There is an imminent crisis that all media companies are going to face in the near future, as a number of factors are lowering earnings because of the lack of new revenue streams for entertainment, cable and satellite companies in a digital age.
One of the biggest of these elements is retransmission fees, which at this time the content providers hold the upper hand, but over the next two, and probably three years, will turn in favor of content distributors.
The basic challenge is the cost of content in relationship to providers, and then the passing on of that cost to cable, telecom and satellite companies.
Complexity of the Problem
This is not a simple problem to solve, as there are many elements involved which will have to be worked out.
For example, Disney (NYSE:DIS) has to work out deals with a variety of sports leagues to secure content for its popular ESPN channel. The problem is content is getting increasingly expensive, to the point consumers are demanding a la carte content alternatives to offset those higher prices. This is especially true for those who have no interest in sports, but must still pay for the content.
So in that scenario, eventually there is going to be a ceiling that the sports leagues will have to accept, otherwise they'll price themselves out of the market.
To add to the complexity, colleges are becoming more and more reliant upon income from these deals in order to remain competitive and fiscally sound. So they will have to change their way of thinking with regard to the market. Eventually the market will deem the costs too high, which will force colleges and other sports leagues to lower their demands.
Sports is far from being the only content challenge, but it is the most important because of how lucrative it is for all parties involved. At least for now.
Within this scenario we'll look at retransmission fees at the major networks, as it's becoming a big part of the strategy of the giant companies to generate a significant new revenue stream as TV advertising is expected to remain flat or slightly fall over the next two or three years. It is unlikely that digital revenue will make up for the falling TV advertising prices in the years ahead.
If this ends up being the result, cable, satellite and telecoms will have to pass on the price raises to their customers, which will without a doubt end up with a much higher churn rate.
It's eventually going to go the route of the film industry, where it still has pricing power, but fewer people go to the movies. I believe we'll see prices rise and the number of cable, satellite and telecom customers drop over the next several years.
Because of the demand for content, the pricing should offset the drop in customers, although eventually there will be no more room to run, and market forces will take over.
What will determine the timing of all of this is the pace at which the content companies increase their fees. If they go at too fast of a pace, they'll get some short-term earnings success, but will come under increasing pressure as consumers and content distributors complain about the higher prices, which will put pressure on politicians to take a look at the fees.
The other side of it is the content industry is fighting to hold onto its bundled offerings, fearful it will go the way of the music industry when it unbundled albums.
Breaking Down Retransmission Fees
At this time, CBS (NYSE:CBS), Twenty-First Century Fox, Inc. (NASDAQ:FOXA) and Disney lead the retransmission fees field, with all of them generating about $250 million. NBC Universal (NASDAQ:CMCSA) on the other hand, as it is with advertising revenue, is behind its peers in revenue generated from retransmission fees.
CBS, being the most-viewed network, commands the highest fees, as its retransmission fees bring in over $250 million, which accounted for about 10 percent of earnings in the segment. Estimates are that it will double by 2015, and could at least double again by 2018 for CBS, if Kagan's estimates are fairly accurate.
There are of course macro-economic factors to consider. But people will continue to watch TV, and that ensures the fees will climb, although it's possible it won't be at such a bullish pace.
Again, it's churn versus earnings that is at stake, and content providers will have to walk a tightrope in measuring how much consumers are willing to pay before they revolt by voting with their dollars by cutting services.
Disney, because it has so many different business segments, won't be affected as much as some of the other major broadcasters, but investors can still count on it generating more revenue and earnings from its retransmission fees, specifically with its strong sports programming advantage. Disney should be a little less than CBS in the numbers, although it depends on how it performs going forward. For example, it could improve its performance in the 18-49 demographic on ABC, which would provide strength when it negotiates deals.
Twenty-First Century Fox, Inc. is in a similar situation as CBS and Disney with transmission fees, and its strength in the 18-49 demographic, which it is stronger in 2013 than it was in 2012, will help the company to continue to boost fees over the next couple of years at least.
For NBC Universal, it continues to lag its peers in all areas. With transmission fees it commands about $200 million annually at this time, which isn't guaranteed to go up in the same manner as its competitors because of its internal struggles to offer compelling content. This of course also hurts its advertising business, which also underperforms its peers. NBC has been improving with its 18-49 demographic in 2013, so that could help it when asking for higher fees.
Escalating Retransmission Fees Battle
There have been a lot of skirmishes between broadcasters and satellite and cable providers over the retransmission fees, and this is only going to escalate going forward.
The battle between CBS and Time Warner Cable (NYSE:TWC) is going to be considered small in comparison what is probably going to happen in the near term. Time Warner Cable blacked out a number of CBS channels, including those in some of the biggest markets in the country. While Time Warner blinked in this case because of the arrival of the major sports season, it's unlikely that it will be that easy of a battle in the future.
It's simply a matter of economics, and broadcasters will only be able to boost prices so high before the real battle begins. Eventually that will draw in consumers if the cable, satellite and telecoms draw battle lines against the content providers in a united front. In that case, there would probably be no viable alternatives for customers if there is a huge blackout. At that time we may see lawmakers step in, or some deals worked out that all parties can live with, which would lower fees for content companies.
The problem is broadcasters are challenged by a declining viewership in many cases, and advertising dollars are gravitating toward digital properties. Digital isn't making up for that loss of revenue, and so retransmission fees are the growth area in this segment.
Lines will be drawn as this plays out, as both industries will fight for their own interests and earnings performances.
Content providers believe they're content is undervalued, while content distributors see a growing number of customers complain about the rising costs of the services they offer. It must and will come to a head, which will be determined, again, by the pace the broadcasters decide to boost fees, and how strongly the cable and satellite companies decide to fight them. It's not a matter of if, but only when it becomes a full-scale war.
In the broadcasting segment of the major media companies, retransmission fees are considered the growth area of the future, as TV advertising revenue levels aren't able to be replaced by digital advertising revenue growth.
There is no doubt there is a price ceiling approaching because churn will rise as a result of the high price of cable, satellite and telecom services, which will force an all-out battle over retransmission prices and the type of content bundles offered to customers.
Cable companies like Comcast have been experimenting with low-price basic bundles with a carrot stick like HBO added to sweeten the offer, but that is unlikely to placate the majority of subscribers since they're used to having access to much more content. It may help to attract new subscribers, although over time the prices of these bundles rise to pretty high levels as well.
I don't believe the growth of retransmission fees is sustainable, although the market isn't near a top yet. Within a couple of years we should start to see more resistance from cable and satellite companies, with the consequences being a war to win the minds of consumers. After the Time Warner Cable debacle, the cable and satellite industry will have to hold its ground if it doesn't want to take a huge earnings or churn hit because of rising prices.
Churn will also hurt the broadcasters too, as less consumers watching their content means less advertising dollars.
As mentioned earlier, this is similar to the film industry and theater owners, where there is a decreasing number of people attending theaters for similar reasons that less people are accessing content via television. Higher prices are making up for the lower number of those attending films, but that is also going to hit a price ceiling.
It's unclear what the outcome will be, but I believe we'll see higher retransmission fees won by broadcasters, although it's probably going to slow down to sustainable levels. Cable, satellite and telecom companies will have to pass a lot of that onto subscribers, which at the lower economic level will start to be priced out of the market. That's where the churn will be, and it's difficult to see how that will be avoided, as consumers are forced to make decisions on spending on needs versus wants.
When the next recession hits it will put pressure on all parties involved.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.