Diane Mermigas'  Instablog

Cable networks are a sweet spot in a media industry struggling to find its financial footing. They are driving conglomerates' earnings as well as richly priced deals, and will be a growth vehicle for branded content across all digital platforms.

Whether it is Comcast's bid for 51% ownership of NBC Universal or Scripps Networks Interactive's 65% control of The Travel Channel, cable networks are commanding mid- to-high-teens earnings multiples at a time when most media values are in flux.

The complex structure of the Travel Channel deal implies around a $1 billion price that is 14 times 2010 earnings, according to Morgan Stanley. Analysts initially estimated that The Travel Channel was worth between $600 million and $700 million. A proposed $30 billion-plus stand-alone NBCU, to include all of Comcast's content assets, would rely on cable networks for 75% of its earnings, analysts say.  

Cable networks will account for nearly 70% of Time Warner earnings next year, 60% of Walt Disney s earnings in 2009 and 40% of News Corp.'s overall operating profit this year, analysts say.

There are many ways that cable networks will be a catalyst for change:

*Cable networks' established dual subscription and advertising revenues, which generally have been recession-proof, inspire new paid content models.  ESPN and other cable networks, as well as single programs, command the kind of affinity and relevance for which increasingly selective consumers will pay. 

This is no small point considering that the bottom 50% of the U.S. population lacks discretionary income and credit, according to Bernstein Research. That means they are unable to support existing and rising paid-content options, from monthly cable TV and on-demand fees to rising box-office ticket prices and video games.

*Cable networks' economic power is best illustrated in Scripps Networks Interactive, which was publicly spun off from E.S. Scripps more than a year ago. Closing the gap with its peers between its audience and revenues (from advertising and subscriptions) represents a $300 million incremental opportunity, which would be about a 20% boost to 2012 earnings, according to Goldman Sachs analyst Mark Wienkes. Scripps Networks Interactive converts about 60% of its earnings to free cash flow. That allows it to bring $183 million cash to its new Travel Channel venture with Cox, buy up the 31% Food Network stake owned by bankrupt Tribune Co., and invest in international network joint ventures.

*Cable networks will be a catalyst for robust asset sales and acquisitions. Other cable networks and their owners also have cash resources to consolidate cable networks and other content assets.  Scripps Networks Interactive, Discovery Communications, Lions Gate Entertainment, DreamWorks and Sony Pictures Entertainment are among the content compared identified as potential merger and acquisition targets in 2010, according to UBS.

Consolidation could result in the formation of cable-network super hubs. Time Warner has downsized to cable networks and magazines. It has $7 billion in cash (from the spinoff its cable systems) to acquire more cable content after it jettisons AOL by year's end. Viacom, News Corp., Walt Disney and Liberty Media also are buyers.

*Cable networks could provide a way out of deteriorating broadcast networks. For instance, a  new controlling owner like Comcast could opt to convert the peacock network into several more financially viable cable networks supported by both advertising and subscription revenues. It also could seek to relegate NBC TV's sports, news and entertainment elements to existing NBCU cable properties (such as MSNBC, CNBC and USA). Alternatively, Comcast could sell the NBCTV Network and TV stations could be sold to major NBC affiliated group owners such as Hearst, Gannett, Belo and E.W. Scripps.

*Cable networks are providing a template for more affordable program production and faster, more assured return on investment. With more than 90% of all new prime-time broadcast network series never surviving to a second season and hour-long episodes costing into the millions, cable networks have a better way. USA, TBS, TNT and other cable networks judiciously produce series cycles for particular calendar and audience windows. They are not bound by broadcast network prime-time schedules or seasons. Continuously rerunning original programs on-air generates enough ad revenues to more than cover production costs.

Many cable networks, such as Scripps Networks Interactive, have low and controlled production and talent costs on how-to and other evergreen programming. The result is spending an estimated 25 cents per viewer annually to create programs compared with generating 85 cents per viewer in advertising revenues, according to Wienkes.

*Cable networks whose programs have universal appeal and endless shelf life will continue to experience rapid international growth. This includes food, travel and home improvement, as well as news and sports. Global markets will eventually comprise as much as half of cable network revenues in some cases, analysts say. More than one-third of Discovery's revenues come from global markets. Scripps Networks Interactive, whose cable networks had 26% domestic ratings growth in October, generated less than 5% of its revenues from international sources this year and will be seeking to expand globally.

*Cable networks will be conduits for targeted addressable advertising on cable systems through efforts such as Canoe Ventures. Many cable networks are accelerating their use of addressable advertising, interactive marketing and e-commerce, particularly as television morphs into another Internet-connected screen. Opportunities for this in 2010 will include cable operators' TV Everywhere trial and Apple's new e-Tablet and iTV rollout.

