How Netflix Helped Create a Multibillion-Dollar Industry...

Alexander Moschina
by Alexander Moschina, Managing Editor, Investment U

How Netflix Helped Create a Multibillion-Dollar Industry...

by Alexander Moschina, Investment U Research

Thursday, December 2, 2010

The company that crushed Blockbuster (OTC.BLOAQ.PK) is about to take things to another level.

Three levels, actually.

A large chunk of Netflix's (Nasdaq: NFLX) newest and most promising business will soon be in the hands of little-known Colorado tech company, Level 3 Communications (Nasdaq: LVLT).

News that Level 3, along with two much larger rivals, will stream online video content to millions of Netflix subscribers has triggered a big increase in trading volume on LVLT over the past few weeks. And this despite the fact that no pricing details have been released.

But it's easy to see why in-the-know investors are getting bullish on the company, following the success of similar deals in this rapidly expanding industry...

Note to the Market: Sign With Netflix and Your Shares Will Rise

The positive precedent for partnering with Netflix is evident.

Back in March, Level 3's largest competitor, Akamai (Nasdaq: AKAM), teamed up with Netflix to stream its growing library of movies and TV shows over the web. Nine months later, Akamai's shares are 101% higher.

Another content delivery company, Limelight Networks (Nasdaq: LLNW), enjoyed a strong boost from its relationship with Netflix. On November 5, the company raised its full-year outlook, citing its strong position "as one of Netflix's core delivery partners." A few days later, the shares jumped by 36% to a 52-week high of $8.97.

So why all the Netflix fuss?

The Industry Leader... Bar None

Simply put, Netflix, currently worth $9.15 billion, is the leading provider of streaming media. During the last quarter, its services reached 16.9 million subscribers. And more than 66% of them viewed at least 15 minutes of streaming content. That's up from 41% of 11.1 million subscribers a year ago.

At the moment, the company is hurriedly preparing for the transition from "mostly DVD to mostly streaming." And by working with Akamai, Limelight and now Level 3, it's protecting itself against slow load times and costly service outages.

For Level 3 - a communications company moving into the content delivery market - the contract is a game-changer. Having Netflix as a customer could open doors to other deals, thus raising its stake in this relatively young market.

And it's a market that is set to reach $4.7 billion over the next five years...

Netflix Competitors Jump on the Streaming Bandwagon

After all, the streaming business is booming. And not just for Netflix, but for others like Amazon (Nasdaq: AMZN) and Hulu...

  • Amazon: Its Video on Demand service is now available via TiVo DVRs, set-top boxes like Apple TV, and even smartphones. Its success has led the company to develop its own subscription-based service a la Netflix, which it will launch early next year.
  • Hulu: The much-younger Hulu is also offering monthly subscriptions for its Hulu Plus service. Monthly users of its free ad-supported service have grown from five million in 2008 to more than 30 million in October. For the whole of 2010, it predicts revenue of $240 million - a 122% increase over 2009.

And as these companies build up their subscriber bases and media libraries, they need content delivery networks (CDN) like Level 3 to handle the dirty work...

Level 3 Readies Itself for a Flood of Business

CDNs are responsible for the massive amounts of data sent to consumers' laptops, smartphones and PDAs - everything from eBooks to HD feature films. And as demand for digital media soars, the CDN industry is seeing exponential growth.

In less than five years, annual revenue is expected to double. And that's based on current growth rates. If products like Apple TV and Google TV take off, the digital media push could explode even higher.

On its own, Level 3 is well-positioned to snag a huge chunk of this business because...

  • Its services are competitively priced, roughly half that of industry-leader, Akamai.
  • It can invest heavily in boosting its speed and storage capacity, thanks to the money from the Netflix deal.
  • The company's network will soon double in size, making it the largest and fastest in the industry.

The bottom line: As this young market booms, Level 3 can boom right along with it.

Good investing,

Alexander Moschina

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