Home Technology Netflix, Inc.’s Interconnection Agreements to Reduce Profitability

Netflix, Inc.’s Interconnection Agreements to Reduce Profitability

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Netflix, Inc. (NASDAQ:NFLX) disclosed that its interconnection agreements with AT&T Inc. (NYSE:T), Time Warner Cable Inc (NYSE:TWC) and Verizon Communications Inc. (NYSE:VZ) resulted in better speeds last month.

Based on the USA ISP Speed Index released by Netflix, Inc. (NASDAQ:NFLX), AT&T U-verse had the best average speed improvement month-over-month, up by 81% and its rank improved by seven spots. The internet speed offered by Comcast also improved month-over-month.

Netflix, Inc. (NASDAQ:NFLX) emphasized that faster networks offer better picture quality, quicker start times, and lesser buffering when streaming online videos.

Analysts at Wedbush said the internet speed improvements were in-line with their expectations after the interconnection agreements of Netflix, Inc. (NASDAQ:NFLX) with the three internet service providers (ISPs).  However, they believed that the interconnection agreements will become an increasing drain on the company’s profitability going forward.

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Netflix’s speed in US still behind other countries

Wedbush analyst Michael Pachter and his team noted that the average speed in the United States was 2.57 Mbps in August. Among the countries tracked by the online video streaming company in terms of ISP speed, the U.S. ranked eleventh.

The analysts believed that Netflix’s speed in the U.S. still behind compared in many other countries because the networks in certain international markets are faster and domestic ISPs have the power over the company’s streaming experience.

Pachter and his team noted that the U.S. Court of Appeals for the DC Circuit struck down the rules of the Federal Communications Commission (FCC) that requires ISPs to be neutral on bandwidth restrictions. The ruling of the court allowed ISPs to discriminate between different websites based on the demands placed on their bandwidth.

According to the analysts, since then, Netflix, Inc. (NASDAQ:NFLX) faced problems with certain ISPs. The online video streaming company was compelled to pay more interconnection fees to the ISPs to provide a better experience to customers to maintain its competitiveness against rivals in the industry.

FCC powerless over net neutrality

Pachter and his fellow analysts opined that the FCC is powerless to restore the status quo regarding net neutrality following the decision of the Court of Appeals. According to them, it is unlikely for the rules to be reinstated without the action of the Congress.

They believe that it is possible for the Congress to change the law and enact net neutrality over the long-term. However, the analysts believed it may not happen because the ISPs and Congress may not receive pressure from consumers regarding the issue.

Pachter and his team suggested that it is more likely for consumers to change their streaming services away from Netflix, Inc. (NASDAQ:NFLX) than switch ISPs. They pointed out that consumers can cancel Netflix anytime, but not with ISPs because many of them were locked into long-term deals.

The analysts believed the interconnection agreements of Netflix, Inc. (NASDAQ:NFLX) would reduce its profitability going forward. They noted that the domestic content delivery expense of the company increased by $17.3 million year-over-year and $15.1 million in the second-quarter. Pachter and his team expected that company content delivery expenses will “have a larger sequential increase in the third-quarter.

The analysts “believe that ISPs retained the opportunity to seek ever-increasing fees on annual or biannual basis.” Pachter and his team maintained their Underperform rating for the shares of Netflix, Inc. (NASDAQ:NFLX) and $254 price target.

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