Lack of Clarity on OTT Monetization Strategies Combine with FCC Actions to Sow Confusion
Chris Winfrey, EVP & CFO, Charter Communications
Upheaval in the pay TV industry has made the job of providing guidance to investors harder than ever for Wall Street analysts. There’s not only considerable disagreement over who has the upper hand, MVPDs or broadcasters. More fundamentally, there is deep concern over how FCC regulatory initiatives are going to impact the health of the industry and its ability to sort things out in an intensely competitive environment.
Just how difficult it has become to weigh any entity’s prospects was evident in a discussion involving leading investment analysts and Charter Communications CFO Chris Winfrey at the recent INTX Show in Boston. The following edited transcript of that conversation offers their take on where the bundle is going, how far the broadcasters will go in pursuing direct-to-consumer business models, what the impact of Google Fiber will be, the future role of wireless and many other issues in the context of the new regulatory environment.
Participating with Winfrey were: Jason Bazinet, managing director, Citi Research; Craig Moffett, partner and senior analyst, MoffettNathanson, LLC; Marci Ryvicker, managing director, Wells Fargo Securities, and Ben Swinburne, managing director, Morgan Stanley
Chris Winfrey, EVP & CFO, Charter Communications – I want to ask each of you to give us your broad assessment of the overall health of the industry. And, in particular, from a financial perspective, growth and protected earnings, what’s your favorite platform right now – whether that’s satellite, cable, programmer, content production, OTT – and why?
Jason Bazinet, managing director, Citi Research
Jason Bazinet, managing director, Citi Research
– I’m going to distinguish between favorite stock and favorite platform, just to make that clear. I don’t think it’s controversial on the Street to say that the satellite operators are in real trouble without broadband. There’s the most concern on the buy side about their growth prospects. So I think you have to put that at the very bottom.
At the very top I would probably say content owners, but it depends on what sort of content you’re talking about. I’d put at the very top anyone that owns sports content. And probably in the middle I would put the cable operators.
The way I think about the cable operators is they may not have the most robust growth prospects, but it’s very stable and largely hedged from a lot of the changes that are going on in the ecosystem. You have a great Internet business, a very robust small-medium enterprise business, a video business that probably faces some challenges but, I think, manageable in the broad scheme of things.
Craig Moffett, partner and senior analyst, MoffettNathanson, LLC
Craig Moffett, partner and senior analyst, MoffettNathanson, LLC
– I think the cable business right now is actually in a pretty good spot with a very big caveat, and that is, as former [FCC] chairman [Michael] Powell [now president and CEO of the National Cable and Telecommunications Association] said this morning, there are some very real regulatory questions that have suddenly become much more pressing. Leaving aside the regulatory or at least marking the regulatory as a question mark for the moment, I think the cable industry is probably in the best position.
We’ve [heard] for a long time this old adage content is king and distribution is just a commodity. Historically that has always been a good sign to say, well, I’ll take the distribution, thank you very much, and it’s usually worked out pretty well. Distribution right now is in a pretty good position. On the content side of the world, it’s a little less my coverage, but I think I’d rather be a studio than a programmer at the moment.
Marci Ryvicker, managing director, Wells Fargo Securities –
Marci Ryvicker, managing director, Wells Fargo Securities
I’m a cable bull. I would choose cable over media any day.
I’m going to disagree already with Jason. I actually think sports content providers are in a very, very difficult position, because they have a multibillion-dollar, multi-year investment cycle. And as we go over the top and a la carte and skinny bundles, if they’re not included, that affiliate revenue goes down. And I don’t know how they ultimately match up the sports content. So I would put those guys towards the bottom. I think cable with the pipe is where I’d want to be, as a platform, as a stock, because no matter how you monetize your content you need your cable in your home.
Ben Swinburne, managing director, Morgan Stanley –
Ben Swinburne, managing director, Morgan Stanley
I guess I’d add a little nuance to Jason’s point. I’m not sure he was talking about sports networks or sports IP (intellectual property), but I would go with IP and sports. You want to move as far upstream as you can in this environment. There’s an explosion in distribution platforms, and it’s hard.
If you had asked us about stocks, we wouldn’t be able to answer content players’ IP [intellectual property] because it doesn’t really exist as an assessment vehicle. But if I could snap my fingers and own the Red Sox, I would do that. I think that’s the appreciating asset with the most secure future, given the landscape today, than anything else that you’ve asked about.
