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by Elliot Turner

Well that was fast. On Monday Netflix (NASDAQ: NFLX) announced it would be offering a streaming only plan for $7.99 while raising the price on all existing dvd-by-mail plans by $1, and the execution was instant. Just as the change to users was instant, so too was the positive impact on the company’s shares. Shares of Netflix soared $15.28 or 8.83% on the news.

New streaming option on Netflix.

I already went onto my account in order to change from the 2 DVD plan to the “Watch Instantly Unlimited” option. I used to watch the occasional DVD here and there, but since Netflix beefed up its streaming offering in the last few years, my use of the by mail function became ever more intermittent. I’ve now had the same two DVDs sitting on my desk for a six whole months.

It helped when I gained the ability to stream content directly to my HDTV via my Playstation. Surely my usage habits benefited Netflix bottom line margins, as I paid the premium price for multiple DVDs and the company accrued little variable expense by way of me mailing and receiving DVDs. Now I finally have the reason I was looking for to officially change my plan.

The fact that people can just subscribe on a streaming basis is yet another crucial pivot on the company’s path. Netflix CEO Reed Hastings clearly had some foresight in naming the company Netflix. While the company always incorporated the Internet in how people requested their movies by mail, the connection to the “net” has consistently evolved over time to the point where it’s now a service in and of itself. What makes this particular pivot that much more significant is that it comes at a time when the move is completely demand driven.

In the company’s latest earnings release we learned a few important pieces of new information [Click here for Earnings Call Transcript]:

  • The Netflix subscriber base grew 52% year-over-year.
  • 66% of subscribers streamed some video content during the past quarter.
  • Cost per acquisition (the price the company spends to bring in each new sub) dropped 18% during the quarter.
  • The churn rate (rate at which subs leave Netflix) dropped from 4.4% to 3.81% year-over-year.

Taken together, these points paint a clear narrative as to what exactly is going on at Netflix. The growth and stability in subscribership has now reached a tipping point where people basically have to have it. How else can you explain the drop in cost per acquisition? People don’t have to be sold on subscribing to Netflix today like they did not too long ago, they simply need to see and hear from their peers what Netflix has to offer and then they’re hooked. I knew something big was happening when my parents and their friends started talking about the latest cool movie they saw on Netflix streaming.

This latest move is the next step in broadening the company’s appeal, and that’s exactly why the stock price went up so much. Streaming only opens the door to a whole slew of new customers who had either held off because they have no interest in DVDs, or who never really had exposure to just how legitimate a new entertainment option the service is. Netflix has done an outstanding job of strategically reinvesting the proceeds from its rapid growth into enhancing the quality of its service, having taken the streaming option from fairly slim pickings to a substantial library of entertainment in the past year. In the process, the company has built a serious moat against competition through expanding to more content, building a substantial distribution system, and nurturing a growing and satisfied subscriber base.

This week on Fast Money the panel debated whether “Netflix is at a top.” What’s amusing about that discussion is it can only happen about a stock that’s actually making highs (i.e. you can keep raising the question so long as it keeps going up, and Fast Money surely obliges). Not too long ago, Amazon (NASDAQ: AMZN) publicly quipped as to how hard building a streaming service would be and since that time it’s only become more difficult, not less. This leads to a crucial point: when analyzing Netflix, the company has to be viewed in a slightly different context than your typical stock.

People have questioned the company’s ascent from early on, citing facts as archaic as postage rates, but what we all need to remember is that Netflix is a dynamic money-maker meets profitable startup that continues to refine its product and make more money. That is why the company deserves its premium valuation. There will be ups and downs on the way, but this is a company that has a vision and is growing into it.

Disclosure: Long NFLX

Source: Why Netflix Deserves Its Premium Valuation