The Federal Communications Commission's (FCC) recent proposal that allows Internet Service Providers (ISPs) to charge fees for faster connections is a significant blow to video streaming service providers such as Netflix ( NFLX ).
The FCC's original net neutrality rules called for equal treatment of all traffics irrespective of their source of generation. The rules had also opposed fees for faster access. However, Verizon Communications ( VZ ) challenged the rules, which were eventually rejected by a U.S. court in January this year.
Since then, the FCC has been seeking to replace the net neutrality rules. However, the new rules have already stirred significant controversies among regulators and consumer forums. The acceptance of new pay-for-faster-access rules will make Internet much more costly for start-ups, non-profits and general users.
Although the complete change in the FCC's stance will also hurt other services like Amazon ( AMZN ) Prime and YouTube, Netflix is set to be the biggest victim of the proposed new rules. This is due to the fact that both Amazon and Google are more diversified than Netflix in terms of revenue source.
On the other hand, Netflix is completely dependent on its streaming service that accounted for almost 90.0% of its revenues in the recently concluded first-quarter 2014. Streaming revenues jumped 45.8% from the year-ago quarter to $1.14 billion.
Most significantly, streaming contribution margin surged to 18.5% from 7.0% reported in the year-ago first quarter. However, the proposed FCC regulation will dent Netflix's profitability. The company is already paying millions of dollar in fees to Comcast Corp. ( CMCSK ) for faster streaming.
FCC's new regulation will pave the way for other ISPs to demand a similar kind of fee from Netflix. The company consumes approximately 30.0% of peak Internet traffic (particularly in the evening) in North America. Netflix streams shows through its free Open Connect program that involves setting up its servers within ISP networks. However, Open Connect is not supported by Comcast, Time Warner Cable ( TWC ), AT&T ( T ) or Verizon.
Netflix has been the most vocal in support of a strong net neutrality rule that will ensure smooth content transmission to end users at no extra cost. Netflix has also voiced strong opposition to Comcast's planned $45.0 billion acquisition of Time Warner Cable, as it will create a giant that will have too much control over Internet access in the U.S.
Moreover, if the deal gets approval, Netflix may face significant pressure from the combined entity to increase its annual fees, which will further dent cash balances.
Netflix is already facing significant headwinds related to rising content costs. The company currently charges $7.99 for its streaming service that had 35.7 million U.S. subscribers at the end of first quarter 2014. Netflix is planning to raise streaming prices by a modest $1.0-$2.0 for new subscribers in selected regions beginning late second-quarter 2014.
However, this modest increase may not be enough to offset the rising costs. Further, too much price aggressiveness may hurt subscriber growth, amid intensifying competition from Amazon and HBO.
Currently, Netflix has a Zacks Rank #3 (Hold).