Winfrey – That’s an interesting way to get into the next question I was going to ask, because if you think about it, there are really big changes in content afoot right now, whether it’s a change in the landscape for who’s buying the studio output or in some case who’s buying the studios, short-form and user-generated content, or consumers who are now conditioned to view content from different places and without advertising. A lot of balls are up in the air. So from your financial perspective, where is the content market heading and how do content players across that ecosystem evolve, and, to make it more complicated, how do they make sure they have a revenue stream that’s protected?
Swinburne – I’ll pick up on the comment I just made. If you think about distribution more broadly than we have historically, you could look at Facebook as a big distribution platform of content. Most of that content historically has been what your niece and nephew are up to, but that’s quickly evolving into live video. They have a sports piece, etc.
I think you’re going to see more and more platforms leverage content to drive their business and use it as a loss leader, and that’s going to drive margins down for the historic program aggregators. If you think about your typical cable networks who have enjoyed this beautiful bundle generating 40, 50, 60, sometimes 70 percent contribution margins, you’re now facing a world where you’re competing for audience, advertising dollars. And also you’re competing for IP and content with so many more players than you did before who have a lot more capital and often have the permission of Wall St. not to make any money for the foreseeable future.
That’s going to squeeze margins in that part of the ecosystem over the long term – we’ve already seen that start, and I think that’s going to accelerate. If you can figure out how to play that trend as a piece of IP, I think that’s a great place to be. But it’s very hard to find that space if you’re an operator. The reason the cable business is so obviously, as a consensus view, doing so well is it has that connectivity piece of the puzzle that’s very difficult to compete with without a lot of capital.
Winfrey – So you’re suggesting that having the distribution but adding some unique content even potentially as a loss leader is a way to offer something else for customers.
Swinburne – Yeah. We’ve seen that happen outside the United States already pretty dramatically in use of content in a mobile setting where mobile carriers are using content to differentiate their product. That’s going to happen here. We might all chuckle at [Verizon’s] go90, but the go90 concept of using content is to differentiate, I don’t think that’s going away. I think you’re going to see a lot of money thrown at that, successfully or unsuccessfully.
Ryvicker – I think we’re just at an early stage of experimentation [with] content providers going all over the place. I think Fox was very clear on their [earnings] conference call that they want to be everywhere the consumer is, and I don’t know that they know what that means. So we’re sitting here trying to figure out what does the ecosystem look like five years from now and assign a multiple to stocks, and you really have no answers.
Winfrey – That sounds a little bit dangerous. Not to pick on one particular company, but if you have people saying I want to be everywhere in everyplace in every home, but they don’t have a view of exactly how it’s going to be monetized and how they protect their revenue streams and the advertising, where does that leave you in terms of feeling about the ability to model the revenue stream, and what are the ups and what are the downs, and how do they mitigate them?
Ryvicker – It’s a tough fight. You can see it by the stats. You can see why Fox’s stock slid. I don’t mean to pick on them, but they were very clear that they want to be everywhere, and that stock went down on a good print, because the question was, okay, you did really well this quarter, but what happens in the transition from where we are today to wherever you want to be? And that’s what we can’t answer.
Winfrey – As an operator’s translation, print means their quarterly results.
Moffett – It’s a really interesting question, because I hear from investors all the time that the cable industry is in real trouble because they have these big fat margins in video, maybe less fat than they used to be, but they still have all these margin dollars in video. Inevitably the content owners will go direct to consumers and try to keep that margin for themselves. I’ve heard that argument since it became the key controversy in the cable industry at around 2004. And I always scratch my head and say, what in the world would that look like?
Winfrey – From the consumer perspective or from the programmer’s?
Moffett – From the programmer’s perspective. Let’s say there’s $40 for argument’s sake of programming cost in the bundle, and let’s say they bring the price down to something, not all the way to $40, but they’re entirely made whole. Well, what does year two look like when they’re typically used to pushing a 10 percent price increase through to distributors on a like-for-like basis?
Are they going to push a 10 percent price increase through to consumers on a like-for-like basis? You do that for three years, and suddenly the economics look horrible. Is that the model? I’m going to create a new Netflix that raises its prices by 10 percent a year?
Winfrey – With or without advertising.
Moffett – And, by the way, at a time when the advertising is going to start to come down.
Those things look good as a sort of bumper sticker as long as you don’t poke at it. When you poke at it you realize this is really squishy. It doesn’t hold up to scrutiny very well as a premise.
As I said, I’ve been hearing that same argument since 2004 that it’s right about now that it’s coming. And maybe Hulu is the thing. They certainly have access to programming rights because of who owns it. If they decide that’s what they want to do, they can get the rights packaged together. But I’d love to see what the spread sheet looks like that says this is a good idea.
Winfrey – Meaning, this is the way you actually get dollar increases?
