The $1 billion in retransmission fees CBS (NYSE:CBS) expects to generate annually within five years - falling straight to the bottom line - dramatically underscores the transformation of broadcast networks into content producing-distributing juggernauts fueled by multiple screens revenues.
It's a good life as long as retransmission and syndication fees hold out against streaming video competition and regulators rethinking the value and use of the broadcast spectrum.
It's a stunning turnabout in traditional TV economics at a time when digital and online video are garnering all the attention, but still generating relatively sparse revenues. Online video licensing will comprise only 2% of CBS' overall revenues this year.
Retransmission fees paid by cable operators, as well as reverse compensation fees paid by CBS affiliates, were virtually nonexistent three years ago. In 2005, when CBS was the slower-growing asset spun off from Viacom, the entire ad-dependent network broadcasting system appeared headed for extinction in the digital explosion.
Although more than $250 million in retransmission fees will account for 10% of CBS' 2012 segment earnings, those revenues are expected to double by 2015, generating 70% of earnings growth during that period. Even with another 5% audience erosion at the broadcast networks, robust retransmission fees are closing the sizable disparity between cable and broadcast content economics.
"The four networks are the most sought-after product, so the sky should be the limit," CBS chairman and CEO Les Moonves told a Goldman Sachs' conference last week. It's a simple case of supply and demand among a widening array of platforms and devices. "We're entitled to ask for more," Moonves told investors.
But there is risk in the argument that cuts both ways.
The proliferation of cloud video automatically synced across all platforms and screens could eventually marginalize the retrans proposition and cable's dominant distribution pipe. That notion surely appears to be driving Comcast/NBCU's recent decision to partner with Zeebox, whose "second screen" app automatically syncs video from any source across all platforms, including Apple and Google.
The broadcast networks have unilaterally filed lawsuits to block TiVo Stream and Aereo, and even DISH Networks' (NASDAQ:DISH) Auto-Hop DVR service, because streaming free over-the-air broadcast signals to subscribers over the Internet bypasses their content management and payments on the retransmission, affiliate and syndication fronts.
Moonves points out that "syndication is still the big dog" with 70% of CBS' program schedule produced and monetized by its CBS TV Studio, enhanced by more than $1 billion in international sales and new lucrative library deals with the likes of Netflix and Amazon.
Even the CBS TV Studio accounts for 27% of earnings and 3% to 5% annual earnings growth this year, compared with 5% to 15% for its peers, according to a Morgan Stanley analysis. CBS' ability to limit expense growth and capital expenditures also is at the low end of its media peers.
The bull case for an incremental $100 million in TV library content deals in 2013 could provide at least another 2% upside to earnings. I Love Lucy reruns still generate an average annual $20 million in income for CBS, Moonves notes. Plus, CBS expects 40% growth in cash flow over the next 12 months.
Potentially selling its $4 billion outdoor business would further strengthen an already debt-free balance sheet. So would its aggressive stock buyback and dividend payouts, while making CBS even more dependent on its traditional content proposition and stretching it into a tumultuous video marketplace.
The threat posed by the steady onslaught of new disruptive options could upset the broadcast networks' new financial equilibrium, in which retransmission fees are critical to offsetting modest and even no growth of their anchor ad revenues.
The bear case forecast is for top-ranked CBS' advertising to grow a mere 2% in 2012 (down 2% before political year spending), according to Morgan Stanley, while local ad revs will account for about 35% earnings in 2012. Although broadcast TV controls about 75% of the world's $200 billion ad dollars, network broadcast ad revenues in the U.S. are expected to decline 1.5% in 2013.
National ad growth is now below expectations, and broadcast network advertising is declining. Local advertising is bolstered by election-year spending. Domestic advertising grew less than 1% last quarter. Despite the weaker ad trends, the broadcast networks' new dual revenue streams are stabilizing and even bolstering the bottom line.
Affiliate fees alone represent one-quarter of broadcast and cable network company revenues, expected to continue growing high single digits annually for the foreseeable future, Swinburne says.
CBS' narrowly structured pure-play broadcast business makes the benefits and potential challenges of this new delicate economic balance all the more intense. It wouldn't take much in swift new tech developments or the cyclical nature of broadcast network competition (given NBC's promising signs of revival) to upend CBS' new status quo. All broadcast networks must be wary that their retransmission windfall eventually will be squeezed by pervasive streaming video options and regulators rethinking the value and use of their spectrum.
While News Corp. also expects to achieve $1 billion in annual retransmission fees to offset low single-digit ad growth in the coming years, Rupert Murdoch's empire is fortified by the meteoric value of its sports and film content, cable networks and international sales.
For now, CBS - even with its history of fighting early cable and digital - offers the starkest evidence of the massive shift in revenue sources that is giving the broadcast networks a new lease on life.
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. I have no business relationship with any company whose stock is mentioned in this article.