Late last week, LIN Television (TVL) announced it had secured a retransmission deal with Dish Network Corp. (NASDAQ:DISH), formerly Echostar Communications, for 26 television stations in 17 of its local markets. In its March 13, 2008 note to clients, a Bear Stearns analyst estimates this deal to be worth approximately $3.6 million per year (based on an estimated 1 million subscribers at $0.30 per subscriber, per month). The note goes on to state that, “we believe TVL is on track for $13 million of retransmission fees in 2008 based on the 4Q run rate and now are more confident of the $25 to $30 million in fees longer term as reflected by this deal”. They maintain an Outperform rating on TVL.
Retransmission fees, for those not in the day to day of the television industry, are fees paid by cable and satellite operators to local broadcast television stations for the right to retransmit the over the air broadcast signal to their subscribers as part of their overall programming offering to consumers. While the concept of retransmission consent has been around for a while, it is only in recent years that television broadcasters have been able to maximize the revenue opportunities therein, primarily as a result of the ongoing battle between satellite operators such as Dish and Directv (DTV) and cable operators including Comcast (NASDAQ:CMCSA), Charter (NASDAQ:CHTR), Cablevision (NYSE:CVC), Time Warner (NYSE:TWX) and a myriad of smaller carriers. Television broadcasters have historically had two options by law when negotiating with cable carriers- retransmission consent and “must-carry”. Must-carry is simply an obligation of the cable operator to carry the local television station on its system so long as the television station meets certain standards and conditions, but no consideration is otherwise given by the cable companies. On the other hand, retransmission consent is the free-market negotiation between the parties for cable carriage. In the past, it may have had a monetary component to it, but more often provided the broadcaster better or additional channel positions and other promotional consideration for the right to redistribute their signals. Both create a no-lose situation for local broadcasters in expanding their reach beyond the over the air signal, but retransmission consent heavily rewards broadcasters who invest in quality news operations, syndicated programming and network affiliations that consumers desire. Rupert Murdoch was known to use retransmission consent to his fullest advantage in the 1990’s. Newscorp (NASDAQ:NWS) capitalized heavily on the strength of the Fox Network and its owned and operated television stations to secure national carriage for many of the then fledgling cable networks that are now highly profitable franchises for that company. EW Scripps Co. (NYSE:SSP) is another company that used this strategy to create lucrative national cable networks on the backs of its television station group. Others, such as Belo Corp (NYSE:BLC), used the negotiating leverage of their station groups to launch local and regional news networks on cable systems. Cable operators were willing to provide additional channel capacity then as they wanted to ensure they continued to offer such things as local news and sporting events, but did not want to pay-out rights fees to do so. In addition, capacity was not as constrained or as valuable as it would become, hence the concessions were made. However, cable positions did eventually became much more in-demand with the proliferation of niche cable networks on both the analog and digital tiers of their systems, and cable operators significantly curtailed this practice. The introduction of satellite television as a formidable competitor forced the cable companies to revisit their stance on retransmission consent, though. The likes of Dish and Directv began aggressively seeking new ways to offer differentiated content, and broadcasters eventually persuaded regulators to mandate certain retransmission rights on satellite as well. This put many broadcasters in an enviable position, and finally gave them significant leverage to demand cash payments from the cable companies in the retransmission consent process.
Leading the charge to monetize their content further was Sinclair Broadcasting (NASDAQ:SBGI), which has been involved in several high profile disputes with cable operators over the past few years. In some instances, Sinclair withheld their retransmission consent from cable companies leaving many cable customers without access to NFL football games, other sporting events, and top rated shows such as American Idol. Sinclair and the satellite operators encouraged viewers to subscribe to satellite as an alternative, and ultimately many of these cable companies gave into Sinclair’s demands for fear of massive subscriber defections to their satellite competition. A number of other broadcasters such as Nexstar Broadcasting (NASDAQ:NXST) followed suit, reaping large financial benefits in the process.
Included in the latest LIN Television deal with Dish Networks is a marketing agreement, which according to the Bear Stearns analysis will “encourage consumers to switch to DISH Network if LIN TV's local station signal is removed from a cable system. The parties will jointly market LIN TV's availability on DISH Network.” This is similar to previous strategies employed by Sinclair and gives LIN ever more firepower in dealing with retransmission negotiations with its local cable operators. The $25-30 million of new retransmission fees LIN is estimated to generate long term is something few would have guessed a decade ago, and the sudden rise in these retransmission revenues fueled a tremendous rally across the board in broadcast television stocks this time last year. However, as a result of the broader advertising downturn and overall financial market turbulence the past 6 months, most of these stock price gains have since evaporated. Those are normal cyclical events for the television broadcasting industry, and not entirely unexpected. While the pendulum may have swung too far one way last year on the excitement of a second revenue stream for television broadcasters, it now appears it has reversed course in excess as well this year on this cyclically bad news. This current downtrend in broadcast television stocks presents a significant buying opportunity for media investors to buy on the dip as cyclical issues will eventually correct themselves in time while the retransmission fees will be steady, reliable sources of income so long as broadcasters maintain their regulatory advantages and satellite and cable remain viable competitors with each another. It should be noted that there are two unknown variables in the retransmission revenue opportunity, long term. First is the reaction of television networks to the financial windfall of local broadcasters, and second is the impact broadband television offerings will have on cable operators’ willingness to pay these fees. For broadcasters who do not produce their own local content but mainly rebroadcast network affiliated programming and low-grade syndicated fare, networks could ultimately decide to forgo an affiliate relationship in a local market, instead negotiating directly with cable operators there for carriage. In some television markets, cable penetration is as high as 90% of television households which would all but eliminate the need for an over the air signal to maximize distribution. If the local broadcaster has no unique content to offer, then the cable operator would have no imperative other than to accommodate their must carry status. In other markets, a highly compensated affiliate may encourage the television networks to seek at least their fair share of the retransmission revenues either directly or in the form of increased reverse compensation from the broadcaster to the network. Some analyst reports have placed this figure as high as 35% of the total retransmission revenues paid out. As for the impact of broadband television offerings on retransmission revenue, that simply remains the wildcard. If more viewers watch their favorite television shows and news clips online, the less likely the cable or satellite operator will be willing to aggressively compensate the local broadcaster who offers that redundant content over the air. This is a big unknown as broadband distribution has great promise to content creators, but could threaten content distributors. For the best of breed broadcasters though, they are a little of each, and should benefit from this as their proprietary news content becomes more valuable overall online. Overall, as a result of retransmission consent revenues and the increased value ascribed to locally generated video content, anyone who states broadcast television is through as a business clearly does not understand the complexity of companies like Sinclair, LIN, Nexstar, Hearst-Argyle (HTV), Gray (NYSE:GTN) and others in the space. They also do not understand the regulatory and legislative protections provided to the industry by the Federal Communications Commission and Congress as the primarily medium of news and information distribution to the American public. Television broadcasters are evolving to meet the times, and will continue to evolve as further conditions warrant. The implementation of this second stream of revenue found in retransmission consent is clearly evidence of that. Of the group, LIN Television is my favorite mainstream television operator and I share the same bullish tone for it as most of the analysts who cover it. In addition to a solid business model, strong local brands, and aggressive new media initiatives, the company has previously indicated it would like to put itself up for sale. It may seek that exit strategy again once valuations rebound and the credit market turmoil subsides, providing tremendous upside potential for patient investors in the stock.
DISCLAIMER: This article reflects the individual views of Mr. Hannan and may not be attributed to any person, company or other entity with whom Mr. Hannan is affiliated.