Moffett – Not only net dollar increase on day one, but net dollar increase in the terminal year of whatever that spread sheet looks like. It’s a hell of a challenge.
Bazinet – I don’t think it’s challenging.
Winfrey – So you’re a believer. Tell us why.
Bazinet – Let me step back just to give you some context in terms of how at least I think we got here. Everyone in this audience has a different utility that they would ascribe to their particular channels. Maybe you like ESPN; maybe you like CNN. Maybe you like podcasts. It’s all different.
What the industry has done – your industry and the content owners – is they’ve pushed all that content together into a big fat video package and essentially taken very steep demand curves and made them quite flat. If I put enough stuff in the bundle, everyone essentially has roughly the same utility for that content.
What we’re all struggling with here on this stage, and it’s the crux of the controversy that I have with Marci, is where is the value? Where does it really reside? We really don’t know today.
What I would posit is that for sports content, yes, it’s the most expensive part of the cost of goods for a cable company, but I actually think there’s a tremendous amount of headroom in terms of what consumers would pay for that piece of content.
Winfrey – When you say that, are you multiplying it by the percentage of consumers that would actually take the content? Or are you saying the retail rate would go up on those who do?
Bazinet – The retail rate goes down. The number of consumers that take it will be a subset of the total universe. But by pivoting from wholesale economics to retail economics, getting rid of equipment lease fees, getting rid of DVR lease fees, it leaves a lot of headroom.
Moffett – Adding customer service centers?
Bazinet – Adding customer service centers.
Winfrey – From a cable operator’s perspective, I actually hope you’re right. It would give us the opportunity to do what we’ve always wanted to do, which is to build genre-based bundles and packaging. But it does mean a complete breakdown of the economic model for programmers. That has to be scary.
Bazinet – So I would say on this platform question it’s impossible to stand up here and answer. Is it a content packager that’s in good shape or not? Because what we’re going to see is some of the packagers are in good shape and some aren’t.
Moffett – The question that always comes back to me is, find me another model that’s better than ESPN saying I can get $7 for every family in America who chooses not to take my product. Where else can you replicate that?
Bazinet – Well, I would just say using your $80 ARPU/$40 cost of goods, $7 from every household on a wholesale basis is $14 for half the houses. I see that as headroom.
Ryvicker – But it’s not $7, because what Disney does with ESPN, they have a whole bunch of other networks. It’s actually $11.24. And then if you have the average, the 30 million viewers on a unique basis every month with ESPN, those guys are going to have to pay $33 a month.
Winfrey – So the ecosystem is changing. It sounds like there are different views of where it’s all going to land. It’s going to be fun to watch.
In the meantime, we’ve heard the death of pay TV for many years now, that this change in landscape was going to cause a falling apart of the ecosystem. But if you take a look at 2015, there wasn’t a meaningful decline in pay TV penetration yet.
So what does it tell you despite all the things we think are happening and the consequences that could be for different players in the industry? What’s the play about the pay TV business as it stands today? And when do you think we’ll really start to fundamentally move away from that in a material way?
Bazinet – I think it’s happening. The typical buy sider would say one to two percent cord cutting is sort of the generic answer you get from those clients. I don’t disagree with that. It was about that rate on wireline voice, and it lasted for about five years. And then it accelerated to three, and it accelerated to four. I don’t see why that’s not a reasonable outlook for the business.
Swinburne – It’s definitely happening. I guess the only nuance is how we define pay TV is the biggest challenge to answering your question. Just look at the fully distributed cable networks, your VH-1s, ESPNs, CNNs. They’re losing two, three percent of their subscribers already.
If you look at the pay TV universe, it looks pretty flat. But the subscriber counts for the networks are declining much faster. And that’s a function of the shrinking bundle, shrinking of root networks. We went through a 30-year period of adding more and more channels to the legitimate scenario. [Now] we see real reduction in the number of networks that the consumer has access to.
Winfrey – Because of viability.
Swinburne – Yeah. It seems like the media companies are reaching that conclusion, that having a small number of strong networks is preferable to having 20 plus.
Winfrey – You’re jumping to something else I was going to ask. Maybe you’re saying it’s just a fait accompli. But do you see any skinny bundles out there that you think work for the mass market and that have the ability to be sticky and to gain real customer counts and market share? And attached to that, do you see the opportunity for a lower number of channels billed that sits inside of that baseline program that MVPDs can sell, meaning you have a baseline that’s smaller so that you can sell more and tack on other genres?
Swinburne – My sense is in the last 12, 24 months there’s a pretty dramatic shift in the media companies’ perspective on this topic. Years ago it was we’re absolutely not doing a deal unless you carry everybody. Now it’s how do we make this work so that I can at least keep most of my economics.
