After last week’s initial response to the new pricing plan it seems every Netflix (NFLX) subscriber was ready to riot in the streets. Is it really that bad? No. The response wasn’t that surprising because nobody is ever going to be happy about being charged a higher price for the same service. As well, we feel the situation has been overblown and don’t believe Netflix will be materially affected despite the initial backlash. Why you ask? Netflix offers a service that almost guarantees instant gratification, is still extremely cheap in absolute terms, and has a die-hard fan base that isn’t going to shatter over something like this.
Now we understand Netflix isn’t perfect but it’s hard to say it doesn’t offer something much better than what used to be around. Not to mention the firm is constantly attempting to offer better service and keep customers happy in a variety of ways. So even though Netflix subscribers aren’t in jubilee over a price increase, we doubt they’re flying over to the competitor Coinstar/Redbox (CSTR) by default. We rate Netflix a buy because of its monopoly power, spectacular service, and a customer’s willingness to pay because it’s still a cheap entertainment subscription fee.
Feel the Power of the Empire
Netflix dominates the rental and streaming video space without question, in our view. The firm has generated strong economies of scale and now enjoys sizable barriers to entry that include licensing agreements and patent technology. This isn’t something that can be easily duplicated.
The firm has created an economic moat and it’s now ready to show the power of the empire. Don’t think so? Well consider the fact that it literally applied price discrimination to its customer base. No firm would attempt this unless it had a dominant position in the market and felt it could implement this successfully. Subscribers may not like the power that the firm now wields but from an investment perspective it’s spectacular.
Great Service Sells Itself
Now some people are going to disagree with us in this article so here is a reminder of what the world was like before Netflix arrived. A typical Blockbuster experience was like going on a blind date in that it was either going to turn out great or be horrible. First off you are spending money on gas with no real idea if the movie you want is even there. Not to mention you are taking personal time out of your day, which we consider a valuable commodity. Then you are hoping that the movie you want to see has been released because you really don’t want to rent anything else. Finally, right before you walk into the store your praying to the gods in your head that Blockbuster wasn’t stingy this time and ordered more than five copies of an extremely popular new movie. Yes this was the pre-Netflix world and it sucked. This is just a reminder of how stressful and unpleasant just attempting to rent a movie you wanted to see could be. Blockbuster was archaic at best and there really shouldn’t be much surprise why Netflix ran the former rental king into the ground without even lifting much of finger.
The point is that if Netflix didn’t offer great service then it wouldn’t have sent Blockbuster into Chapter 11 so quickly. Do you even remember seeing many ads for Netflix when it first came out? We sure don’t. Yet its business went viral literally by word of mouth because it was so great. Beyond Netflix and Google (GOOG) we don’t know many profitable multi-billion-dollar firms that have been able to grow exponentially through word of mouth. This right here is what makes this firm unique.
Subscribers Love Netflix
Netflix subscribers are die-hard fans of the service. They’re about as passionate as Apple (AAPL) buying consumers relative to the pleasure derived from the service. For this reason we don’t think that the price hike will materially affect the firm’s subscription base. As well, the overall cost of the service is something that people in our view are unlikely to cut even if they needed to reduce spending. This stems from the fact that the most expensive service comes out to $.53 a day. Given what’s offered if that isn’t a value deal we don’t know what is.
Call to Action
Normally we wouldn’t give a firm like Netflix a "buy" rating because of the high forward price multiple valuation. Fortunately for the firm we think it’s one of the few out there that has structurally changed society and breaks the rules. Given Netflix’s sustained top and bottom line growth combined with opportunities abroad we feel this firm has plenty of upside potential left. But we wouldn’t bet the farm.