We have previously discussed certain media industry risk phenomena and the potential longer-term ramifications to the overall profit pool, but it was only just recently (April 15) acknowledged by Federal Communications Commission (FCC) chairman Tom Wheeler. “For the first-time, we saw a full-year decline in the number of pay TV subscribers, with most all of those losses coming from cable. Why is this happening? Broadband is bringing new services….and consumers are pursuing alternatives.” This decline is concurrent with broad employment gains and positively inflecting new household formation. In other words, the macro economic backdrop cannot explain it. The present U.S. base of approximately 100 mm TV households (Nielsen) may only decline fractions of a percent, or hundreds of thousands in any quarter, but in mass media small numbers often translate to huge dollars. Broadband services are something new and disruptive to the existing ecology.
The business of being entertained is flowing in two directions. Legacy TV viewership, which is easily measured and monetized, has been declining for years and was again down in Q1 2015 (-9% for cable networks, -15% for broadcast networks). However, the aggregate consumption of video, including over-the-top (OTT), mobile, and subscription video platforms (SVOD) is still rising modestly. It’s a sufficiently diverse phenomena as to be challenging to measure, though some estimates peg video consumption as high as five hours a day, with over an hour of this specifically on OTT platforms. This still difficult to measure total viewership reality suggests video content as valuable as ever to consumers, but monetizing it for both content generators and distributors is as uncertain as ever. Both traditional TV monetization mechanisms – advertising and affiliate fees – at heart require a measurable TV-viewing base. But as total TV audiences morph their viewing hours to new consumption platforms, often entirely ad-free, how does one monetize this? A majority (59%) of U.S. households currently subscribe to some kind of SVOD service (such as Netflix, Hulu…), suggesting the problem of monetizing and measuring content consumption is poised to grow significantly.
Television has been remarkably immune to the forces of digital disruption and deflation that have plagued print media and the record business up to this point. Pay TV platforms, which have comfortably provided a relatively constant flow of incrementally monetizable subscribers, are now more tangibly at risk from broadband substitution. Other revenue streams such as syndication also appear vulnerable. Syndication is usually possible after 3-4 seasons and roughly 100 episodes of a particular TV show run. Broadcast and cable syndication have long been highly profitable revenue sources for both producers and networks, selling for as much as $100k - $500k per episode, with cable syndication as high as $1-3 million per episode. Typical sit-coms and procedural dramas have been the preferred syndication content because they could be run and viewed non-sequentially, but with the growing popularity of serialized dramas (which seek to establish must-see viewing at a particular time), these programs are being squeezed at the margin from a demand perspective. Moreover, SVOD platforms like Netflix enable “binge viewing” at the consumer’s discretion, thereby diminishing the value of ad-supported content. Why watch two 30-minute shows with a 7-8 minute commercial load on each, when with a broadband connection one could watch nearly three back-to-back 22-minute episodes commercial free via SVOD? Or one could trade out 8 nights of an hour long serial for 320 straight minutes of commercial-free viewing of those 8 episodes on a single Sunday afternoon…for $11 per month. Digital deflation is tough!
But to suggest all is lost overnight is far too simplistic and dangerous. Industries morph, good companies adapt to sustain and grow cash flow, and it remains our job to identify these value opportunities as they emerge. We have continued to find opportunity in media, right now a little bit lower in the market cap spectrum domestically, most recently in local broadcast TV. This is an area that has seen considerable consolidation in recent years, in part the result of the decade-plus long structural decline of historically dually-owned newspaper assets alongside broadcast TV rights. Local broadcast TV, though still considerably reliant on cyclical (and economically sensitive) advertising spend, has seen significant revenue diversification emerge in the form of retransmission revenue – whereby pay TV operators are now paying to re-transmit these local stations. Local broadcast TV still holds roughly 35% viewing share (local news, sports, etc). Local broadcasters are paid on average $0.58 per viewing household, against $20 for ESPN, $7 for TNT and $5 for CNN as stark examples of the gap.
Local TV broadcasters also hold an interesting core asset with significant intrinsic value given their spectrum position in a spectrum-constrained physical world. Another auction is slated for 2016 that may shed further light on the resident value inside some of these businesses. An emerging new broadcast standard called ATSC 3.0 is set to allow for robust data transmission capability, increasing the degrees of freedom around business model and monetization potential – notwithstanding TV ratings challenges. Not to be dismissed either is the promise of the 2016 political year, with spend estimates for the Clinton Presidential campaign alone already ranging north of $2 billion, much of which finds its way to local TV. This is highly unfortunate for “battleground” states such as Colorado – home of Cambiar Investors.
Andrew P. Baumbush - Principal