I thought of [Discovery Communications CEO] David Zaslav on the last earnings call for Discovery. He made a really interesting comment. His top six networks are X percent of his earnings – I think it was 78 percent – I’m not quoting exact numbers. But he said this specifically: we as an industry are going to have to make some compromises.
Thirty channels for $30 isn’t going to work with every network. I think that’s the reality today. That’s going to lead to more and more flexibility for the MVPDs and bundling. And I think we should give some credit to Mr. [Charlie] Ergen for pushing the puck down the ice.
The Sling TV idea was generally mocked when it was first announced. I think Disney sort of suggested, well, no one is really going to want this – you mentioned mass market – it’s niche. And maybe it is niche. I think Sling is niche.
But what Sling started is not niche, at least in my view. You asked about the mass market demand for the new bundle. It’s impossible to answer what the real utility value of video is inside the triple-play bundle – you know, $85 video ARPU. That number seems increasingly made up.
I don’t mean it in a nefarious way. Broadband is such a big part of the value the consumer sees. If you call your cable operator or telecom operator and ask for just broadband, and it’s 80 bucks and video plus data is $75, what is the value of video in that bundle?
Winfrey – What do you think the timeline is for an MVPD that has a discussion with a programmer and starts to have some flexibility to be able to pick and choose, maybe not without limits, but has the ability to put together packages the way it thinks is going to sell the best in the marketplace? And how does a programmer economically rationalize that in a way that they have a glide path for what they’re doing in terms of revenue today?
Ryvicker – It’s starting now. We only really have numbers, sort of, for Sling. Comcast is doing something. Charter is doing something. Everyone is trying to come out with smaller bundles.
I think what’s really interesting is Intel fails, and Apple is nowhere. So that just tells you something about the relationship between the incumbent provider and the programmer. I think that as long as there’s flexibility among the two parties and they’re both there for the same purpose, to make money and provide for the consumer, we’ll start to see it happen.
I think one of the reasons Sling was really successful – think about what Sling was. It was one stream, one device. So there was no threat that a family downgrades to this product. It was more for the cord-nevers, the millenials.
Winfrey – But that is changing.
Ryvicker – That is changing, which is really interesting. Even Disney, Bob Iger, said on the call, we are having conversations that are productive with the multi-stream, which you never would have thought someone like Disney would be involved in, because that may actually lead some people to downgrade.
We still think it’s part of the common experimentation. Everybody is experimenting. They seem to be experimenting together within the ecosystem, which means, at least to me, that it’s a net positive.
Winfrey – The rumor on the Street is that some of these agreements have subscriber ceilings, which is designed to protect. But is the genie now out of the bottle, and how do you put it back in from the programmer’s perspective if you have something that’s working in the marketplace? And, from a regulatory standpoint, how do you put it back in, if that’s generally what the consumers wanted because it leads to something that’s a more affordable product set? How are they able to balance those thoughts? And did they ever really intend to hold people accountable to the subscriber limits that were in theory put in place?
Swinburne – I think you answered it in your question. I’d be surprised if those agreements actually impacted what happens on the field.
You bring up the regulatory issue that you’ve eliminated consumers’ choice. That starts to taste bad for everybody involved. It reminds me a little bit of, instead of the ceilings, the floors we always talk about for network subscriber numbers. Are you hitting your floor? Is that good?
Well, no. People actually don’t like your service; it was actually bad. And, ultimately, as negotiations rumble on over time, things reach a market equilibrium.
Ryvicker – You could have asked the same question on Netflix. They [the programmers] let the genie out of the bottle. They sell a lot of content to Netflix. Now people are watching prime TV, and we’re not getting paid as much.
Winfrey – Beautiful feed into my next question, which is how much of this content are people really paying for? One of the things that we spend a lot of time worrying about, thinking about at Charter, isn’t that you have to deal with paid competition, but the fact that in many cases we think we’re dealing with free competition, because it’s been the content that has been placed sometimes for free, sometimes at lower prices, many times unbundled, and many times without a brand and usually without advertising. And it’s also put in an environment that’s not authenticated; it’s not encrypted.
So you’re fighting in terms of selling cable subscriptions against free. And that makes it pretty challenging. At the end of the day it hurts us. But I would argue it hurts the programmers every bit as much as it hurts us.
Why do you think the security topic, the password sharing, hasn’t gotten more air time? It hasn’t really created more concern and, frankly, so far has been perceived a little bit as a joke on the side. But the reality is that those are paying dollars that are going out the door and not paying.