Yahoo and AOL could be choice assets to savvy players that are better at integrating and utilizing than Time Warner's debacle with AOL. It may be unthinkable to suggest that AOL should enter a new corporate relationship after an agonizing decade. But it is difficult to imagine AOL -- or Yahoo, for that matter -- flourishing long-term as stand-alone entities, even if they succeed in adjusting to their new business models. Here's why:

*Both companies command valuable online audiences that can be better monetized by a smart partner. AOL's audience is valued at around $1.7 billion, based on Yahoo's audience valuation of $11 billion, according to Credit Suisse analyst Spencer Wang.

*Both companies are limited in value they can create from their audience base over the next five years.

*Including its access service, Wang figures AOL's overall stand-alone value is at least $4 billion. (Compare that to AOL's $161 billion value when it merged with Time Warner in 2000 and its $20 billion value when Google paid $1 billion for a 5% stake in 2005.)

*AOL's total revenues are expected to stagnate just below $3 billion through 2014, when its adjusted operating income (before depreciation and amortization) is expected to decline to about $600 million from $975 million this year, Wang estimates.

*Yahoo's revenues will decline 13.5% to $4.7 billion this year, and average only 4.8% through 2014. Its operating income will decline 11% to about $1 billion in 2009 and grow an average 11% to $1.7 billion by 2014 -- due largely to aggressive cost management, Wang says. Yahoo's $22 billion equity-market cap is the lowest of its Internet peers, half of which is comprised by its 40% stake in Alibaba Group and 35% stake in Yahoo Japan.

Still, Yahoo and AOL have heavily invested in original and third-party content, making them more valuable to larger media players. While both companies continue new initiatives -- such as improved home and search pages, mail, mobile connections and content categories -- none are game-changing enough to do more than generate incremental gains. Yahoo continues its longtime lead in news, sports and finance, while AOL is making good strides with its robust content verticals.

Both companies also are more aggressively pursuing advertisers, especially from newspapers and television. At its first analyst day since 2007 on Oct. 28, Yahoo executives discussed their holistic approach to ad sales targeting audiences across its search, display and mobile platforms.

Yahoo is chasing what it estimates as a $30 billion revenue opportunity by closing the 2-to-1 gap between the amount of time consumers spend online and the amount of ad dollars spent online. But Yahoo's biggest opportunity is outside the U.S., where 75% of its total users generate only 27% of its overall revenues. Less than 3% of its total ad revenues come from emerging markets. By comparison, AOL India -- a portal that eventually may prove valuable -- will continue to be owned by Time Warner.

Clearly, what is missing from Yahoo and AOL is a broader leadership vision of what the companies should look like in five years and how to generate sustainable double-digit growth. All emphasis is on short-term rebuilding.

Yahoo's analyst day was "long on feel-good factor but short on substance and numbers," Bernstein analyst Jeffrey Lindsay writes in a client report. "CEO Carol Bartz started the day on a contrite note, acknowledging that Yahoo had lost the respect of advertisers and investors and was keen to win it back."

That's not a vision -- it's a survival strategy.

Unfortunately, there also does not appear to be much strategic or innovative vision at larger companies on how to use Yahoo or AOL to expand their online content and advertising business. Other media and entertainment companies are unclear about their own futures, thus unwilling to place bets on companies with troubled deal track records.

That doesn't mean AOL and Yahoo won't be acquired or engaged in joint ventures, as they represent scare good-sized publicly traded Internet names with online content and advertising potential.

A lingering scenario is that Microsoft's announced search advertising deal with Yahoo opens the door for a three-way arrangement with AOL. An alliance works even if Microsoft (with $31 billion cash) acquires Ask.com search from InterActiveCorp prior to taking over management of Yahoo search in 2011. The overriding notion is that the three companies could accomplish more working together than individually in search, advertising and content.

Yahoo or AOL also could be a strategic play for a traditional pure content company such as CBS with many overlapping niche interests in news, sports and finance. With CBS' $1.8 billion acquisition of CNET nearly integrated and bolstering the company's coverall Internet profile, a Yahoo or AOL acquisition or alliance could be a surprisingly good fit.

Such speculation will accelerate if Comcast successfully acquires a majority stake in NBC Universal from General Electric. The $35 billion deal, which could be announced by mid-November, hinges on French-owned Vivendi getting enough money from GE for its 20% stake in NBCU.

The willingness and need of Vivendi and GE to unload their relative stakes in NBCU, despite plummeting valuations, could have a domino effect in a 2010 deal market expected to be led by traditional ad-supported media and the Internet.

