Netflix (NASDAQ:NFLX) raised the price for U.S. and Canadian subscribers last month, adding an extra $1 or $2 to most subscribers' monthly bills. When Netflix last raised prices, early last year, it saw its first quarter of subscriber losses since the Qwikster fiasco in 2011. Investors are hoping the company can avoid a similar fate in the fourth quarter.
Things are even more difficult for Netflix this time
There are several factors working against Netflix in the fourth quarter that could lead to subscriber losses in the U.S. and Canada (UCAN) region.
First of all, there are a lot more big name competitors. Walt Disney (NYSE:DIS), Comcast's NBCUniversal, and AT&T's (NYSE:T) WarnerMedia are all competing for viewers with premium video. That also means their content is leaving Netflix in quick order, something that was just starting in early 2019. What's more, consumers have shown a growing interest in the improving selection of ad-supported video services.
The increased competition in the space, most of which is still priced well below Netflix's standard plan, could put pressure on the company to attract new subscribers and retain its existing viewers.
A second factor is the pull forward of subscribers in the first half of 2020 amid the outbreak of the COVID-19 pandemic. In the first two quarters of the year, Netflix added nearly 26 million subscribers globally, about 5.25 million in the U.S. and Canada. It managed to eke out another 2.2 million in the third quarter.
Over the last four years, Netflix has added new subscribers in the high-20-million range. In other words, it did in three quarters this year what has taken four quarters in previous years. That could result in higher subscriber churn over the next year as some subscribers may have signed up as a replacement for out-of-home entertainment.
Prior to Netflix's U.S. price hike (but after the Canadian price increase), management guided for a net addition of 6 million global subscribers in the fourth quarter. That's less than 70% of its net additions from the fourth quarter last year. If the UCAN region produces a similar ratio to last year -- which may be generous considering it's showing signs of saturation -- it'll add about 377,000 new subscribers in the region. But with over 73 million subscribers, an increase in churn of just 0.5 percentage points over the quarter will completely wipe out those net additions.
Why now's the right time for Netflix to raise prices
Despite the headwinds Netflix faces, there's a big factor that should keep subscriber churn at bay in the fourth quarter: Netflix's value relative to most competitors has increased in 2020.
COVID-19 forced the entire industry to shut down productions in the spring and summer, forcing many media companies, including Netflix's competitors, to delay new television seasons and feature films. Media giant Disney has managed through its meager original content slate over the summer by releasing several films originally slated for theaters through Disney+. Meanwhile, HBO Max and Peacock launched without major titles or flagship content.
Additionally, cord-cutting has accelerated amid the pandemic as both sports and entertainment content dried up. AT&T CEO John Stankey thinks it'll get worse in the second half of the year across the industry. What's more, he sees a lot more room for pay-TV subscriber losses in the long term.
Meanwhile, Netflix's 2020 content calendar remained mostly undisrupted, and it's continued to put out lots of fresh originals month after month. That's led to sustained strong engagement through the third quarter, as management noted in its shareholder letter.
As COVID-19 hits what some scientists are calling a third wave in the United States and colder weather sets in, that means a lot more time spent indoors at home. That's Netflix time. So, the impact of the price increase could be muted compared to last year.
Ultimately, it comes down to Wall Street's expectations for Netflix's subscriber additions. When Netflix underperformed expectations in the third quarter, investors sent shares plummeting.
When Netflix announced the price increase in the U.S., the market sent shares 5% higher, indicating expectations that additional subscriber revenue will more than offset a small short-term uptick in churn. But if the price hike causes Netflix to miss analysts' subscriber growth expectations in the fourth quarter, it could produce a buying opportunity for investors with a long-term mindset.