Equilibrium in TV Deal Making Gives Way to Fear-Driven Chaos

Laura Martin, managing director & senior analyst, entertainment & Internet,  Needham & Co.

Laura Martin, managing director & senior analyst, entertainment & Internet, Needham & Co.

By Fred Dawson

July 16, 2012 – There may not be much in the way of avant-garde programming on the tube these days, but the TV industry itself has now become what promises to be a long-running homage to the theater of the absurd.

The latest developments in head knocking over distribution fees and broadcast rules make clear that intensifying fears of the unknown, high-stakes bets on highly uncertain outcomes and a murky regulatory regime that has pushed things into a surreal twilight zone will undermine efforts to adjust to new market realities for a long time to come.

Cases in point on the regulatory front:

• U.S. district judge Alison Nathan, in denying broadcasters’ request for a preliminary injunction barring online retransmitter Aereo from offering its service in New York City, asserts the technology workaround Aereo developed to avoid infringements of the Copyright Act is likely to pass court muster once she gets around to a final ruling on the broadcasters’ suit. Nathan says the 2008 U.S. appeals court ruling that declared Cablevision’s proposed network PVR service is not a purveyor of “public performance” as defined by the act probably applies to Aereo’s service as well;

• The Justice Department’s recently launched investigation into whether the bandwidth cap and other policies of MVPDs (multichannel video programming distributors) are illegally limiting competition from online providers comes amid FCC preparations for a possible rulemaking that would declare OTT providers are themselves MVPDs;

• Current MVPDs are discovering the only way they can get rights to delivering their premium channels to subscribers’ IP-connected devices is to distribute that content over their managed networks rather than the open Internet, thereby avoiding categorization of the service as Internet based. But this runs afoul of OTT lobbyists’ contentions, and the sympathetic reception those contentions are getting from the feds, that such services are treated with favoritism by virtue of the fact they use broadband access bandwidth rather than the traditional channel bandwidth assigned to pay TV services.

Say what? But that’s just the regulatory side. On the business side we have these latest developments, among many others, to confirm we’re not in Kansas anymore:

• As rising program license fees drive MVPDs’ rate hikes ever higher, non-subscribers point to costs as the main reason for not signing onto premium services, knowing most of the shows they want to see are readily available free or a la carte from the very people who claim the only way they can cover production costs is by getting more money from MVPD subscribers;

• DirecTV has refused to renew its distribution contract with Viacom on terms acceptable to the programmer, resulting in at least a temporary blackout of Nickelodeon, MTV, VH-1 and other networks by DirecTV as Viacom removes from Internet distribution recent episodes from these channels in response to DirecTV’s referral of unhappy subscribers to the availability of such programming online;

• As TV networks walk the fine line between driving viewership online and preserving the pay TV fee model they’re discovering time-shifted viewing of their programs is having a measurable impact on whether a show is considered a success or failure (The New York Times reports NBC’s show Smash, considered a flop based on initial ratings after its spring debut, was actually tied for the top spot among 10 p.m. programs viewed by people 18 through 49, taking into account just DVR playbacks and not VOD or online distribution);

• As previously reported (March, p. 1, May, p. 14), major programmers are ramping up OTT strategies, with plans to deliver multiple niche channels in live streaming mode utilizing content not restricted by first-window rights on pay TV channels in hopes of creating new ad revenue and even subscription opportunities.

One new clue to the growing embrace of OTT by established TV programmers is the newly announced multi-year agreement between two Comcast units – NBCUniversal and Web publisher thePlatform – which adds to the number of NBCU-owned networks using thePlatform’s mpx video management system to reach viewers on PCs, tablets, and other IP-connected devices. USA Network, Syfy, and Oxygen will join current system users E!, NBC Local Media, NBC Sports Regional Networks, Sprout, Style and the Golf Channel, says Marc Siry, senior vice president of digital products and services at NBCU.

Noting thePlatform was selected after rigorous review of all options, Siry says, “NBCU is committed to staying at the forefront of innovation and providing our customers the best entertainment options across any screen. Given the independent needs of our programmers, thePlatform provides us with proven flexibility and enterprise-grade reliability that will benefit us across our organization.”

