Please ensure Javascript is enabled for purposes of website accessibility

Netflix Just Showed a Big Sign of Strength in North America

By Adam Levy – Oct 14, 2020 at 9:30AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

It could mean better-than-expected subscriber additions through the end of the year.

Canadians will have to pay just a little more to stream the new season of The Crown this fall. Netflix (NFLX -0.27%) is raising prices on some of its plans in Canada.

The decision to raise prices is a clear sign of strength for the streaming leader, which has warned investors it expects a stark slowdown in subscriber additions in the back half of the year after a surge in new sign-ups during COVID lockdowns.

The reception desk at an office with the Netflix logo on the wall.

The reception desk at a Netflix office. Image source: Netflix.

A price increase may indicate strong subscriber growth

Six months ago, during the company's first-quarter earnings call, Chief Product Officer Greg Peters told investors, "At this point, we're not even thinking about price increases." While that tone changed back to Netflix's usual rhetoric about price in the second quarter, a price increase still appeared to be unlikely in 2020.

The company's decision to raise its pricing in Canada is indicative of strong subscriber metrics in the third quarter. 

Netflix was expecting to add 2.5 million global subscribers last quarter, which would be a significant drop from the 6.77 million it added in the third quarter last year. But with the number of subscriber additions in the first and second quarters, Netflix investors are prepared for much lower quarterly net addition numbers for a while.

Peters noted the company looks at metrics like engagement and churn to determine when it's demonstrated an increase in value. And when it sees that increase in value, management says, "Hey, it might be time to go back to them and ask them for a little bit more."

So, if Netflix wants to see strong engagement and lower churn before it raises prices, then it probably saw those factors in the third quarter. That suggests Netflix's net subscriber addition might be closer to last year's number than its original outlook.

The rest of the world might not be too far behind

Netflix last raised prices in Canada about two years ago. That price increase was quickly followed by price hikes in the U.S. and U.K. in the early months of 2019. That suggests Canada may be a testing ground for Netflix to determine current price sensitivity in markets similar to its more valuable markets before rolling out broader price increases. (Netflix has about 1/10 the number of subscribers in Canada as it does in the U.S.)

If Netflix continues to see strong engagement, low churn, and continued sign-ups in Canada, the U.S. and other markets might not be too far behind. While several analysts thought a price increase in most of Netflix's markets was a strong possibility in the near future, early next year is earlier than anyone previously anticipated.

One indication that management is confident in its ability to raise prices sooner rather than later will be its fourth-quarter subscriber addition outlook. If management expects the trend from the third quarter to fourth quarter to look similar or better than last year (about a 30% quarter-over-quarter increase in subscriber additions), it's a good indication that it's already seeing a return to normal subscriber growth and it can enact another price hike in bigger markets.

Increasing prices could add $500 million to $1 billion in incremental revenue per year, according to Jefferies analyst Brent Thill. That would accelerate Netflix's path to break-even free cash flow, which is a major milestone for Netflix investors.

Investors in the FAANG stock might get some additional insight into Netflix's price increase decision in Canada and what it means for other markets with Netflix's earnings release next week. More likely, though, Netflix will stick to its boilerplate rhetoric about increasing price when it increases value. We'll have to pay close attention to what its outlook for subscribers and possibly free cash flow looks like to get a better idea of Netflix's plans for future price increases.

Adam Levy has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Netflix. The Motley Fool has a disclosure policy.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.