Netflix plan seen as no big threat to content delivery firms

A sign is shown at the headquarters of Netflix in Los Gatos, California September 20, 2011.

(Reuters) - Netflix Inc's plans to use its own network for streaming movies and TV shows may not be as bad for content delivery companies as the initial market reaction suggested.

Shares of Limelight Networks Inc, Akamai Technologies Inc and Level 3 Communications Inc fell on Tuesday after Netflix said it would slowly shift its video streaming traffic to its internal network.

Content delivery network (CDN) companies help media websites such as Netflix stream videos over the Internet using less-congested routes, enabling them to reach consumers faster.

"Our scale made sense for us to create our own way of delivering the movies and TV shows to more than 26 million members," Netflix spokesman Joris Evers said.

Analysts, however, said it would be difficult for Netflix to create a viable product, and even if it succeeded the shift in traffic would not be a major issue for CDN providers as they could use the freed-up bandwidth to win higher-margin customers.

"This is not Netflix's first effort at bringing CDN capabilities in-house, so there will be questions on credibility," Jefferies & Co analyst Aaron Schwartz said.

Netflix's internal network, dubbed Open Connect, currently handles just 5 percent of the company's traffic.

It will take a few more years for it to be able to deliver most of its content through Open Connect.

"A decision like this from a content publisher requires significant ongoing investment to develop software, to enable monitoring, alerting and reporting," Akamai spokesman Jeffrey Young said.

The sheer volume of Netflix traffic, estimated at 20-30 percent of U.S. Internet traffic at peak periods, allowed the company to drive a hard bargain with CDN providers, leaving them with a small profit margin.

"Usually your largest customers are your lowest-margin customers," Limelight CEO Jeffrey Lunsford told Reuters.

"To us, the whole Netflix thing is much ado about nothing. We've them for another year and a half and we've plenty of opportunities to replace their traffic and we are growing other services."

Akamai got about 1 percent of its 2011 total revenue of $1.16 billion from Netflix, Level 3 less than 0.5 percent of its core network services revenue of about $3 billion, and Limelight about 11 percent its overall revenue of $171 million.

"If Limelight could backsell the revenue it bleeds off with smaller customers that pay a higher price per megabyte or terabyte, then it's a win-win situation," Capstone analyst Rod Ratliff said.

Jefferies and Co's Schwartz said revenue from Netflix was not profitable for Limelight, and that the company had refused to raise Netflix volumes in the past for this reason.

"We have known about this for many months, and Netflix has been talking about their intentions for many years. It is not material to Akamai," spokesman Young said.

Wells Fargo analyst Jennifer Fritzsche said Level 3 could benefit from the network capacity Netflix would have to buy to support its CDN.

Netflix said it was open to sharing its Open Connect software and hardware designs with others interested in creating a content delivery network.

Limelight shares, which fell 12.5 percent on Tuesday, were up 2.5 percent at $2.42 in early trading while Akamai's shares were up 4 percent at $28.51 after dropping 3 percent the previous day. Level 3, which initially fell on the Netflix news, was up 2 percent at $20.54, adding to a 2 percent gain on Tuesday.

(Reporting by Supantha Mukherjee and Sruthi Ramakrishnan in Bangalore; Lisa Richwine in Los Angeles; Editing by Ted Kerr, Sriraj Kalluvila and Saumyadeb Chakrabarty)