Netflix Does a Bad Deal With Verizon

After Comcast, Netflix deals with Verizon to improve viewing performance.

Alex Dumortier
Alex Dumortier, CFA
Apr 29, 2014 at 10:15AM

Stocks are slightly higher in morning trading as the Federal Reserve begins its two-day April monetary policy meeting. The benchmark S&P 500 and the narrower Dow Jones Industrial Average (DJINDICES:^DJI) were up 0.32% and 0.40%, respectively, at 10:15 a.m. EDT. As always, financial journalists and analysts will parse the tea leaves of the Fed's statement tomorrow, but expect the central bank to continue on its now-standard course of ratcheting down securities purchases by another $10 billion per month.

In this morning's company-specific news, Netflix (NASDAQ:NFLX) has reached an agreement with Verizon (NYSE:VZ) to improve the viewing experience for its customers. Meanwhile, another Internet service provider, Comcast (NASDAQ:CMCSA), will divest 3.9 million customers in a $20 billion deal with Carter Communications in order to obtain regulatory approval for a larger, strategic deal: Comcast's proposed $41 billion tie-up with Time Warner Cable -- a deal that Netflix publicly opposes.

Streaming television and movie provider Netflix has agreed to pay Verizon an interconnection fee in order to speed up performance for its users; the deal is similar to the agreement it put together with Comcast in February. In both cases, terms were not disclosed publicly, but the latter deal is already paying off -- for Netflix's customers, at any rate. According to The Wall Street Journal, "the company's own traffic data showed a sharp performance jump for Comcast subscribers after the two networks reached a deal."

Netflix is an enormous source of Internet use, representing as much as 30% of peak residential traffic; as such, the company is locked into a debate over who ought to pay for the infrastructure required to handle that traffic to ensure it meets broadband speed standards. In a blog post from March 20, Netflix CEO Reed Hastings argued that the requests for video data emanate from users who are already paying handsomely for their broadband Internet service, so cost sharing makes no sense for Netflix without the other side of the coin: revenue sharing. Netflix opposes the interconnection fees it is now paying, but feels it has no choice in order to ensure its customers enjoy a high-quality service.

As such, Netflix opposes Comcast's proposed acquisition of Time Warner Cable. Hastings took the opportunity to highlight that opposition in his quarterly letter to Netflix shareholders on April 21:

The Internet faces a long term threat from the largest ISPs driving up profits for themselves and costs for everyone else as detailed in our recent blog post.

If the Comcast and Time Warner Cable merger is approved, the combined company's footprint will pass over 60 percent1 of U.S. broadband households, after the proposed divestiture, with most of those homes having Comcast as the only option for truly high-speed broadband (>10Mbps). As DSL fades in favor of cable Internet, Comcast could control high-speed broadband to the majority of American homes. Comcast is already dominant enough to be able to capture unprecedented fees from transit providers and services such as Netflix. The combined company would possess even more anticompetitive leverage to charge arbitrary interconnection tolls for access to their customers. For this reason, Netflix opposes this merger.

I tend to agree with Hastings here (full disclosure: As a customer of both Comcast for broadband Internet access and Netflix, I find the former service barely tolerable, while I'm delighted with the latter). I think Comcast's offer to divest 3.9 million users ought not to influence regulators as they review the tie-up with Time Warner Cable -- it's insignificant.