Wall Street is cheering Netflix because it still sees the service as a bargain

Key Points
  • Netflix is raising its U.S. prices by 13 percent to 18 percent.
  • Shares soared more than 6 percent on the news.
  • The gain suggests that investors still believe Netflix offers a great service for the price.
Netflix just raised prices — Three experts debate what it means for the stock
Netflix just raised prices — Three experts debate what it means for the stock

Investors are cheering Netflix's decision to raise prices, suggesting they view the streaming service as so beloved by consumers that they'll willingly pay more for it.

Netflix is raising the cost of its most popular U.S. plan by $2 per month to $12.99 from $10.99. The ability to raise prices without significant subscriber churn is core to the company's financial model, which has always subsisted on a thin profit margin.

Netflix burned through a record $859 million in cash in the third quarter and there's no indication the company will be less aggressive going forward. Content spending is expected to rise in 2019 from the $8 billion Netflix shelled out in 2018.

Netflix, with an enterprise value of about $157 billion, trades for around 92 times earnings before interest, tax, depreciation and amortization. That dwarfs the trading multiples of Disney (13), Viacom (7.5), and AMC Networks (7.7), as investors bet Netflix has plenty of growth and market share gains ahead relative to traditional media companies.

It's also still an inexpensive entertainment option, said Rich Greenfield, an analyst at BTIG who has a "buy" rating on Netflix. HBO charges about $15 per month for its streaming service and the average cost of traditional pay-TV tops $100 per month.

"Whether it's a movie ticket, HBO or ESPN as part of the cable bundle, the price-value that Netflix offers is compelling," Greenfield said, in an interview.

Disney charges about $9 to a cable company like Charter for each subscriber that gets ESPN, Greenfield said. Nearly a million subscribers cut the cord on their pay-TV carriers in the third quarter of 2018, limiting the pricing power of traditional media companies.

Netflix will use the extra cash from the price increase to "make even more stuff," Greenfield said, rather than pay off debt or "fix its free cash flow." That should soften the blow for the 58 million U.S. subscribers who get Netflix and may demand consistent quality and quantity if they're going to spend more money.

A boon for earnings?

Greenfield suspects Netflix is announcing a price increase two days before earnings because CEO Reed Hastings and other executives will want to discuss the motivation to charge more without distracting from the company's performance. The last time Netflix announced a price increase, in October 2017, was also just days before earnings, he noted. Netflix then reported global streaming net additions of 5.3 million, topping guidance of 4.3 million.

Goldman Sachs analysts expect Netflix to report fourth-quarter results "well above" the company's forecast for both domestic and international subscriber additions. They predict Netflix will add at least 2 million domestic subscribers and 8.4 million international users, ahead of guidance of 1.8 million for the U.S. and 7.6 million international.

Mark Mahaney, an analyst at RBC Capital Markets, said this is the fourth time Netflix has increased its pricing, and he remains bullish, with a $450 price target, well above the current price of $356.

"There's no real cheaper alternative," Mahaney told CNBC. "Hulu is still 25 percent more expensive for a comparable plan. Even Amazon as a standalone Prime subscription service, Netflix just brought its prices up to match that."

Watch: Netflix 'flexing its pricing muscles' with price hike, says analyst

Netflix 'flexing its pricing muscles' with price hike, says analyst
Netflix 'flexing its pricing muscles' with price hike, says analyst