Broadband Cable Association of Pennsylvania

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January 21, 2014

Netflix's Internet video service thrives on drama and suspense, but not the kind triggered by a legal ruling that threatens to affect the company's growth and pricing.

The intrigue stems from an appeals court decision last week overturning Federal Communication Commission regulations that prodded high-speed Internet providers to treat all online services equally, including video transmissions that placed higher demands on their networks. The dismantling of that FCC rule, known as "net neutrality," raises the possibility that Netflix might someday have to pay additional fees to Internet service providers to ensure that its video continues to stream smoothly.

Netflix Inc. could still refuse to pay if the cable and telecommunications companies selling most of high-speed Internet access demand more money. But that option would risk diminishing the quality of Netflix's video streaming to the frustration of its 31 million U.S. subscribers who pay $8 per month for the service. Netflix declined to comment on the fallout from the net neutrality decision. But the Los Gatos, Calif., company has consistently depicted its video service as one of the main reasons many households are willing to pay $50 to $70 per month for high-speed Internet access, suggesting that the providers would be foolhardy to do anything to undermine Netflix.

Given that conviction, Netflix might be willing to defy any high-speed Internet provider that demands an extra fee to carry its video service, betting that the provider would back down rather than face a backlash from its own customers. That's one reason BTIG Research analyst Rich Greenfield doubts that high-speed Internet service providers will dare to enter a public relations battle with Netflix over the net neutrality issue. Besides possibly alienating its own customers, any Internet provider that tries to collect a toll from Netflix might provoke the FCC and lawmakers in Congress to draw up tougher regulations. "We believe economic logic will prevail, limiting abuses" among Internet service providers, Greenfield wrote in a research report last week. Internet service providers so far have given no public indication that they will seek additional fees from Netflix or other online services that place heavier loads on their networks, such as Google Inc.'s YouTube.

Netflix nevertheless could be a tempting target for Internet providers looking for more revenue. Netflix accounts for about 15 percent of residential broadband usage in the U.S., according to Stifel Nicolaus analyst George Askew. The demands will only rise if Netflix realizes its long-term goal of attracting 90 million subscribers in the U.S. Wedbush Securities analysts Michael Pacther believes Netflix could be hit with an annual bill of anywhere from $144 million to nearly $1 billion by the Internet service providers. The wide range between those estimates reflects Pachter's uncertainty about how much of Netflix's video is watched in a high-definition format that consumes more bandwidth and theoretically would result in higher surcharges. If Netflix is hit with additional fees, Pachter thinks the company will be hurt as its profits shrink and it has less money to pay for high-quality programming such as its Emmy-award winning series, House of Cards. Alternatively, Pachter believes Netflix could raise its prices by $1 per month to help defray its costs. Associated Press

Verizon Communications Inc., the second-largest U.S. communications company, agreed to acquire Intel Corp.'s pay-TV startup to extend its offerings of Internet-based TV services. The acquisition of Intel Media, along with its about 350 employees, will accelerate the availability of next-generation video services, New York-based Verizon and Santa Clara, California-based Intel said in a joint statement today. Financial details weren't disclosed.

Intel, which developed the service called OnCue, began looking for a buyer last year rather than invest in the programming and bring it to market on its own. The takeover could shake up pay TV, by bringing more competition to cable companies that dominate territories, as well as satellite companies with wide coverage that lack the interactive capability of the Web. OnCue is designed to provide pay-TV programming over any high-speed Internet connection, making it a threat to cable-TV services that deliver shows over dedicated lines restricted by territory. Intel's system includes servers, set-top boxes and applications that can stream content to televisions, phones and tablets. As part of the deal, Verizon will purchase intellectual property rights and other assets related to the OnCue platform, the companies said. Intel Media's management team will stay. Bloomberg

Storm clouds have stalled over the Weather Channel. The cable channel on Tuesday will enter its second week blacked out from DirecTV's program lineup, as a result of a dispute over fees, with no sign that a resolution is near. The two companies aren't even in talks, representatives for both said.

The stakes are high for the Weather Channel, a unit of Weather Co., owned by private-equity firms Blackstone Group LP and Bain Capital LLC as well as Comcast Corp.'s NBCUniversal Inc. DirecTV is the second-biggest pay-TV operator in the U.S., serving more than 20 million subscribers, or about a fifth of the pay-TV universe. The blackout therefore is depriving the Weather Channel of access to a significant chunk of the TV audience. But settling the dispute could be costly. DirecTV wants to reduce the fees it pays the Weather Channel by more than 20%, a person familiar with the situation has said, while the channel wants a slight increase. DirecTV has declined to comment on its rate requests but has said the channel has less value because many people get their weather information from mobile devices.

Analysts warned last week that if DirecTV succeeds in winning a rate reduction, it could trigger a cut in fees the Weather Channel receives from other pay-TV operators. Agreements between channel owners and large pay-TV operators typically guarantee the operators the lowest price charged by the channel. A 20% rate cut extended across other pay TV operators could reduce the Weather Channel's cash flow by about $40 million, or 24%, SNL Kagan estimated in a report last week. On Friday Moody's Investors Service cited the potential for a subscriber-fee reduction as one of several factors relating to the dispute that could affect Weather Co.'s credit rating. In a report, Moody's also noted that being permanently dropped from DirecTV "could have several operational and credit ramifications" for the Weather Channel. Moody's calculated that the loss of Direct TV could lead to revenue declines in the midteens for the Weather Channel, which accounts for between 50% and 60% of Weather Co.'s total revenue, Moody's estimates.

Still, Moody's believes there is a "good chance" the dispute will be resolved because the channel isn't "fully replicated elsewhere on TV" and it also "provides valuable public service programming during periods of regional extreme weather events." It predicted the two sides would resume negotiations "over the coming weeks." Weather Co. declined to comment on either the Moody's or the Kagan reports. DirecTV has replaced the channel with WeatherNation. It said Monday it was getting "inundated" with positive responses from customers about the new channel, while the Weather Co. spokeswoman said, "We have been overwhelmed with the amount of support we've seen from our viewers." Wall Street Journal

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