Netflix Is Spending its Price Hike, Are Investors Set up for a Fall?

Netflix is launching a new series that may be as expensive as House of Cards. Will this level of increased expense shock investors on the next earnings call in July?

May 31, 2014 at 1:00PM

Netflix (NASDAQ:NFLX) isn't wasting any time in spending the revenue from its recently announced price hikes. According to the Hollywood Reporter, Netflix is close to a deal with Sony Pictures Television for a TV series titled "The Crown", based on the weekly audiences given by Queen Elizabeth II to prime ministers. This is another shot in the arms race between Netflix and Amazon (NASDAQ:AMZN), while Google (NASDAQ:GOOGL) has embraced a different strategy.  Are investors ready to see all of the revenue increase from the price hike disappear before falling through to the bottom line?

The Crown's budget blows away that of House of Cards
If the Guardian is correct , this new venture will cost Netflix £100 million, more than the initial cost of House of Cards. Like House of Cards, the company will base this on a tested platform in Europe, Peter Morgan's play "The Audience".  Possibly because of the likelihood of success, Netflix had to compete against the BBC and ITV for the rights and this could partly account for the high price.

This high price isn't holding back other high-priced production ventures. The Baltimore Sun recently announced that an open casting call had taken place for "DC types" to play various roles in the third season of House of Cards. It looks like the third season is going ahead as planned for a February 2015 release date.

Increased revenue won't flow through to profits but do investors realize that?
Both the CEO and CFO have been vocal about saying that the bulk of the price increase would go toward improving the company's content library and video quality rather than increasing its profits. Reed Hastings addressed the issue on the most recent earnings call by saying "if we want to continue to expand to do more great original content, we have to eventually increase prices a little bit". CFO David Wells addressed the profit question more directly, reminding analysts that "we said before that mostly it is going to be toward content".

However, the stock price increase hints that investors' expectations have increased since the earnings call. After the company reported good results in its announcement, the stock jumped up 8% overnight but then gave back all of its gains as investors realized that the dramatic price increase did not lead to a dramatic increase in profitability. However, after the shares found solid support at $315, their price has increased 28% in less than a month.

New international markets should bolster revenue growth
Today Netflix serves more than 40 countries and will be expanding in Europe later this year. This expansion may be crucial to maintaining a growth rate that has been supported by dramatic international growth.  In the most recent quarter, international revenue almost doubled with new service areas in France, Germany, Austria, Switzerland, Belgium, and Luxembourg.  

Amazon is digging deep into its pockets to compete
Amazon recently bulked up its streaming-content library by partnering with HBO to offer shows like the Sopranos, the Wire, and Six Feet Underbut the company is developing its own content for both adults and children and this has forced Netflix to compete in the content arms race. Google, on the other hand, offers subscription channels but has not embraced original programming. The first real attempt began last year with Youtube Nation, which didn't take off, but may be reinvigorated through a partnership with DreamWorks.  This is an attempt by DreamWorks to extend its video platform beyond the movie business and may represent a new direction for Youtube, which has preferred to fund its partners' channels instead of funding its own content. 

It's no surprise for investors that competition in the streaming-video subscription business is increasing.  However, it may not be fully understood that Netflix's increase in revenue will not flow through of the price increase  to bottom line earnings per share.  Investors need to be wary of expectations getting ahead of themselves.

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David Eller has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, DreamWorks Animation, Google (A shares), Google (C shares), and Netflix. The Motley Fool owns shares of Amazon.com, Google (A shares), Google (C shares), 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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