For years I have been tooting the bull horn for Netflix (NASDAQ:NFLX), but recently, my view of the company's future has become so foggy that I wouldn't feel comfortable owning any number of its shares.
New costs have appeared called Internet Service Providers Interconnection Fees and they may wreak havoc on Netflix' future ability to generate profit.
On March 20, 2014 Reed Hastings posted an article to Netflix' U.S. and Canada blog titled "Internet Tolls & The Case For Strong Net Neutrality" in which he outlined the fees Internet service providers such as Comcast and AT&T are demanding for improved interconnectivity for Netflix. From the article, investors can conclude a few things:
1. The CEO of Netflix, Reed Hastings, is clearly concerned about "net neutrality" and the fees that Netflix may pay in the future for better quality streaming.
2. Netflix will continue to reluctantly pay large ISP's to ensure high quality member experiences.
AT&T (NYSE:T) quickly responded to Reed's post through its Public Policy Blog. Jim Cicconi pointed out the fallacies of Reed's blog post. From AT&T's article, investors can conclude the following:
1. Jim Cicconi believes that Netflix should pay for the costs associated with the increased Internet usage caused by its streaming service rather than the Internet service providers and ultimately Internet users as a whole.
2. Jim believes that Hastings' proposition is arrogant and ignorant of how the telecommunications industry functions.
My view on how this will affect Netflix AT&T & Comcast
In my opinion, Jim Cicconi's case is more logical. The recent strain on Internet service providers and lowered quality of Netflix' streaming content for certain subscribers has been caused by increased Netflix viewership. If it weren't for Netflix, it is likely that Internet service providers would have fewer costs. In a sense, Netflix believes that the Internet service providers should pass their increased costs on to their subscribers rather than Netflix. This does not seem fair as many Internet service subscribers do not use Netflix and would be indirectly paying for Netflix viewership if Reed Hastings had his way.
Currently, it is anticipated that the Federal Communications Commission will continue granting companies such as AT&T and Comcast the ability to charge companies such as Netflix and Amazon for offering them quality streaming ability. If the FCC continues supporting this activity, a few things will happen to Netflix.
1. Netflix will continue paying fees to Internet service providers to maintain the viewing quality for its customers.
2. Either Netflix' shareholders will feel this cost through lowered margins, or Netflix will pass this new cost on to its subscribers in the form of increased subscription fees, which could cause subscribers to cancel their current plan and/or deter new people from subscribing. Regardless of which route Netflix management chooses, it appears these new costs will hurt Netflix shareholders.
These things will probably negatively affect investors' outlook on Netflix. Until recently, ISP interconnection fees didn't exist. Netflix quality was high because the total viewership hadn't yet strained ISP's ability to stream its content. Now that Netflix'sviewership has reached such a massive size, ISP's are forced to "drive more fiber into their networks to create the capacity necessary to deliver those services to consumers" (from Jim Cicconi's blog post) and will pass on these increased expenses to their source: Netflix.
The ramifications of ISP interconnection fees could be monumental for Netflix. Internet service providers have virtually complete control over how much they charge the Company and from the sounds of it, Netflix' viewers are pushing Internet service providers to their capacity limit and if Netflix' subscriber base continues growing, it is likely that to meet this demand Internet service providers will have to continually increase their capacity to deliver satisfactory service to Netflix subscribers—to me this sounds very expensive.
Internet service providers fees will probably be negative for Netflix and positive for large Internet service providers such as AT&T and Comcast (NASDAQ:CMCSA). Not only will these new fees serve as a stream of revenue for ISP's, they may also serve as a tool to control the streaming content market. Although currently it seems unlikely, it's worth noting that if ISP's are able to drive Netflix out of business (or at least cause some Netflix subscribers to jump ship), companies like Comcast will probably enjoy a higher viewership as ex-Netflix subscribers search for new ways to watch TV shows and movies.
I have been a Netflix bull for years. But because of this new ISP interconnection fee I am no longer bullish on Netflix. I'm not entirely sure what the future will look like for the company; maybe it will work out a deal with Internet service providers that will be mutually beneficial, maybe not. But, right now, there is way too much up in the air and purchasing Netflix stock without a decent understanding of how high ISP interconnection fees will be in the future would be completely reckless. I recommend staying away from this stock until the fog lifts and we have a better idea of what Netflix' future costs will look like.
Michael Nielsen has no position in any stocks mentioned. The Motley Fool recommends Netflix. The Motley Fool owns shares of 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.