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Why the Netflix, Comcast Agreement Is Such a Big Deal

Some on Wall Street weren't entirely sure what to make of the deal, whether it will impact Netflix's margins or not. "The Netflix-Comcast paid-peering deal, while likely creating headwinds to margin leverage near-term, removes a major structural concern. No terms were disclosed, but we believe that this agreement is likely to precipitate others in the U.S. and internationally," Cantor Fitzgerald analyst Youssef Squali wrote in a note. "The stock's valuation and lack of visibility into the contribution margin impact of this deal (and potentially others) are keeping us on the sidelines."

BTIG analyst Rich Greenfield said he believes the deal is a precursor to getting Netflix on Comcast's X1 set-top boxes, which ultimately is beneficial to Netflix over the long-run, even if it means paying a bit more now. "We believe Netflix agreeing to a paid peering relationship with Comcast was tied to Netflix being integrated into Comcast's X1 set-top boxes later this year," Greenfield wrote in a blog post. "Time will tell if we are right, but we simply do not believe this is as simple as Comcast won and Netflix lost."

With the Comcast, Time Warner Cable (TWC) proposed merger is under intense scrutiny because of fears of net neutrality being dead and higher prices for broadband and television access, the timing of the deal is suspect. In the press release, the companies noted they'd been "[w]orking collaboratively over many months," and The Wall Street Journal, which first broke the news, said Hastings and Comcast CEO Brian Roberts seriously discussed the idea at January's Consumer Electronics Show.

Analyst Craig Moffett of MoffettNathanson Research notes Netflix may wind up being the winner in this deal, as it gets "cost certainty for a long time at a very low (negligible?) price and they get more capacity and therefore better service for customers." Conversely, Comcast in the long-run, may wind up losing out. "Comcast has arguably given away the potential to charge more in the future - the idea that the single largest source of traffic on the Internet is only paying "several million dollars" to the largest broadband provider in America hardly sounds like a watershed moment to us - in return for one less opponent to their merger."

By brokering a long-term deal with Comcast now, Hastings has decided that it's better to pay a bit more now and get direct access to Comcast's pipes. In the company's fourth-quarter shareholder letter, Netflix noted Internet Service Providers (ISPs) can now "legally impede the video streams that members request from Netflix, degrading the experience we jointly provide. The motivation could be to get Netflix to pay fees to stop this degradation. Were this draconian scenario to unfold with some ISP, we would vigorously protest and encourage our members to demand the open Internet they are paying their ISP to deliver."

JPMorgan analyst Doug Anmuth noted by giving Netflix users more direct access, it's a "positive for the Netflix user experience," not to mention Netflix "likely anticipated some degree of higher costs related to network agreements in its 2014 guidance."

Anmuth also noted that while other multichannel video programming distributors (MVPD) could ask for a paid-peering agreement, they likely don't have the same clout. "As the leading MVPD and broadband provider, Comcast likely has greater leverage with Netflix than other ISPs," Anmuth wrote in the note. "Comcast's footprint will also increase post the potential merger with Time Warner Cable, with the combined company having a presence in 19 of the top 20 DMAs and a managed subscriber total of ~30M. The Comcast agreement does raise the likelihood of paid peering with other ISPs, but we do not believe they would have the same degree of leverage with Netflix."

-- Written by Chris Ciaccia in New York

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