Will Price Hikes Take A Huge Toll On Netflix Inc. User Growth?

  • Speculation is rife regarding customer loss that might result after Netflix implements its intended price hikes.
  • Some estimates point to as high as 15% churn for affected members.
  • How bad is the defection likely to be?

There is currently a lot of speculation amongst investment circles regarding the effects of Netflix, Inc.'s (NASDAQ:NFLX) planned subscription price increases. There are rampant fears partly based on speculations and partly based on recent surveys by analysts that we might witness a mass exodus of Netflix customers once the hikes are effected in a month’s time or so. Netflix plans to hike its monthly subscription from the current $7.99 and $8.99 for older customer who have been grandfathered, to $9.99. Netflix says that 37% of its U.S. subscribers have been grandfathered into the lower prices which means that ~17M are likely to be affected by the ‘‘ungrandfathering.’’

Here we are talking about 11%-25% price hikes, or 18% at the midpoint assuming the two camps are evenly split, making it a pretty steep increase. Netflix had earlier talked about the subject in a shareholder letter where it said it expects relatively modest churn due to the ungrandfathering. But what exactly is modest?

Wall Street has some interesting thoughts on the subject. Analysts at UBS have conducted a survey where 41% of respondents said they would cancel their subscription as a result of any price increase by Netflix. Now that would be a classic case of extreme price elasticity. If 41% subscribers cancel their plans ostensibly to defect to a rival service or otherwise, then that would represent a demand price elasticity of 2.28 which is extreme price elasticity by almost any yardstick. That scale of cancellation would be unprecedented at the company. Netflix has in the past raised its subscription fees by $1 and only witnessed minimal churn. And, $1 hike from $6 is bound to be more keenly felt than a $1 increase from $9 yet we have never witnessed cancellations on the scale predicted by the UBS survey.

Indeed, UBS predicts that it’s highly unlikely that Netflix subscriber cancellations will be anywhere near the degree suggested by the survey. The analysts have modeled their projections on cable TV where customer loss has been ongoing for years with Netflix, ironically, being the biggest beneficiary of cord-cutting. UBS observed that 68% of pay-TV respondents in similar surveys say that they would cancel their subscriptions if their service company increased prices even by a small margin. Yet pay-TV churn has remained less than 1% despite a 3%-5% price increase every year.

Netflix’s 18% increase is certainly steeper than the average pay-TV increase. But Netflix is still much cheaper than pay-TV based on the number of hours that customers use the service. Netflix typically costs $0.09 per hour of viewing, much cheaper than the $0.30 average by pay-TV services. UBS estimates that churn at Netflix attributable to the cancellation will be limited to just 3%-4% of affected subscribers, which works out to less than 1% of Netflix's total subscriber base. Netflix expects total U.S. subscriber additions to clock in at 903,000. The expected churn would therefore, lower this to about 400K net additions which is roughly in-line with Netflix’s guidance for 500K net additions for U.S. subscribers during the second quarter.

Not all analysts are so sanguine, however. One of these, JPMorgan, estimates that as many as 15% of affected subscribers (2.6M) might jump ship when Netflix implements the hike. This works out to about 3.2% of total Netflix subscribers. If this case plays out, then this will mark the first time that Netflix will record negative subscriber growth considering the company expects to add 2M subscribers in international markets. This appears like a rather unlikely outcome.

I believe UBS’ estimate is more in the ballpark, though I suspect customer attrition will actually come in lower than that. Even after factoring in the expected 3%-4% churn, Netflix would still realize a net gain of at least $300M on its top line after the price increases. But even more significant is the fact that Netflix’s free cash flow would receive a significant and much-needed boost. Netflix exited the last quarter with free cash flow of -$273M with trailing 12-month free cash flow approaching ­-$1B. The price increase could lower the cash outflow by as much as 30%.

Brian Wu Brian Wu   on Amigobulls :
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