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Netflix price increase feeds pre-earnings bulls

As Netflix Inc. prepares to report earnings on Jan. 17, a price increase for its U.S. streaming subscribers is expected to drive up revenue and help the company pay for its expanded content budget in 2019 despite a potential short-term increase in churn.

The Jan. 15 announcement of a $1 to $2 price increase on Netflix's various streaming plans sent the stock up 6.5% for that day, adding to 2019 gains for a company that has outperformed the S&P 500 and its FAANG technology stock peers, despite recent market volatility. Netflix shares were up 32.5% year-to-date as of market close Jan. 15, compared to a 4.1% gain for the S&P 500 and a 5.9% gain for the tech-heavy Nasdaq. The announcement-day gain of 6.5% was roughly in line with gains on the days when Netflix announced price increases for new U.S. streaming customers in 2017 and 2015, according to data from Kensho Technologies Inc.

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In various research notes immediately after the Jan. 15 price increase announcements, several analysts predicted that the move would up Netflix's revenue with limited negative impact on customer additions. While Netflix has rarely missed its guidance for quarterly subscriber additions in the U.S., some of its biggest misses followed the implementation of price hikes, including in the second quarter of 2016. At the time, executives acknowledged that the roll out of price hikes announced in October 2015 on older customers was creating more churn in the quarter.

Even so, most analysts remained bullish on Netflix following the latest price hike announcement. Piper Jaffray analyst Michael Olson, for example, said the firm's survey data indicated that customers are willing to pay over $15 for the service. Following the latest price increase, Netflix's most expensive streaming plan, which includes 4K Ultra HD resolution and allows for multiple streams at once, costs $15.99. The standard plan, which can stream on fewer devices simultaneously and includes only HD resolution, costs $12.99. Prices for both plans went up by $2 per month.

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Olson maintained a $430 one-year price target on Netflix following the price increase announcement, implying upside over 20% of its Jan. 15 closing price of $354.64. That target is based partly on an expected fourth-quarter subscriber beat. Olson said search-term tracking used to measure demand for the service indicated subscriber additions would be well above consensus estimates domestically for the fourth quarter.

International subscriber growth has been yielding the largest subscriber gains since the company expanded globally in early 2016, but domestic memberships generally drive the highest average revenue per user, or ARPU. The company exceeded its third-quarter 2018 membership guidance largely on international subscriber additions.

"While any price increase, particularly one this significant, is likely to be met with increased churn, we believe the value Netflix offers to subscribers and the strong content slate in the year ahead will largely offset that," Goldman Sachs analyst Heath Terry said in a Jan. 15 note. He raised his price target to $420 after the price increase, up from $400.

Netflix expects to end 2018 with about $8 billion in content spend, largely driven by debt financing. The company closed the third quarter of 2018 with $8.34 billion in total debt against revenue of about $4 billion. Heading into 2019, analysts expect Netflix to face a set of tougher conditions than in 2018 as it looks to balance funding growth with rising interest rates on its debt, increasingly volatile market conditions and increased competition from an expanding array of streaming video providers.

Wedbush Securities analyst Michael Pachter cited this balancing act of putting new profits against a "ballooning content budget" as reason for moderated long-term expectations. While the price increases will increase ARPU in the U.S., Pachter noted that they also mean that Netflix will be competing head-to-head with now lower-cost services from Hulu LLC and Inc., potentially impacting net additions in the already maturing U.S. market.

However, the analyst said he expects Netflix to report a membership beat when its releases numbers Jan. 17 for the fourth quarter of 2018. The quarter should see a subscriber boost from new content such as the hit original film "Bird Box," Pachter said.

SunTrust Robinson Humphrey analyst Matthew Thornton said he viewed the price increase as an overall positive despite potential near-term subscriber churn. The potential ARPU upside "is potentially, and only partially, offset by lower near-term subscriber adds," he said, adding that he sees the price hike as a sign of Netflix executives' "confidence in the content slate and subscriber trajectory in 2019."

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