UBS estimates some 200 media and tech-related companies are targets for acquisition or partnerships driven by economic recovery, accelerating legacy structure pressures for established players, consolidation cost savings, and the need for private equity and other investors to cash out.

The list of likely global deal candidates is topped by DirecTV, DreamWorks, Netflix, Scripps Networks, Take Two, and ValueClick. The list also includes AOL and Yahoo.

Broadcast and cable TV are under siege by the very interactive digital technology that will extend their profitability. Television networks are finding it difficult to aggregate large audiences that generate ad revenues and fees to underwrite production. New platforms like Hulu could possibly help to ease that financial imbalance. However, the longer the ad-supported video hub remains free, the more it contributes to television's demise, according to a new report by Soleil Securities analyst Laura Martin. Her arguments and math are clear-cut.

Annual domestic TV ad revenue is about $65 billion and video subscription revenue is about $120 billion. The overall market cap of media companies participating in the TV value chain is an estimated $330 billion, Martin says. All is at risk due to a variety of factors, including $600 million in value transferred to Hulu by its owners -- General Electric's NBC Universal, News Corp.'s Fox and Walt Disney Co. -- for which they receive no payment.

For instance, unbundling the content from respective TV networks to allow Hulu consumers to cherry-pick shows discourages them from paying cable, satellite or Telco subscription fees, which in turn subsidize retransmission payments to broadcast networks. It also further diminishes TV viewership that is used to price and sell advertising time, which ultimately reduces ad revenues.

That chain reaction undercuts the networks' practice of securing advance payments to finance the creation of all TV programs (both hits and flops), either through upfront advertising commitments or affiliate fees paid by cable operators. "When content is moved to the Internet, risk moves to the content company. The consumer only watches the hit programs after they are produced and does nothing to fund the non-hit shows," Martin says.

The longer consumers get used to not paying for the convenience of free, on-demand Web viewing, the more difficult it will be to recondition them to pay for content. Only a mass platform can create a hit that can be monetized across other platforms, Martin observes. But the only way to recreate a mass audience in today's digital marketplace is by creating a uniform distribution ecosystem that preserves the content price/value to customers across all platforms -- from TV to Internet-connected PCs and smartphones.

Some Hulu rivals are trying. CBS' TV.com sells its aggregate viewers for programs regardless of where they are watched at the same network CPM of $35. Cable operators' new TV Everywhere will allow authenticated pay TV subscribers to password access subscription content on any platform or device for no additional fee. The Apple Store and iTunes sell content for an on-demand fee.

With nearly 40 million unique visitors and nearly 500 million online streamed videos in August, Hulu needs to establish its place in the emerging paid content ecosystem. Having set the gold standard for an easy and efficient online experience, Hulu has leverage to institute select content fees and possibly increase ad inventory.

Hulu offers just two ad slots that bookend the streaming video, compared with an average 16 30-second spots per half hour show on network TV. It has a willing domestic Internet audience, 82% of which viewed at least one monthly online video. The average single viewing for Hulu is one hour and 17 minutes compared to the average online video of 3.7 minutes.

But Hulu's economics are not taking advantage of that positioning.

Hulu has an estimated $200 million in direct costs for sales and marketing, research and development, bandwidth and general administration. In 2009, it will generate about $166 million in ad revenues -- three-fourths of which is paid back to its content providers, leaving it with $33 million in losses. There also are bigger hidden costs associated with Hulu, Martin contends.

For every 1,000 viewers who substitute the PC for the TV, Hulu's owners (NBC, Fox and ABC) lose $920 in ad revenues. That would amount to $425 million in lost revenues (at current user rates) in the unlikelihood that all viewing of network TV shows featured on Hulu transferred to the Web, per Martin.

As more viewers flock online, the broadcast networks especially will scale back the nearly $3 billion each spends annually to create high-quality programming, more than 90% of which never survives. One such cutback is NBC's decision to move Jay Leno to prime-time weeknights, since it costs less to produce than the scripted drama it replaces.

Because content on Hulu is not stamped with the screen logos of their originating networks, Martin estimates that about $3 billion of brand value is at risk at each of NBC, Fox and ABC when they move their most popular programs there. Such quantifiable and unquantifiable potential hidden costs could blow a hole in the media conglomerates' $330 billion TV value chain. It's happened before: The destruction of 80% of the market cap of newspaper and music companies in their botched transition to digital, she said.

Martin's report underscores the economic risks and challenges involved in the creation and transfer of value from traditional to new digital platforms. And her solution is correct: A distribution ecosystem must encompass consistent content pricing across all platforms and devices to preserve and grow value.