Comcast, with bets placed across the ecosystem, is clearly committed to supporting whatever works to drive success among its various holdings. Whether or not this turns out to be a zero-sum game remains to be seen.

But industry wide the chaotic state of affairs is causing havoc on the deal-making front. As evidenced by a recent spate of brinkmanship dealings between MVPDs and programmers, the historical perspective that the big picture is all about mutual interests is giving way to distrust and a growing fear on the part of MVPDs that the regulatory deck is stacked against them.

“How,” asks a senior cable MSO executive, speaking on background, “can anybody do a long-term deal under these circumstances? Half the time, the people we deal with at the affiliate contract level are clueless about what’s really going on with their companies, other than they have marching orders to squeeze more money out of us with the old refrain that costs are going up. Well, fine, so we’ll cover your costs to eat our lunch.”

Such thinking completely misunderstands the programmers’ point of view, says a network executive, also speaking on background. “Nothing has changed,” she says, “other than the fact that the opportunities for all of us to increase the pie through smart use of the Internet are growing, which makes things a little more complex. But contract negotiations have never been easy.

“You may have noticed,” she continues, “there haven’t been a lot of suits trying to stop the latest cable TV Everywhere strategies, and that’s because programmers in general have made a conscious decision that TV Everywhere is good for all of us. Nothing we are doing or will do online is intended to cut into our pay service fees; it’s all about driving more revenue.”

Setting aside the regulatory uncertainties, there does, indeed, seem to be ample opportunity for both sides of the pay TV divide to benefit from the explosion in video consumption on connected devices. Buttressing the upside perspective, Needham & Co. analysts in January projected that TVE services stand to add close to $12 billion in annual revenues from advertising and enhanced services subscription fees for U.S. cable, telco and satellite premium TV service distributors within three to five years.

The report, prepared by Laura Martin, managing director and senior analyst for entertainment and Internet, and Dan Medina, another analyst for entertainment and Internet, predicted advertising would add $10 billion and subscription fees $1.7 billion to the MVPD revenue pool, resulting in a capitalization value expansion of $24 billion-$48 billion within five years. But, in a report issued in June, the analysts made clear the risks MVPDs face from various factors, including regulatory changes and Internet competition, could undermine their prospects despite ongoing indications that the bundled service value proposition is an overwhelming winner with consumers.

Citing federal initiatives and investigations “mostly aimed at the distribution sector of the TV ecosystem,” the authors caution, “Everything affects everything: All parts of the TV ecosystem rise and fall together. If any part is damaged, the entire ecosystem is negatively impacted. For example, the rising uncertainty surrounding potential governmental intervention raises the cost of capital for all TV participants.”

Martin and Medina cite three areas where “[e]ven with the best intentions, government interference in the TV ecosystem adds risk of negative unintended consequences.” A government action that undermines the economic framework that supports the efficiencies of bundled service distribution in favor of a la carte modes could result in a loss of one million jobs in the TV ecosystem, destroy the economic foundation for about 125 TV channels and destroy three fourths or about $300 billion of market value, they say.

On the Internet front, obviously government intervention in the direction some OTT lobbyists are advocating would heighten the threat to MVSPs. But even without such intervention, the analysts acknowledge there’s a potent threat.

Noting that Internet power houses have committed hundreds of millions of dollars to develop original content in an environment where new content is badly needed, they say, “YouTube, Netflix, AOL, Yahoo, Hulu and several others are creating a parallel high-quality video business on the Internet. If they work together to solve several tactical issues, we are optimistic that they can unseat the TV ecosystem over time.”

How all the interests competing for high-quality content will be able to shape distribution agreements in the months ahead is anybody’s guess. But given the fact that assumptions that have long been the foundation for doing business are no longer operative, no matter how much individual players may wish they were, there’s a strong likelihood the mutual antagonisms will intensify, bringing about the much-feared disruption much faster than many would like as different players place their bets with the strategies they believe are most likely to succeed in the wake of the demise of the old foundation.