Netflix Building Sign

Photo: Netflix.

Shares of Netflix (NASDAQ:NFLX) fell more than 7% on Wednesday. The content-censorship challenge from Indonesian regulators suddenly got real, as Telekomunikasi Indonesia (NYSE:TLK), the nation's largest Internet service provider, decided to block the streaming-video service.

Netflix must have seen this coming -- at least in general principle. And I'm sure that the company will work out its differences with Indonesian market forces well before Telkom's block makes any real difference to Netflix's success (or lack thereof) in Indonesia.

What's going on?
According to the Wall Street Journal and Indonesian news outlet Uzone, Telekomunikasi took its cue directly from government regulators.

"We're blocking Netflix because it did not have permission and contains content that is not allowed," said Telkom's director of consumer affairs, Rachmawan Dian. "Our state-owned enterprises should be an example, and we should uphold the country's sovereignty of the Republic of Indonesia in business."

Dian pointed out that Netflix works together with many business operators in other countries, and should cooperate with Indonesian businesses, as well. "If cooperating with local operators, many benefits can be gained from both sides," Dian said.

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The error facing some Indonesian Netflix customers right now: "Site not found -- The site you visited is not currently active or a typo."

In particular, Telkom would be willing to filter out offensive content from the Netflix catalog, streaming a heavily scrubbed version to Indonesian consumers. Again, this is in line with government comments. Dian also pointed to long-established regulations for traditional film and TV content, which must pass review by Indonesia's censor board before facing consumers.

"Netflix will be encompassed by the terms of our regulations because there are interests of society that must be protected, especially in terms of content," said communications and information minister Rudiantara in a recent statement.

For now, it's a war of words.

Netflix argues that the existing regulations were written specifically for TV and cinema, and should not apply to the brand-new medium of Internet streaming. Rudiantara doesn't seem terribly keen on enforcing these rules, noting that unhappy Telkom customers can still use competing Internet services to reach the Indonesian Netflix catalog.

It's easy to see why Rudiantara is treading lightly. The Netflix service offers a landmark test of Indonesia's content regulations, as it will in dozens of strictly monitored markets around the world. Whatever bar the censor board sets here will also apply to local media start-ups and incumbents, as well as other foreign incursions. It's a fine line to walk, with many ways to get it all wrong. This could take a while.

Of course, Telkom is more than just a bandwidth pipe. The company also runs Indonesia's largest cell-phone network, along with video-on-demand service UseeTV. Netflix is a direct threat to some of Telkom's own operations.

We have seen this situation before, and it's not always pretty. But in the end, there's a good chance that Telkom -- and similar dominant service providers in other markets -- will come to appreciate the way Netflix motivates broadband customers to pay up for faster and more-stable connections.

How badly does Netflix need Telkom Indonesia?
In the meantime, it's not like Telkom Indonesia is cutting Netflix off by the ankles. The service only just launched in Indonesia and some 130 other brand-new markets, and there aren't a whole lot of proper broadband subscribers there to begin with. Recent estimates point to not much more than 3 million fixed broadband connections in Indonesia, a nation with 255 million citizens. Fast Internet connections aren't a mainstream thing here, yet.

That gives Netflix some time to adjust its catalog, while negotiating with censors and broadband providers. In a nation with strict limits on sex and violence in public media, it would be easy to remove MA-rated shockers like Netflix original series Narcos from the local content list. The company would have to figure out exactly where to draw the line -- will A Clockwork Orange make the cut, or might The Shawshank Redemption be even too much?

Netflix has hammered out specific maturity-ratings scales for many individual countries, including most of its pre-January territories. The ratings in Canada are different from the ones in Denmark, separate from the broad brush applied across Latin America, and hardly even familiar to consumers in Taiwan. But I find it telling that Indonesia doesn't have its own scale yet. Instead, this service falls under Netflix's ultra-simplified "Rest of World" category, which looks like this:

Nflx Rest Of World Maturity Ratings

Source: Netflix.

The future market potential in Indonesia is certainly large enough to qualify for a custom-tailored maturity-ratings system. By 2020, Telkom Indonesia projects reaching some 30 million households with high-speed fixed-broadband services. By 2025, Indonesia's government hopes to have 100-megabit connections in virtually every household. By then, Netflix-style video services will be everywhere, and Netflix itself would love to own a large slice of that market opportunity.

What's next?
Netflix will work out its friction with Indonesian regulators. Because this is one of the earliest big-ticket tests, the spit-shined agreements and scrubbed content catalog could become a template for other markets to follow. But there's no rush to get all of this done overnight, so Telkom's block may remain for a while. Certainly weeks, maybe months -- but I'd be shocked to see this roadblock still in place when 2017 rolls around.

In the meantime, I would have loved picking up some additional Netflix shares on the cheap as the market overreacted to this not-too-terrible Indonesian tidbit. But our Foolish disclosure rules stayed my hand, because I keep talking about Netflix for the benefit of you, dear reader. And on Thursday, share prices had already recovered more than half of what was lost on Wednesday.

I'll just wait for the next big drop, and hope that I can hold my tongue long enough to make a move -- because this stock is going places, with or without Indonesia's immediate help.

Anders Bylund owns shares of Netflix. The Motley Fool owns shares of and recommends Netflix. The Motley Fool also recommends Telkom Indonesia. Try any of our Foolish newsletter services free for 30 days.

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