.
However, in countries like China and India, which are huge market opportunities, cable prices are well-known for being cheap, around $10 per month. And in Europe, cable prices are about half of what we pay in the U.S. Therefore, it is going to be hard for NFLX to hike prices significantly in international markets, whereas it can in the U.S.
The big question is, will it.
So while Netflix stock is a favorite of investors right now, sooner or later year-over-year growth will begin to slow, and as content costs soar, NFLX must prove that the streaming business model can be profitable.
Over the next five or so years, these are natural questions that will be raised, and hopefully, NFLX responds with higher prices, especially in the U.S.
If so, Netflix stock can continue its current trajectory, but if not, don’t expect high returns long-term.
As of this writing, Brian Nichols did not own stock in any of the aforementioned companies.
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