Netflix Earnings Illustrate Why Price Hikes Are Imperative For NFLX Stock

- July 19, 2016

 

With Netflix’s (NASDAQ:NFLX) valuation near all-time highs in November 2015, I went on the record saying NFLX stock is gearing up for another epic collapse. And when I say “epic” I am referring to the 2011-like crash that saw 3/4 of Netflix stock wiped out.

nflx stock chart

With NFLX stock down 34% from its 52-week high, it certainly seems I am on the right path. Furthermore, Netflix earnings illustrate a much bigger issue that I first noticed and unveiled in that November article. It is this issue that explains why Netflix stock is still overpriced for long-term investors, and why a $40 billion peak market capitalization is about all Netflix is worth.

Netflix earnings not good for NFLX stock

What Netflix earnings illustrate is that competition is becoming more fierce. In years past Netflix had a huge lead on any other company that wanted to compete in the OTT market. Then, even when Showtime, HBO, CBS (NYSE:CBS), Nickelodeon, Verizon (NYSE:VZ), Dish Network (NYSE:DISH) and Comcast (NYSE:CMCSA) launched competing services, it took time for those companies to penetrate the Netflix’s network.

In fact, none of these competing service providers are yet on Netflix’s level, besides maybe HBO. Yet collectively, they are big problems for Netflix stock. That said, we saw firsthand in Netflix earnings that the market is tightening up very fast. Netflix had just 160,000 net adds for the U.S., 1.52 million overseas. Just three months ago Netflix had guided for 500,000 net U.S. adds and 2-million international.

Therefore, it is getting harder to find new subscribers. What’s most alarming is that there is no end in sight. Fact is that competition is only increasing and the price for new content is getting more expensive. As a result, Netflix earnings guidance for 2.3 million new subscribers in the coming quarter is also well below expectations for 3.5 million adds.

Netflix stock: change the narrative

Source: CBC News

Source: CBC News

Albeit, Netflix has 47 million U.S. subscribers. eMarketer confirms that more than one-third of the U.S. population consumes Netflix via shared accounts and such. That does not leave a lot of upside when you consider how many OTT options are now available. As a result, it is increasingly imperative that Netflix changes the narrative associated with NFLX stock.

Netflix stock can no longer be tied to its total number of subscribers. If that’s what drives NFLX stock, then investors are doomed. The company must start increasing prices, which are currently an industry-low.

If the average sub pays $10/month, an increase to $13 would grow Netflix’s U.S. revenue by 30%! Importantly, $13 is not a high price to pay for Netflix’s content, and should be a very easy move to make. By keeping growth robust, NFLX can become less about subscriber gains and more about price hikes, where it clearly has more room to wiggle.

What worries me for long-term investors is that Netflix does not seem to realize this fact. The company even blamed its poor subscriber performance on the “sensitivity of consumers” to reports of rate hikes. While I do not believe this to be true, and believe the reason for poor performance is tied to a near mature U.S. market, the company should not put that idea into the heads of investors. After all, price hikes is the only thing that saves NFLX stock long-term.

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All things considered, I do think that Netflix stock is doomed long-term. I don’t think there is anyway to avoid this obvious conclusion. However, I also expect NFLX stock to fully recover its losses by the end of this year, and potentially retest old highs or create new highs as its Walt Disney (NYSE:DIS) partnership goes into effect.

That may seem hard to comprehend, but in September Netflix will become the exclusive U.S. subscription television service for Disney. A lot of people forget about this deal because it was signed back in 2012! However, it means that Netflix will have rights to all those blockbuster films from Marvel, Star Wars, and Pixar.

Disney dominates the box office

Its market share has risen from 15% in 2014 to 31.4% so far in 2016. The success is due to Disney’s success with titles like Zootopia, Jungle Book, Captain America: Civil War, and Finding Dory.

Source: recknews.com

Source: recknews.com

Not to mention, that share might actually rise by the end of year. Disney has new films Doctor Strange, Moana, and Rogue One that could all be blockbusters. Then, you look ahead to 2017 and Disney is releasing Beauty and the Beast, Guardians of the Galaxy Vol. 2, Thor: Ragnarok, a Black Panther film and the next sequel of Star Wars.

These are all going to be huge at the box office, and Netflix will have rights to all of them! It is a catalyst that investors have seemingly forgotten. However, it could be key to letting Netflix raise prices in a significant way without risking the loss of subscribers. After all, I think most would pay $13-$15/month to add each year’s biggest box office films to their library of video content.

Why wouldn’t they? It’s not like all the billions of dollars that Netflix has spent on content, or the dozens of original films and series in production will be eliminated once Disney comes onboard. No, Disney is an added bonus. It’s just something extra, and it might very well be the difference in whether Netflix can increase prices or not, and whether it can find another 5-10 million U.S. subscribers or not.

Hence, Netflix stock is not a good long-term investment. It’s just too expensive. But over the next 12-months, those who buy at $85 or below will be greatly rewarded.

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