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Will the End of Free Trials and Higher Prices Hurt Tuesday's Netflix Earnings?

Streaming-video titan Netflix (NASDAQ: NFLX) rolled the end credits for its domestic free-trials program in October. Two weeks later, the company said that its monthly fees would rise for U.S. subscribers. Both of these changes took effect during the fourth-quarter reporting period. Should we Netflix investors expect disappointing subscriber-addition numbers when the company releases that report on Tuesday evening?

It's the end of free trials as we know them, and Netflix feels fine

Netflix bears have long argued that the company should do something about people taking undue advantage of the company's free trials. In theory, you could have waited for the premiere of some acclaimed title such as The Queen's Gambit or the next season of Stranger Things, sign up for a free trial with a different credit card and email address each time, and cancel the subscription as soon as you had consumed the desired new content. Wait a few months for the next big release: lather, rinse, repeat.

It was never clear exactly how much this hypothetical abuse might have hurt Netflix's financial results. I don't even know if it actually worked. But Netflix always took pride in its quick-and-easy cancellation process and the fact that people who abandon the service often come back for a second serving of paid subscription services.

Image source: Getty Images.

The company also hasn't reported free-trial figures since the third quarter of 2019. The last report with free-trial data showed that 3.9% of global members were using a free trial at the time, down from 4.7% a year earlier. The data may be useful for internal planning, but the metric wasn't a reliable sign of sustained business growth. In fact, the company has learned some interesting lessons from canceling free-trial programs on a market-by-market basis.

"We are learning that no free trial may result in greater revenue in some markets," CEO Reed Hastings wrote in the third-quarter report of 2018.

With this history in mind, it's fair to say that investors should have expected the free-trial program to end at some point. I don't expect this move to result in higher revenue right away, but I also don't think the company will miss free trials in the long run. I expect management to spend a few seconds on this topic in the earnings call, and that's it. No big deal.

Fight the pricing power

The higher monthly fees will be easier to read. Netflix reports a couple of useful data points for this one:

  • The regional breakdown of each quarter's shareholder letter shows the average revenue per user (ARPU) in each of Netflix's four reportable segments. The price hike should drive this figure significantly higher in the UCAN region (short for U.S. and Canada). In the third-quarter report, ARPU stood at $13.40 per subscriber per month in the UCAN region, a 2% year-over-year increase.
  • Each letter also provides a graphical presentation of week-by-week subscriber additions. The COVID-19 lockdowns of the spring boosted Netflix's weekly additions dramatically, followed by a slower pace in the summer and fall. Critics might argue that higher prices would inspire a rush of canceled subscriptions, which would start near the announcement in late October and the actual increase in fees for existing customers in November and December.

Image source: Netflix.

Analyst firm Cowen doesn't expect the combination of higher prices and no free trials to hurt Netflix's fourth-quarter subscriber additions in the slightest. In an earnings preview two weeks ago, Cowen analyst John Blackledge said that his surveys of 2,500 American consumers pointed to surprisingly strong additions in this report, with plenty of room for further price hikes down the road.

Where do we go now?

Netflix shares have gained 47% over the last 52 weeks, but most of that was in the first half of 2020. Today, the stock is trading almost exactly where it was six months ago.

The concerns that are holding the stock back from further gains appear to be overblown. Tuesday's report stands a good chance of exceeding Wall Street's expectations and kicking off another solid share-price jump. Netflix's incredible growth story is far from over.

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Anders Bylund owns shares of Netflix. The Motley Fool owns shares of and recommends Netflix. The Motley Fool has a disclosure policy.


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