When President Barack Obama gives the State of the Union speech tonight, he will likely address many different topics. Net neutrality could be one of those topics—perhaps. A district court recently struck down net neutrality, which basically means that we could see the whole landscape of the Internet in the U.S. start to change. Companies may use their deep pockets to reserve sizeable bandwidths to provide their services to consumers, and that’s just the tip of the iceberg. At the end of the day though, consumers could be the ones paying more, in one way or another.
There is a long list of possible implications due to the ruling against it. Unfortunately, however, these implications may take investors and consumers by surprise, as many don’t really understand what this phrase really means. Even lawmakers and regulators may not be aware of the full reality of what has happened.
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What is net neutrality?
Net neutrality is basically the idea that governments and Internet service providers should give equal treatment to all kinds of data over the Internet. In other words, there should be no discrimination based on how much money is being paid for access, differences in types of users (like consumer versus business), the type of content, the site, apps, equipment used, etc.
Proponents of net neutrality believe that ISPs want to control the Internet pipeline, eliminate competition and make connectivity artificially scarce in order to force consumers to buy their more expensive packages. Some opponents, however, say ISPs don’t have any plans to do this, in spite of one case (according to Wikipedia), in which Comcast Corporation (NASDAQ:CMCSA) was reported to have purposely slowed down peer-to-peer communications.
Other opponents think it would be beneficial to discriminate against Internet traffic in some cases, particularly to guarantee quality of certain types of service. One example of this might be Netflix, Inc. (NASDAQ:NFLX), which relies heavily on the Internet to provide quality video services to subscribers. If the connection is horrible, then people won’t subscribe, so Netflix is very dependent on the quality of Internet service available to consumers, as it accounts for about a third of all Internet traffic.
Examining net neutrality from an investor standpoint
So as an investor, what does net neutrality mean for you? Of course it depends entirely on which company you’re investing in. Goldman Sachs analysts looked at the entire picture in terms of the Telco, CommTech and Internet industries. They see the net neutrality ruling as a positive for the telecom industry because it enables distributors to tier their services and charge more for higher quality internet. However, they see an increased risk of oversight becoming more stringent.
For the CommTech industry, they see it as a long-term positive because telco or cable operators could become incentivized to develop more services which can generate more revenue. In terms of the Internet industry, they see no impact for now, since they say many large Internet companies, including Netflix, Inc. (NASDAQ:NFLX) have already built out their own infrastructure to improve delivery and hedge against changes in net neutrality.
How Netflix, Google could be affected by net neutrality
Netflix, Inc. (NASDAQ:NFLX) addressed the subject of net neutrality in its recent letter to shareholders. Like analysts at Goldman Sachs, they’re not too worried about the issue. The company notes that Verizon Communications Inc (NYSE:VZ) could have been trying to get it to pay more fees to stop the potential degradation of its services. Management said if this happens with any ISP, they would “vigorously protest and encourage” their subscribers to “demand the open Internet they are paying their ISP to deliver.” They see this scenario as being unlikely though because it’s pretty unfriendly to consumers.
Wedbush analysts, however, think Netflix, Inc. (NASDAQ:NFLX) isn’t taking the net neutrality issue seriously enough. They think ISPs to be more motivated by profits than anything else, which means they will try to pull out as much value as possible from every place they can. They think Netflix users will end up being throttled by ISPs unless they pay extra for delivery. The result could be Netflix having to pay more or subscribers having to pay more, or both.
Google Inc (NASDAQ:GOOG)’s YouTube, which makes up about one-fifth of Internet traffic, could be affected in the same way Netflix would be, as could Hulu, Amazon and other streaming video providers. This means that somewhere along the way, someone could end up paying for what was previously free—if the industry moves in this direction and the ruling doesn’t end up getting reversed.
Google Fiber could “protect economics”
In a recent report, Morgan Stanley analyst Scott Devitt and his team addressed concerns that Google Inc (NASDAQ:GOOG) might be “unfavorably positioned” if ISPs start to adopt policies which discriminate against certain types of traffic. While this may be true in terms of Google’s YouTube, Google Fiber may act as a sort of hedge against net neutrality concerns.
Devitt and his team said it looks like Google has been quietly building its own “private internet,” snapping up fiber optic cabling starting as early as 2005. The search giant has also invested in some major undersea fiber optic cabling projects and “purchased enough networking equipment to have constructed one of the largest global Tier 1 internet backbones.” As a result, they suggest that Google may end up controlling distribution for much of the Internet traffic in the world.
The analysts say Google Fiber is a sort of hedge because the world’s ISPs rely on its massive global network. Because of this reliance, Google Inc (NASDAQ:GOOG) itself could be able to avoid such discriminatory traffic practices by charging ISPs fees which are equal to the fees they try to charge Google.
Here’s a look at how Internet connectivity is delivered to consumers. Google Inc (NASDAQ:GOOG) actually owns a good chunk of the Tier 1 networks, which as you can see, provides the beginning point for ISPs. Without Tier 1, they’ve got nothing to connect to.
So who are the ultimate winners and losers in the net neutrality fight? It remains to be seen, and this is one topic we should be watching closely over the next few years.