Could AT&T's Purchase of Time Warner Crush Netflix?

When AT&T (T -0.43%) announced its plans to buy Time Warner (TWX), many people expected Netflix (NFLX -2.52%) -- a fierce opponent of Comcast's (CMCSA 0.15%) attempted purchase of Time Warner Cable -- to oppose the merger. After all, merging a major internet, wireless, and pay TV provider with a media powerhouse could hurt Netflix with all sorts of bundling strategies.

But during a recent Wall Street Journal Live conference, Netflix CEO Reed Hastings expressed surprising support for the deal, stating that AT&T's creation of a "national competitor to all of the cable companies" could actually "be in the consumer's interest."

Image source: Netflix.

However, Hastings emphasized that he would only support the deal if it didn't "give an unfair advantage to HBO" and that "Netflix's bits" and "HBO's bits" were treated equally across AT&T's networks. "The key thing is whether there is going to be net neutrality," Hastings stated, "which hasn't been AT&T's favorite topic."

But that could be wishful thinking on Hastings' part, since AT&T has repeatedly taken shots at Netflix long before the Time Warner deal was announced. Could buying Time Warner finally give AT&T the power to throttle Netflix's growth?

Why would AT&T take aim at Netflix?

Netflix relies heavily on fast and reliable internet connections to deliver its streaming videos to its customers. But the more the quality of those streaming videos improve, the more data they consume on telecom companies' networks.

To counter that growing data usage, which increases their expenses, telcos started capping home internet data plans and asking companies to sign "paid peering" deals for direct access to their networks. That move enables companies to sidestep the congestion on the regular networks, while partially subsidizing the higher data usage expenses. Netflix opposed those deals on grounds that they violated net neutrality, but nonetheless signed them with AT&T, Verizon (VZ 0.98%), and Comcast in 2014.

Over the following two years, those ISPs adopted additional strategies to throttle Netflix's growth and discourage cord cutters from reducing their pay TV revenues. Comcast introduced strict data caps for home internet use, but "zero-rated" (excluded from data consumption limits) data from its own streaming platform, Stream TV.

Image source: Netflix.

AT&T and Verizon both recently introduced "data free" mobile video, but only from its own sources (like DirecTV and AOL) or sponsored partners. Other companies had to pay AT&T to zero-rate their apps. Instead of paying that fee, Netflix reduced the quality of its videos on AT&T and Verizon's networks to 360p to help users remain under their data caps -- a move that "outraged" AT&T.

The upcoming war could be brutal

Based on AT&T's past actions, the company is clearly trying to bundle together its internet, wireless, and pay TV services into a single package to offset higher data transfer costs with more advertising on zero-rated streaming platforms.

It can continue offering unlimited data plans to convince users to sign up for its pay TV services, then toss in lucrative streaming services -- like HBO Now -- to sweeten the deal. It could also add so much new Time Warner content to U-verse TV and its DirecTV streaming platforms that customers might think twice before buying separate Netflix subscriptions.

In this upcoming war, AT&T will have the upper hand because it controls the internet infrastructure. Netflix doesn't have the resources or desire to build wireline or wireless networks of its own, and its paid peering deals with AT&T and other ISPs indicate that it's willing to pay the toll.

Netflix quarreled with Comcast for years over net neutrality, but finally reached a compromise earlier this year when Comcast agreed to put the Netflix app on its X1 set-top boxes. However, it's still unclear if using that app (still in a beta test) will count toward Comcast's monthly data caps. If AT&T closes its megamerger with Time Warner and bars Netflix from the new streaming version of DirecTV, Netflix might need to strike a similar deal with AT&T to reserve a spot on the platform.

But Netflix investors shouldn't panic

Netflix bears often claim that the telcos will eventually crush streaming services like Netflix with their massive bundled ecosystems. While that might happen, investors should note that Netflix has a huge first-mover's advantage in the space, explosive user growth, and well-received original content which can't be viewed on most other platforms.

Netflix's total paid memberships climbed 26% annually to 83.3 million last quarter, while its revenue rose 36% to $2.16 billion. Analysts expect Netflix's revenue to rise 30% this year, compared to 23% growth in 2015. 

As Netflix continues growing, ISPs that exclude Netflix from their data-free plans could lose business to smaller telcos. A war is certainly brewing between Netflix and the ISPs, but I doubt that Netflix will be easily crushed.