Why Netflix Still Bears Substantial Risks For Shareholders

| About: Netflix, Inc. (NFLX)

Netflix (NASDAQ:NFLX) is down over 25% from its peak reached on July 13 ($298.73). Shares remain at risk of ongoing selling pressure. Insider selling totaled $1.089M for the week of August 22.

When Netflix provided a too-good-to-be-true unlimited plan that included both unlimited streaming and DVDs by mail, its total subscriber count grew to over 20 million.

A high price multiple for Netflix was previously justified when strong consumer acquisitions grew unabated, due to an abnormally low pricing structure. When the price structure changed, investors continued to question the ability for Netflix to keep growing its customer base.

The rate increase was justified by Netflix on its blog. Instead of calling it for what it is (a 60% price increase), the company described the change as “giv(ing) our members a choice” and “provid(ing) great value to our current and future DVDs by mail members.”

This drastic price increase will result in a decrease in subscriber count (though offset by growth in other countries). Netflix appears willing to reduce the count:

“As always, our members can easily choose to change or cancel their unlimited streaming plan, unlimited DVD plan, or both by visiting Your Account.”

The price change was not thought-out. Netflix could have justified the price increase if:

  • The plan offered its entire collection available for streaming. The current streaming offers many titles consumers would not want. By doing so, Netflix would show it is offering true value to its customer. The price increase appears only to be helping the bottom line.
  • Subscriber growth came from consumers during a period of economic downturn, at a time when cable TV rates are too expensive. The percentage increase will sticker-shock consumers, result in a large initial drop in subscribers, and putting into question the forward 32.3x multiple in the share price.
  • Price increase is too drastic. $16 a month is a 60% increase. A moderate price increase to $12 or $13 for both streaming and DVD would be passed easily to consumers.
  • Netflix product is demand elastic. Amazon Instant (NASDAQ:AMZN), Redbox, and Hulu offer consumers equivalent alternatives.
  • Offering an incentive to have both services would reduce subscriber loss.

Netflix is hoping that its expansion in the emerging markets will support the past rate of customer acquisition. Rightfully so, investors are not willing assign a high premium, because there is a risk that this expansion will be successful and will put pressure on margins. Until Netflix reveals the impact on customer loss in North America in its next earnings report, shares will remain under intense selling pressure.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.