Moffett – My own theory, and it’s sort of dispiriting, is that we’re responsible and that the pressure on media companies – and, look , I get to say this because I don’t cover the media companies, so it’s easy for me to say – but the pressure on media companies to meet the expectations of their shareholders to say that we are at the avant garde of selling our content, that we are actually participating in the ecosystem and capturing advertising, that we are competitive with Google and Facebook in the ad community and what have you, creates this tremendous pressure where it’s just not acceptable to say, you know what, some of this is a dumb idea and that actually protecting the existing ecosystem is a better model.
You’d be laughed out of the corner office if you said that even if it was the right answer. And so it’s very difficult if you’re managing one of these businesses to try to be steadfast in saying, until we find something better, we’re going to stick with our existing distribution model. It doesn’t fly.
Winfrey – All four of you speak to media companies all the time, some more than others. How often does the topic of security and encryption come up in those conversations?
Swinburne – Never.
Winfrey – Marci?
Ryvicker – I can’t remember one.
Winfrey – Craig?
Moffett – I don’t talk to the media companies as much, but it’s very rare that it comes up in those discussions. It does to some extent, but not frequently.
Bazinet – Certainly not in earnings calls. But it does come up with them when you meet with them one on one. The general response is, we’re just in the experimental phase; we’re just marketing.
Winfrey – We’re getting free eyeballs. We’ll put the genie back in the bottle later.
Let’s talk a little bit about competition for cable – back to cable a little bit out of the ecosystem around programmers. There is competition coming for cable whether it’s in the form of Google Fiber or whether it’s in the form of wireless.
For many years we’ve been debating what is the key objective for Google Fiber. Are they multiple objectives? Are they fallback objectives? Or is it really just an experiment? Where do you think Google Fiber is now in terms of the broader rollout?
Bazinet – We struggle with this question. The only thing I can tell you is we sort of rank ordered 30,000 municipalities by population density. We used whatever Google is charging in some of their markets as a proxy. We asked a simple question. What penetration would Google need if they’re willing to have breakeven economics, zero NPV (net present value)?
And [the calculation] said they could pass half the United States, where it was neither so urban where FiOS is already there and you wouldn’t get 50 percent penetration, so it would be a three-player market, nor was it so rural that you’d have to have a penetration more than 50 percent to get zero NPV. Intriguingly, in all the real markets, they mapped against that 50 percent of the country where they could earn zero NPV.
So it at least suggested anecdotally that Google isn’t throwing darts at a map to decide where they’re going to go. There is some logic behind it. But what their overall motivation is, I have no idea.
Moffett – It’s pretty obvious now. Remember the bakeoff that led to Kansas City started in 2010. We’re now seven years into this, and they are far behind where a typical overbuilder would be.
So it’s pretty clear looking backward over seven years, if their ambition were how many homes can you pass and how many subscribers can you get, this ain’t that. So it’s something else.
That doesn’t mean it can’t change later. But if you look at what they’re doing – in Kansas City there was largely feeder plant that existed that was built by the electric utility, and they’re building their own drop. In Provo they bought a network for a dollar and they’re going to market it. In Huntsville, Ala. they’re actually going to have the municipality build the network and then they’re going to sell it. In Atlanta they’re only doing apartment buildings. In San Francisco they’re having Zayo [Group] build some facilities out to public housing, and then they’re going to resell that.
So it seems to me this is more a let’s see how many different constructs we can find with municipalities in order to showcase as many possible models as we can in the hope that other people will come along and say, okay, I’m going to do the Huntsville model or I’m going to do the [Atlanta] model. They just want as many different flowers blooming as possible, but they don’t want to have to plant them all.
Bazinet – There’s an irony to me about the FCC getting very concerned about broadband prices rising. If I was sitting in DC, I’d be begging you guys to raise prices so it would attract capital to be the next overbuild.
Winfrey – So far Google has been able to go into different towns and get a reverse auction bidding process to get the most favorable terms that really don’t apply towards a typical cable company or overbuilder. So people are very willing to accept Google coming in and building not only where they want to build but only where they have a pre-determined successful penetration by getting consumers to opt in first before fiber ever gets built. And that’s worked well so far.
But if they didn’t get it to scale, do you think that type of approach to the marketplace that only goes after the more attractive places really can hold up? Or do you think they get pushed from a regulatory standpoint into more types of typical franchise buildouts where they have to do it all?
Ryvicker – I went to Kansas City. That’s the only way you can really see Google Fiber, because they don’t really talk to people. The product is amazing, and I was really nervous, because I came out of there saying, my gosh, what’s going to happen to cable? And then I realized that the rollout is taking forever.