That involves a multitude of considerations and actions that can't begin too soon, such as the creation of new measurement and metrics, integrating social networks and users' personal relevance into the equation, and creating a new price/value proposition for marketers based on consumer targeting and e-commerce. Since three media giants have complete control of Hulu, they can begin the heavy lifting.

Original Post at Mediapost

Diane Mrmigas does not directly own media or Internet stocks.
 

One of the few calculated risks worth noting is NBC's move of Jay Leno from late-night to weeknights at 10 pm EST, which is the most pilloried maneuver this fall. Although it has cost the General Electric-owned NBC TV network and many of its affiliated stations double the steep ratings losses of its rivals in that pivotal time slot (a decline of about 33%), it is a risk that could have financial upside regardless of the talk-show's continuing performance.

The full year of "Leno" that NBC has committed to will cost less to produce and market than the original hour-long drama it replaces. Already a proven commodity, "Leno" is likely to generate higher advertising revenues and profit over time, regardless of early missed ratings guarantees, although the show will be useless as a syndication option.

The bigger gamble for NBC owned and affiliated TV stations -- which depend on a strong "Leno" lead-in to their late local news -- is probably worth taking. All TV broadcasters are overdue in rethinking local news production and economics in an era of 24/7 digital news. NBC has the opportunity to recapture some of the viewers abandoning its last hour of prime time -- and generally not fleeing to rival broadcast networks, according to Bernstein Research -- by aggressively innovating online with interaction between Leno and his fans.

Indeed, all four broadcast networks are missing a major economic opportunity to experiment more online and in wireless mobile with creative and financial models that will define their future.

The $2 billion less in upfront advertiser spending (nearly one-quarter of the broadcast networks' prior year's take) was not only a byproduct of the recession. It also signals the steady shift of dollars to digital and advertisers' reluctance to automatically invest it all in broadcast TV.

Broadcast network revenues and the ratings estimates have become so anemic that the risk of trying something different can only bring improvement. It is a counterproductive ritual: Three weeks into the new season, Big 4 have declined another 4% in key 18-to-49 viewers (NBC and Walt Disney-owned ABC each are down about 10%, News Corp.-owned Fox is down 6% and CBS is down 1%). Better than 90% of new programs will fail. Clearly, prime time's diminishing returns suggest it is no longer a gamble to change the broadcast business model.

Consumers' increased willingness to watch television programs and advertising on Web-connected devices means that giving it away for free, with weak returns, doesn't make much sense.

A recent survey conducted by Bernstein indicates that many consumers are willing to pay $1 per television show and $5 per movie viewing online and on their connected devices. The broadcast networks have the capacity to do more with a pay-for-play business model -- not unlike what has worked for them on Apple's iTunes -- using their online Hulu.com platform.

As Bernstein analysts point out in an insightful new report "Web TV: Friend or Foe?" a selective paid access option on Hulu would be formidable competition to cable and to Google's YouTube (leading online video with 1 billion daily views). Hulu should leverage its position as a dominant online ad-supported aggregator with an exclusive lock on long-form content for three of the four broadcast networks.

It would establish new forms of interactive content and paid access. Plus, it would move advertising from a static pitch to a fluid interactive marketing and commerce relationship with target consumers on various platforms.

NBC, ABC, CBS and Fox cannot get there from where they are today -- touting the rise and fall of their diminishing prime-time foothold. Whether they think online options cannibalize their deteriorating broadcast audiences, ancillary library values or local station monetization doesn't matter; they are all declining businesses.

For instance, Fox's "Simpsons" provides a perfect opportunity to test new forms of online marketing geared to its broad global following. Analysts like Bernstein compare broadcast advertising revenues (an estimated 54 cents per viewer per episode) with ad revenues generated on Hulu (an estimated 18 cents per viewer per episode) and assume that increasing the online ad load will deliver revenue parity. A better alternative is to create entirely new forms of advertising and marketing better suited for interactive consumers, and therefore, more likely to command a premium price.

That's a way for Fox and other broadcasters to buy into the online advertising growth that is powering Google's record earnings. Here are other strategic risks the broadcast networks should take:

*Create interactive connections between select advertisers and their target consumers. Broadcasters can charge a facilitation fee, rather than slapping TV commercials online.

*Selectively charge consumers to download popular TV episodes from Hulu.

*Build social-networking elements into Hulu using Twitter and Facebook.

*Launch other new low-cost, innovative content in prime time. "American Idol" works thanks to real intrigue around real people.

*Use prime-time TV as a creative platform to introduce and develop new content that can morph into paid shows online.

*Work with major cable operators to minimize the damage their TV Everywhere experiment in usage-based pricing is likely to have on broadcasters' free lunch video economics and consumer expectations.

Original Post on Mediapost

Diane Mermigas does not directly oiwn media or Internet stocks,