Yes, Netflix Can Increase Prices Further

Video streaming giant Netflix  has recently (and finally) decided to up its monthly subscription price by $1. Current subscribers need not fret, however: the company is portraying an Amazon-like focus on customers and will grandfather in existing subscribers for a full two years.

Despite the modest increase, Netflix's high-quality video streaming service remains a very cheap and compelling offer for consumers. In addition, the company's growing reputation as an original content producer will enable Netflix to add many more subscribers and enact an even bigger price increase several years down the road and still stay very competitive with other premium TV names like HBO of Time Warner  and Amazon .

Small price hike
Netflix will direct its price hike at newer customers in the U.S. and a number of international markets in which the company operates. Netflix ended the last quarter with more than 48.3 million subscribers across the globe, and the company will not enforce a price hike on these customers for a whole two years. 

As a result, a small fraction of the company's customers will see heightened prices and most consumers who use Netflix will not see major effects from this for a long time. Based on the company's guidance for the second quarter of 2014, Netflix should add 500,000 subscribers in the U.S. and 940,000 subscribers across all of its international markets. 

Netflix will be upping the price from $7.99/month to $8.99/month for new subscribers in the U.S, and the company's subscribers in the UK and Europe will also see similar price hikes denominated in pounds and euros as well. The company continues to add many new movies and TV shows for its subscribers, and will be able to fund even more original content for its growing subscriber base. 

Immense pricing power
Netflix is a vastly different company from what it was in 2011. That year,the company saw its stock price fall from $300 to the low $50s. At that time, Netflix was mostly a streaming and DVD company with commodity content licensed from various content creators like Time Warner, CBS, and AMC Networks, etc.

However, the company has more than doubled its subscriber base from 21.4 million to more than 48 million members worldwide, and now it also offers a lot of exclusive content and is increasingly adding high-quality original shows like House of Cards and Orange Is The New Black, etc. Also, some of these shows got lots of praise from critics and won a number of awards as well. 

With such high-quality content, Netflix can raise its prices even more as the company's high-quality originals are far better than those available from its Internet TV rivals -- Hulu and Amazon Prime. Amazon recently struck a deal with HBO to add old catalog content as well as future shows three years after they debut on HBO for an estimated $300 million per year. However, most of that content will be familiar to consumers by the time it is available for Amazon's 20 million subscribers. So the content is not fully exclusive unlike the originals developed by Netflix.

HBO and Cinemax have a combined subscriber base of more than 43 million in the U.S. but the premium channel is an add-on to basic cable packages at a price point of $15+/month. Also, Amazon's original content hasn't been half as popular as the original content developed by Netflix. So Netflix can easily hike the price to $9.99/month a few years down the road.

For most consumers, a $1 price hike is not really a big deal either. However, the company's earnings profile will see dramatic improvements due to the current price hike when existing subscribers see the price increase in their bills two years from now.

Earnings growth ahead
In the last quarter, Netflix's gross margin stood at 31.6%, which was the highest level in nine quarters for the company. So the company's big investments in developing platforms in Europe and other territories are aiding its margin improvement, and should scale up even more down the road. 

Investors in Netflix will welcome the price increase with both arms as analysts had long expected it to raise prices. As a result, the company's earnings should see stellar growth. Analysts' estimates call for earnings per share of $4.20 for 2014, which is a big jump from Netflix's 2013 EPS of $1.85. 

Going forward
As the company's international segment starts starts to contribute more meaningfully to the bottom line in the next few quarters, Netflix's EPS could likely continue to see big double-digit increases. The company will still retain a lot of pricing leverage as it is investing heavily in adding high-quality originals to its library. The big drop in the company's stock price in 2014 as part of the pullback in tech stocks has created a very attractive risk/reward situation for Netflix investors and definitely warrants closer inspection. As always, Foolish investors should do their own research before making any investment decisions. 

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Ishfaque Faruk owns shares of Netflix. The Motley Fool recommends and Netflix. The Motley Fool owns shares of and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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