I think their ultimate goal is every time they announce a market everybody else’s speeds increase. So I think that’s helps their search. When I went they were very clear to explain to us that we will not build in a municipality that doesn’t want us and that doesn’t allow us the flexibility. So our scale will be capped naturally by those who don’t want us. And [if there’s] any threat of a regulatory issue in any specific state or municipality, they go away.
Moffett – It’s a lot easier to see this happening in traditional red states than blue states for that exact reason. It’s easier logically for a Texas, for example, in Austin to say we will allow digital red lining than it is for a Massachusetts.
Massachusetts is an interesting example. Verizon just announced they’re building fiber in Boston. One of the really interesting parts of that build, by the way, is they’re not building FiOS in Boston, they’re building fiber in Boston.
This is a small but important distinction, because they’re actually cost justifying it with some of the feeder plant for wireless as opposed to video on its own. But in the press release announcing the fiber build, the first two places they’re building it are in West Roxbury and Dorchester.
Winfrey – Underprivileged areas?
Moffett – Yes. It’s still the old model, if you’re going to do this in Massachusetts. That’s not the Google model.
Winfrey – I’m going to use this as a good entry point into 5G. From a cable perspective is 5G friend, foe, unknown? Could it bring business to us? Could it be a new business? Or is it something that could replace cable altogether from a connectivity standpoint?
Swinburne – If I could quickly answer on Google, with our covering it, Google very importantly for us on the investment side split themselves in two in January. One of their companies is called “Other Bets” and actually reports capex on a standalone basis. They have told us and told everybody publicly that the primary capex item is Google Fiber. You can all track at home every quarter the dollars [spent]. So instead of us guessing on their motivations, we’re going to have a real track record.
Winfrey – Dollars per passing, where they’re building?
Swinburne – No dollars in capex.
On 5G I think the answer is both. It could be an opportunity. It’s also a threat.
We don’t have time to get into the regulatory side of this, but to me the most interesting development around 5G recently has been the FCC’s BDS (Business Data Services) initiative. To have Verizon publicly support rate regulation of the wireline business is something that’s kind of mind twisting.
They’re doing that, I think, and Chairman [Tom] Wheeler seems to be very much supporting it, to make sure Verizon has enough backhaul capacity to make 5G work for them when 5G is ready for prime time. If that regulatory path is the path, that seems more of an investment concern, as we like to say in this business, for the cable industry than an opportunity.
Moffett – The chairman is in a tough spot, because obviously he wants to see infrastructure built for 5G. But as the BDS proposal stands today, and there could still be a lot of changes before the final report and order, but as it stands today it’s hard to see the economic motivation for [a cable operator] saying, I’m going to build a lot of that.
Swinburne – If you put the conspiracy theories aside and just think about wireless versus wireline, every G that I can remember being introduced to was supposed to beat wireline. And by the time the consumer growth reaches the point of deployment, we’re back to where we are today.
Moffett – The old adage is a wireless network is 90 percent wired and 10 percent wireless. Well, if you’re going to shrink the radii of the network down to 300 feet, which is what they’re talking about, you’ve effectively built a wired network. And then the question is, we’re right back to the Google Fiber conversation. What are the economics of building a wired network?
Winfrey – If all that’s true, why not cable?
Moffett – Right. We thought about convergence in the past as, do customers want to get their wireless and wireline service from the same operator. But the right question is, ten years from now, is there a distinction between wireless and wireline networks? Even today, nobody connects to their wireline network with wires. You connect to your wireline network wirelessly. So all you’re really talking about is what’s the last connection and what is the OTA (over-the-air) interface. Is it Wi-Fi; is it 5G; is it 4G? And the answer is, who cares? Topologically they’re the same network.
Winfrey – I agree. Let’s move on to regulatory.
The press is full of assertions that the current FCC is highly anti-cable with a slew of different initiatives, and all of them look less interesting from a cable perspective, according to the press. I’m curious to see what your assertions are. You’ve seen a number of different regulatory cycles. What’s the viewpoint here as to whether it really is anti-cable, or is it something else?
Bazinet – When I first started covering cable stocks, it was sort of the good old days when the expert agencies were largely neutral. Maybe they would deviate from the mean a little bit to the left or a little bit to the right. I think we’re living in a world now for better or worse that is so hyper politicized that the expert agencies, whether it’s the FCC or EPA, are going to careen far left, far right as the executive branch changes, which is tragic.
It makes it very uncomfortable for equity analysts, because you don’t have a constant sort of policy coming out of DC. You have these zigs and zags. I would say, yes, it’s anti-cable. But I think it’s probably broader than that. It’s anti-business.
