Netflix Inc. (NFLX) recently announced the launch of its in-house content delivery network (“CDN”), Open Connect. This CDN will directly connect Netflix’s video library to Internet service providers, ensuring smooth and fast data transfer that would eventually enrich customer experience.
So far Netflix relied on third-party CDN service providers such as Akamai Technologies Inc. (AKAM), Limelight Networks (LLNW) and Level 3 Communications Inc. (LVLT). The company confirmed that it would continue its present relationships with these CDN service providers owing to the multi-year contracts that remain in force.
But Netflix added that all data transfers in the future would be done through its in-house CDN, Open Connect. Netflix said that about 5% of its content is already being delivered through Open Connect.
With Netflix’s future growth strategy entirely based on the online streaming business, the company’s initiative in building its own CDN is commendable. First, the company will obtain the service at cost (since it eliminates CDN service provider profit). Second, the reliability of its services could increase, thus improving relationships with Internet service providers. Therefore, margins will expand over time.
Nonetheless, if the company suffers another subscriber exodus like last year, the capital expenditure in building Open Connect would weigh on the results of the company. But on the brighter side, Netflix witnessed additions to its domestic subscriber base in the recently concluded quarter.
Netflix has been trying hard to recover from the 2011 fiasco and has taken positive measures including improving its content and expanding its streaming business internationally. However, its DVD business continues to lose subscribers.
Moreover, Netflix faces significant competition from Amazon.com Inc. (AMZN), HBO and Verizon Communications (VZ). Higher capital expenditure arising from international expansion and building its own CDN will also impact profits.
Thus, we have a Neutral recommendation on Netflix over the long term. Currently, Netflix has a Zacks #3 Rank, which implies a Hold rating in the short term.
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