Content is King, is a phrase that puts fear in the hearts and minds of cable company executives and gets louder each time one of its providers decides it's time to raise prices. Technology, which has a way of disrupting business models, is about to wield its sword once again. While each of these creates a significant headwind for Cable companies, these forces are now colliding, creating the Perfect Storm with an industry sailing straight into the vortex.
Cable, which had its beginnings as early as 1949, has made a very comfortable living acting as a toll collector on the Television super-highway. Unable to continually pass on increased costs, the industry is facing a future with declining margins and possibly fewer premium subscribers.
The evidence continues to pile up with the most recent example right here in New York City. CBS (CBS) and Time Warner Cable (TWC) have until Wednesday to strike a carriage deal that covers re-transmission rights. CBS is threatening to go dark if a deal isn't reached. While it won't be surprising to see this fight go beyond the deadline, come fall, Time Warner Cable Execs will be forced to confront the inevitable. They just don't have the leverage and will succumb to the demands of their customers. CBS is the media home of the New York Jets and Time Warner Cable will face the reality that their fans like football a lot more than they like them.
The wild card in this battle is Aereo Service, backed by Barry Diller. The service uses antennas to pick up freely transmitted broadcast signals and streams them to paying subscribers. They do not pay re-transmission fees to networks, and as you might expect, there are several lawsuits. Aereo recently had a court decision go their way when the Court of Appeals for the second circuit of New York refused to hear broadcaster appeals. In a recent New York Times interview, media analyst David Bank for RBC Capital Markets said he would not be shocked if the distributor somehow used Aereo to skirt the blackout, or encouraged subscribers to do so. He wrote in an e-mail message, "I think it would be more of a 'negotiating tactic' than a real business solution."
This fight is a big deal for CBS as it has been for other networks like FOX and Disney (DIS). CBS plans to quadruple re-transmission revenue by 2017. While they may not achieve that lofty goal, fees will most likely rise and cable company margins will be forced lower.
Comcast (CMCSA) management probably understands the challenges better than the rest of the industry. They've been trying to buy content for the last decade. Comcast launched an unsuccessful bid to acquire the Walt Disney Corporation in February, 2004. Realizing the importance of content, CEO Brian Roberts cut a deal with General Electric (GE) in 2009 to become the majority partner of NBC Universal. They bought the remaining 49% equity stake earlier this year. The street applauded this move, sending up their shares 8% in a single day.
While content providers, exercising their newfound bravado and muscle, present an enormous headwind for the industry, the real threat comes from technology. It took a while, but the dream of broadband being able to carry unlimited streaming video content is now reality and will change the face of broadcast forever.
In most cases, the cable industry is the internet pipe that carries the broadband content. However, that represents what is commonly referred to as the dumb pipe. Uh oh. I said it. Dump Pipe. The phrase is almost a profanity in the world of cable, and they do everything they can to dispel the image.
Google (GOOG), Apple (AAPL), Intel (INTC), and Microsoft (MSFT) all have plans to get in on the action. The success of both Netflix (NFLX) and Amazon's (AMZN) streaming services is certainly a catalyst. Netflix has moved beyond being just a streaming service and is investing in original content. "House of Cards" was well received by both the critics and the public. This certainly sets the stage for more investment.
Last November, Google fiber installations began in Kansas City. In a very detailed report regarding Google's Fiber plans, Goldman analyst Heather Bellini CFA pointed out that Google could bring targeted ads to the $60 Billion TV add market. They could also expand fiber to offer outdoor Wi-Fi.
Cable companies recognize the threat and are trying to force the Genie back into the bottle. In a recent Bloomberg Article, journalists Andy Fixmer & Alex Sherman pointed out that Time Warner Cable CEO Glenn Britt recently told analysts:
Time Warner Cable has more than 300 contracts, and some of them may bar media outlets from providing content to online pay-tv services.
As these contracts rol lover, I think Cable companies will find large media outlets like Disney, Viacom (VIAB) and NBC Universal are far too powerful to be forced into contracts that restrict their ability to deliver content.
The final straw is young people cutting the cord with Cable. Forbes points out that a recent Nielsen study shows 5 million U.S. homes have "Zero TV." That's up from 2 million in 2007. They go on to point out that "Zero TV" does not mean zero video. Streaming is filling the void and in this capacity Cable is likely to remain the Dump Pipe.
While earnings and free cash flow multiples are still attractive in the cable industry, we are at, or rapidly approaching, an inflection point. In the media space, investors should focus on the content providers like CBS, News Corp (NWS), Viacom and Disney. Cable investors will need to come to grips with the harsh reality, "Content is King."