Ryvicker – Or at least anti market forces. This is a government and an FCC that wants desperately to regulate everything. They’re not just anti cable, they’re anti broadcast. They’re anti telco. They’re just anti.
Winfrey – For the transcript, that was not the moderator. But thank you for your candid input.
Bazinet – The only thing they seem to be pro, and, again, 15 years ago when I started with the NAB, it was quite powerful in DC, and now it’s really the Silicon Valley mix that has all the power in Washington. I was in a meeting with a client, and he jokingly said, does Skynet really need any help out there in the marketplace, referring to Google. And that’s the way I think Wall St. sort of looks at it.
Everyone knows Google has huge cash flows. The Street’s willing to accept no profits. They have a great business model on the advertising.
Winfrey – Essentiall a monopoly in search.
Bazinet – Yeah, exactly. To say they need help; it’s mind boggling.
Swinburne – Without taking a political view if at all possible to answer this question, you know Kevin Martin days were some hand-wringing days. I think we all thought they were pretty aggressive. The cable card stuff seemed kind of scary and out there.
I think there’s no question this FCC wants to bring more competition to cable. Whether that’s anti cable or not, I’ll let people decide that. But it’s tough right now between set-tops, special access, blocking mergers, Title II reclassifying broadband. It’s been a tough string for the industry.
Winfrey – Let me turn this back on cable for a little bit of perspective on ourselves. Is there something to think that we have done over the past five to ten years of the cable industry that we could have done better?
It’s very easy to sit back and say, wait a second, we as a cable industry, just the cable operators, we employ hundreds and hundreds of thousands of employees, and we grow employees every year. We invest billions of dollars into network infrastructure, and essentially built the broadband Internet in the U.S.
So it’s very easy to sit back and pat yourself on the back and say, we brought the competition. But obviously we didn’t do something well, or else we wouldn’t be sitting in this position. So what do you think cable could have done differently to avoid some of this taking place and be put in the position where it has the ability to continue to innovate, invest and earn a rate of return?
Ryvicker – I don’t think it’s what you did. I think it’s the fear of what you will do as a monopoly.
Winfrey – Given what we just talked about with wireless, Google Fiber, with U-verse, satellite still competing very much in video, do you think we’re a monopoly?
Ryvicker – This ecosystem has thrived with new competitors, with disruption, with consumer choice. And I feel like the FCC wants to make everything happen faster without realizing there is a lot of investment that has to be made for all this content to come out and all the content to be distributed. And if the cable companies and programmers can’t invest, we don’t get any of it.
Swinburne – I’d introduce both a big compliment to the industry and also maybe a little accusation. I don’t know if this quote is totally accurate, but I think the chairman and the founder of MCI was asked what is his goal for his company, and he said, I hope someday to be broken up by the government.
To some extent the success of the industry, particularly around broadband – we report it every quarter, 100 percent of market share growth is going to the industry – can lead to some unwanted attention. That’s part of it.
On the negative side, there’s always been this undercurrent of consumers complaining to congressmen and senators about their cable bills. I think every one of you, if you haven’t read it, should read the [FCC general counsel Jon] Sallet speech that was made public last summer about why the FCC blocked Comcast-Time Warner Cable and why they approved AT&T-DirecTV.
It’s very clear there that when we all talked about broadband market share it was really about video. They really wanted to help the OTT players enter the market, bring competition to video.
One of the reasons [AT&T-DirecTV] was in the public interest was because of cost synergies on programming costs. It was an amazing sort of conclusion. They thought it would make U-verse a more viable platform. So I think high video prices, and high is a relative term, but that undercurrent of being frustrated with pricing in video may have led into this real push to support OTT.
Moffett – Which, by the way, was the rationale for the ’92 Cable Act. In essence, the FCC has been trying to get at this issue since ’92 without much success.
Even the birth of satellite was originally designed in some ways to help restrain rising end user video prices. It backfired and created more negotiating leverage and ultimately higher prices rather than lower.
I guess I feel a little differently in that it seems to me the FCC is now playing a little bit of catch-up and regulating what they can. You went down the path of Title II, and once you went down the path of Title II – whether that was advised or ill advised is a separate discussion – but once you went down that path, the ’96 Act pretty clearly says, here’s the role of the Federal Trade Commission, and they’re not involved anymore.
And now I have a void to fill, and I have to go in and fill the void for privacy, for example. So I rush to fill the void for privacy that I created by the reclassification, and, by the way, I don’t have jurisdiction over Google. So regardless of what I’d like to do with Google if I had my druthers, it’s not really my bailiwick.
