On April 21, Netflix (NASDAQ:NFLX) released its earnings report for the first quarter of its 2014 fiscal year. In it, the company announced that AT&T (NYSE:T), one of the nation's largest broadband providers, has been surprisingly slow in delivering fast, quality Internet video to subscribers. It just so happened that prior to Netflix's earnings release, AT&T announced plans to ramp up its efforts to bring ultra-fast broadband speeds to as many as 100 municipalities in the United States. Moving forward, what do Netflix's attack and AT&T's plan mean for investors?
Netflix is trying to lure in AT&T
In its earnings release, Netflix announced that AT&T had one of the worst speeds of any of the major broadband providers.
As the table above shows, AT&T's fiber-based U-verse ranked number 12 out of the 16 largest ISPs in terms of speed during the month of March. Even worse was the company's DSL service, which clocked in at number 14. These same services ranked 52nd and 57th, respectively, when Netflix pitted them against the 60 fastest providers in its areas of operation. This news is particularly interesting when investors consider that AT&T is currently the second-largest broadband provider in the U.S. and it has an approximately 20% market share there.
In an attempt to resolve the issue, Netflix suggested that AT&T could provide higher speeds to customers who use the streaming service by interconnecting directly with Netflix. This would not cost AT&T anything and it would simultaneously improve its customer experience, which seems like a win-win, but AT&T would miss out on potential profits.
Netflix is playing a risky game
You see, AT&T could decide not to accept Netflix's invitation and it could instead charge the popular streaming service for faster connection speeds. Comcast (NASDAQ:CMCSA), the largest broadband provider in the country, recently employed this strategy. This strategy would like increase AT&T's return on equity which, in 2013, came in at 20%, far higher than Comcast's 13.4%.
After it received negative feedback from its members who used Comcast, Netflix approached the company and negotiated terms for faster speeds. This ultimately led the companies to enter into an agreement whereby Netflix would pay an unspecified amount to Comcast in exchange for preferential broadband treatment.
While this move by Netflix and Comcast appears to benefit both parties, Netflix has since framed Comcast as a company that does not care about a "fair" Internet. Instead, it branded Comcast as an oligopolistic enterprise that is taking advantage of a new court finding on net neutrality to milk streaming services like Netflix for as much money as possible.
Now AT&T, the second-largest provider in the industry, may have the same ability to strike a lucrative deal with Netflix. In addition to granting Netflix the faster speeds it wants, the transaction would grant AT&T an extra revenue stream. By implementing its plan to increase its ultra-fast network, management will likely have even more power at the negotiating table than it would have had in the past.
Based on the data provided, it's clear that AT&T's performance is anything but great. Although it is the second-largest broadband provider, the company is nowhere near the top when it comes to speeds and this could be troublesome if it continues. Management made a smart move to expand the company's high-speed network to correct this, but in many areas which this plan does not cover the issue of slow Netflix speeds will likely persist.
If AT&T is interested in solving its problems quickly, it could very easily take up Netflix's offer to interconnect through the company's systems but this scenario seems rather unlikely. Admittedly, the free help from Netflix sounds appealing, but AT&T's management team is probably more interested in striking the kind of contract with Netflix that Comcast did. For the Foolish investor, this could mean that AT&T might provide an attractive long-term opportunity if its management does proceed with that route, while Netflix might be stuck, once again, between a rock and a hard place.
Daniel Jones 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.