Price Hikes Will Drive Netflix Stock Higher

Higher prices means more investment in original content

Already up over 35% year-to-date, Netflix (NASDAQ:NFLX) has a high chance of continuing its strong performance for the rest of the year. Even after raising its revolver commitments to $750 million.  Investors justify the high valuation for Netflix stock by pointing to streaming giant’s market share growths. And why not? The price paid for the stock is not a worry when the underlying company is still in its growth phase.

Netflix NFLX stock
Source: Netflix

Netflix amended its credit terms to increase its commitments to $750 million, up from $500 million. It also extended the maturity date to March 29, 2024. The extra two years will give the firm more flexibility in managing its debt obligations. Given the company’s thirst for acquiring content to grow its library, investors are welcoming the revisions.

The terms are that aggregate debt does not exceed $3.75 billion — up from $2.5 billion — and 2.75x consolidated EBITDA — up from 2.5x.

Price Hike

Back when Netflix was in the midst of pivoting from DVD rentals to online streaming some years back, it could not raise monthly rates. At the time, pricing was sensitive to demand elasticity. These days, customers are enjoying fresh, original content so much that they are unlikely to cancel their subscription when prices go up. On February 26, Piper Jaffray speculated that Netflix could raise prices internationally. By adding $1.00 to the monthly rate, Netflix could grow its revenue significantly — almost instantly.

Conservative investors may want to avoid assuming that a price hike in international markets is possible. In India, the $8 a month is already above that of cable service. Plus, India is among the top five countries for peer-driven piracy. I think in India, the best-case scenario for Netflix is that the higher rate will only offset the drop in subscribers.

Although this happened a while ago, Netflix’s price hike in Nov 2018 in Canada suggests that customers in developed countries will absorb the higher rates and will not cancel their service. Investors need to look at the company’s most recent fourth-quarter report to validate that view.

For the U.S. market, Netflix will impose a higher pricing plan on new members, while existing members will face higher prices over several months. Financially, the company will rake in the benefits gradually through the course of the year.

This is still a positive development for investors because ASP (average selling price) will improve over the course of 2019. As Netflix puts that added revenue to good use, better content and unique features like interactive shows will accelerate revenue growth and operating margin sequentially.

Fourth-Quarter Commentary

CEO Reed Hastings provided some color on the price hike strategy. He said that subscribers want incredible content and better product experience. To get that level of service, the company must ask for a bit more money so that it may invest in the product.

Investing in original film also changes the company’s economics. Netflix has to pay for content upfront, which requires more cash flow. But so far, the payback is higher. Bird Box is an example of a title validating the new economics of the business.

The company is so detailed in the way it targets its customers that it tailors the content to the geography. And in Korea, Japan, and India, tastes are more geographically specific, so Netflix needs to stream more unique shows in these regions. So I think, in the long run, raising prices to reinvest in content will pay off.

The Bottom Line for Netflix Stock

32 analysts covering Netflix have a $402.68 price target on the stock, according to Tipranks. Investors will have to decide if the implied 11.8% in upside is worth chasing at this time.

Cautious investors may select a number of number-crunching models to arrive at a downside target. These models assume that EBITDA multiples are too high. It also sets company value, with revenue, discounted back to present value, is not high enough to justify the current share price.

Subscription growth and new content will keep investors interested in NFLX stock. With higher ASP on the way, fundamentals are starting to back Netflix’s valuation, even though that is of secondary importance.

Disclosure: As of this writing, the author did not hold a position in any of the aforementioned securities.

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