Netflix Hikes Prices, Coinstar Cashes In

By Matt Cavallaro | July 14, 2011 AAA

Netflix, Inc. (Nasdaq:NFLX) customers are not happy about the movie rental service's decision to raise subscription pricing plans. Investors in Redbox operator Coinstar, Inc. (Nasdaq:CSTR) should be.

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Netflix Gambles on Higher Pricing
On July 12, Netflix made several changes to its movie rental pricing plan. Here's a rundown of the changes:

  • Unlimited streaming-only plans will be separated from combo packages and will still run $7.99 a month.
  • 1 DVD rental plans will cost $7.99 a month.
  • Customers who want both unlimited streaming and the 1 DVD rental package will now pay a total of $15.98 a month.
  • The new policy is implemented immediately for new customers, and becomes effective September 1 for existing members.

Obviously, Netflix is assuming higher subscription revenues will more than offset churn rate. The timing of the pricing change, however, is something of a head-scratcher. The price hike simply accelerates the process of transitioning entirely to digital distribution. Yet it's not as if rising digital distribution costs, which do represent a concern, are eating away at profits. Earnings per share grew 88% last quarter as 3.6 million new subscribers were added.

Netflix' streaming plan, while very popular, does suffer from a relatively stale library compared with all of the titles available on DVD. Despite the limited movie selection and bandwidth caps from internet service providers plus slow connections, streaming has proved to be extremely popular. The new pricing plan will result in customer attrition, especially if the entire Netflix library is not offered for streaming service in the foreseeable future.

There may be investor attrition as well with valuation becoming a concern. Netflix breached $300 per share after announcing plans to expand online streaming-video service to Latin America and the Caribbean. International expansion is the key to long-term revenue growth for Netflix, but near-term margins will shrink based on Netflix's 2011 Q2 international loss guidance of between $50 million and $70 million, which includes setting up the foreign service.

Movie Rental Competitors Will Benefit
The big question is: what will existing Netflix subscribers do? Will they cancel their streaming-only plan, cancel the DVD only plan, pony up the $15.98 for both, select a different Netflix package, or quit Netflix altogether?

One thing is fairly certain; some Netflix subscribers will jump ship. Blockbuster's (PINK:BLOAQ) demise proved that movie rental demand is not inelastic.

Streaming content beneficiaries of the Netflix price hike will be, Inc. (Nasdaq:AMZN) and Hulu, a joint venture of Comcast Corporation (Nasdaq:CMCSA), General Electric Company (NYSE:GE), News Corporation (Nasdaq:NWS) and The Walt Disney Company (NYSE:DIS).

The biggest winner, however, is most likely Coinstar. While Coinstar has been able to carve out market share, Netflix is winning the war. Each Redbox features a somewhat limited library and the availability of kiosks restricts exposure. Also, Coinstar is taking a big gamble by transitioning away from physical locations and launching their own streaming service to compete with Netflix. Now, Netflix will experience a percentage of churn from the many cash-strapped consumers who are already faced with an option of paying more for convenience and a bigger Netflix library, or renting extremely cheap DVDs from Redbox. The Netflix price hike makes Redbox's pricing advantage much more attractive.

The Bottom Line
Netflix is still a long-term buy, and a good percentage of churn will be offset by higher subscription revenues. The price hike also comes at a time where Netflix is working to rein in costs from movie studios that are trying to charge higher rates for access to streaming content. In the meantime, Coinstar should be able to pick up more loose change from impending customer attrition.

Coinstar has already gained close to 8% in the aftermath and still trades at a comparably low price-to-earnings multiple of 27 (compared with Netflix trading at a multiple of 86). Look for a price target near the 52-week high at $67.56 as the Coinstar momentum trade continues.

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