And so a lot of this has followed from, if you’re going to move one piece of this incredibly complex mosaic, you’ve got a lot of other things that you have to do. And inevitably each of them has their own unintended consequences. And that’s, I think, in some ways the vortex the FCC finds itself in now, which is they’ve moved around a few pieces and it set a whole lot of things in motion. They’re reacting to their own agenda.
Winfrey – Let’s talk a couple of specific items that are on the agenda. Title II. Anybody have any insight, want to take a stab at whether it gets overturned or not?
Moffett – I think the consensus seems to be, leaving aside the procedural issues of whether or not the notice issues were sufficient, but on the merit, wired broadband Title II reclassification will be allowed to stand. Wireless will be tossed out. And interconnection is a tossup.
That seems to be kind of the way most people read it. And then the procedural issues are an overlay on top of that, which people think is interesting to insiders but probably less critical.
Swinburne – I think the consensus also believes there will be an appeal to the Supreme Court, which only has eight judges, in which case the lower court stands.
Winfrey – On the set-top NPRM that Chairman Wheeler has launched, do you think it’s needed? Does it get done? What’s it mean for MVPDs and perhaps more importantly, what’s it mean for programmers and the ability to protect their content, and the edge providers who would like to intercede on the copyrighted content and advertising?
Swinburne – That order is a tough read. It makes your head spin. I try to boil it down in my simple brain to create sort of the Android or iOS ecosystem run by the FCC and some standards body that doesn’t exist yet in sort of a cable ecosystem where the vendor community has always been relatively small and lacking in leverage. I understand the hopes and dreams of that order, but the implication of what they’re trying to do seems virtually impossible.
Moffett – The hard part to me is, when the White House has intervened and said, it’s a great idea, it’s really hard for the Democratic commissioners to say, no, it’s not. On the other hand, there are an awful lot of traditional Democrat fund-raising constituencies, not least the entertainment and creative communities, which are really important in the upcoming Congressional elections, who are not pleased.
And politically that’s something that I’ve never seen the FCC have to grapple with, something this politicized where this many Democrats are coming out against it and yet the White House has come out for it. If you’re a Nancy Pelosi in California and there are a lot of unhappy Californians in the entertainment industry, I don’t know how you juggle all that stuff. It’s not easy.
Winfrey – All this activity that’s going on, it certainly feels that cable is being intentionally disadvantaged. So whether it’s neutrality and privacy on the last mile versus the edge providers or its traffic management versus wireless, I think Marci hit her own opinion straight on the head and said, yes, it is intentional and it’s being done by design. Do you feel that’s the case?
Ryvicker – I feel it’s the case. Netflix can throttle and cable can’t.
Moffett – Where does the FCC have jurisdiction? The FCC doesn’t have jurisdiction over Netflix. The FCC regulates what it can.
Winfrey – Understood, but does that create an unfair playing field?
Moffett – Sure. Life’s not fair.
Winfrey – Your message to us is tough luck. Find another way.
Moffett – Yeah. It is what it is.
I do think what the FCC is grappling with, as Marci put it, the economics of success in distribution networks are challenging from a regulatory perspective. The pendulum started swinging decisively toward deregulation in 1984 in this country.
When you deregulate telecommunications networks of whatever kind, it tends to create this explosion of innovation and investment. But as you do it, the microeconomics start to swing the pendulum back.
Unfortunately, these are businesses that have really draconian economics. There are winners and there are losers. There’s not a bunch of people in the middle.
My suspicion is what the FCC is looking at is, longer term, it’s pretty easy to see that cable is the winner. And, by the way, not just the winner in broadband, but go back to the conversation we were having about wireline. Where is the economic value created in wireless eventually? Wires. Who owns the wires? The cable industry.
And so they’re already looking forward to the day that cable has effectively won the battle for the U.S. network. And if you ask anybody with really long tenure at the FCC, and by tenure I mean going back prior to the Big Bang in 1984, they would say that ultimately that has to be a regulated business. And so there’s at least one line of thinking that, if you say what the FCC is doing, it’s already doing the hard work of putting the stakes in the ground for the ultimate regulation of what will end up being a single network.
Winfrey – It will be interesting to see how that plays into the ability and desire to invest.
Swinburne – I also think the FCC has an awareness of the role of content cost on the consumer price point, but they don’t regulate the bundling of networks by media companies. So they’re aware, but they’re not actually doing anything about it yet.
I wouldn’t be shocked over the next five years to see the FCC move in that direction somehow, whether it’s through merger reviews or something else. I think there’s a clearer understanding around retransmission fees and the rising tide of sports networks, etc. That area will be one to watch going forward.