Do You Need to Worry About the Netflix-Comcast Deal?

Does the Netflix-Comcast agreement affect net neutrality? And what does it mean for investors in Netflix?

Feb 25, 2014 at 6:30PM


Source: Comcast.

Netflix (NASDAQ:NFLX) and Comcast have recently announced an agreement by which Netflix will now pay Comcast (NASDAQ:CMCSA) an undisclosed sum of money for direct access to its network. Not only that, but Netflix is also reportedly in conversations with Verizon (NYSE:VZ) and AT&T (NYSE:T) regarding similar agreements. How does this affect net neutrality? And what does it mean for Netflix investors?

Skipping the intermediaries
According to some estimates, Netflix accounts for more than 30% of all peak downstream Internet traffic in the U.S. With a user base of nearly 34 million U.S. subscribers and rapidly growing, Netflix has understandably generated some stress on the system, and streaming quality has been negatively affected lately.

Under the new agreement, Netflix and Comcast will be eliminating the middlemen, in this case Cogent Communications (NASDAQ:CCOI), to establish "a more direct connection between Netflix and Comcast, similar to other networks, that's already delivering an even better user experience to consumers, while also allowing for future growth in Netflix traffic," according to the press release. 

Lowell McAdam, CEO of Verizon Communications, said in an interview with CNBC on Monday that Verizon and Netflix have been in conversations for more than a year over a similar agreement. According to Engadget, AT&T has confirmed it is also working on a more direct connection with Netflix, so the recently announced deal with Comcast is probably the first of many.  

This is not about net neutrality
Net neutrality is a hot issue lately, and many seem to be concerned about what this new announcement means in that respect. However, this deal is not about net neutrality.

Net neutrality is about Internet service providers treating all Internet data equally, which means refraining from blocking, discriminating, or charging extra fees to different content, sites, or applications, for example. Net neutrality refers mostly to traffic traveling over a provider's last mile into consumer homes.

Commercial interconnect relationships, or paid peering agreements, on the other hand, relate to the level at which different networks interconnect and how traffic is interchanged -- they are about content companies' networks and the edge of broadband access networks. In fact, big industry players like Google, Microsoft, and Facebook have traditionally engaged in this kind of agreement, and this has never raised much controversy on the net neutrality front.

Someone needs to pay for growing connectivity needs, and it may as well be the companies making a lot of money online and accounting for a big chunk of traffic. Eliminating the intermediaries tends to generate economic efficiencies, so consumers could actually benefit from these agreements in the medium term.

Implications for Netflix
Economic terms of the agreement have not been disclosed, so it's hard to measure the direct financial impact for different companies involved. Comcast and other Internet service providers will likely be the major beneficiaries from a more direct relationship with Netflix, while intermediaries like Cogent look like the biggest losers from this kind of agreement.

As for Netflix, some analysts are saying that costs could stay at similar levels, or even fall as the company will no longer have to pay Cogent Communications. It's worth noting that the deal was announced while Comcast is in the midst of its fusion with Time Warner, so perhaps the online streaming company had an advantage in the negotiations, as Comcast may not want to raise concerns from regulators regarding the company's market share and dominant competitive position.

Besides, it's not all about costs for Netflix: Service quality is much more important as the company still has many years of growth ahead of it, so the priority should be making sure that customers get access to a high-quality streaming experience in order for Netflix to capitalize on its long-term opportunities for growth.

From a financial point of view, variables like subscriber growth and content costs will probably have a much larger impact for Netflix than operating costs in the years ahead.

Bottom line
The new deal between Netflix and Comcast is not related to net neutrality. If anything, consumers will likely benefit by receiving better service for a similar price. In addition, regardless of short-term cost considerations, Netflix is doing the right thing by focusing on customer experience. From the perspective of both consumers and investors in Netflix, this deal looks more like a positive development than a reason for concern.

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Andrés Cardenal owns shares of Google and Netflix. The Motley Fool recommends Facebook, Google, and Netflix. The Motley Fool owns shares of Facebook, Google, Microsoft, and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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