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April 22, 2008

Implications of A New HBO-Like Pay TV Network

Viacom, Lionsgate, and MGM announced that they will no longer sell their movies to Showtime (owned by CBS) and instead will launch a new, fourth pay TV channel. The announcement leaves Showtime, the current owner of rights to films from VIA, LGF, and MGM without the rights to output from any of the major movie studios.

This announcement impacts many companies in the entertainment industry including the owner's of the current pay TV services, Time Warner (HBO and The Movie Channel) and Liberty Entertainment, (Starz and Encore). Time Warner also will be affected at the studio level via its ownership of Warner Brothers. Other movie studios impacted include Universal (GE), Sony Pictures (SNE), 20th Century Fox (NWS), and Disney. Cable, satellite, and telcos distribute the pay TV channels and will also feel effects from the new venture.

Pay TV is a big business but at the margin the financial impact on any of the company’s involved in the pay TV industry is not likely to significantly impact stock prices as pay TV is a modest revenue stream for both studios and pay TV network owners. Nevertheless, there are positive and negative implications for the companies involved....

....Showtime, owned by CBS is going to feel the largest impact. According to Jessica Reif Cohen of Merrill Lynch, Showtime represented 8% of revenue and 12% of EBITDA for CBS in 2007. As a result of this new venture, Showtime will not have a supply deal with any major film studio. Given that pay TV does not get new movies until well after the films have been available for sale or rent (usually six months), I have long wondered about how valuable the films are in terms of gaining and retaining subscribers. I suspect that films play an important psychological role in that subscribers like the idea that they will be able to browse their pay TV channels and find something to watch. On this basis, the loss of new movies will hurt Showtime's subscriber retention efforts. Fortunately, Showtime has been on a role in terms of original series production, generating buzz not far from what HBO used to get. In the near-term, Showtime's margins will probably rise as movie rights are very expensive. That would be a good thing for CBS if subscriber numbers can be maintained. Another possible risk to CBS is that the recent decision to start its own movie studio will now lead to a much greater commitment to movie production, a difficult and volatile business. Overall, this news is negative for CBS because Showtime has been one of the few growing businesses the company operates.

For Viacom and Lionsgate, the deal also offers mixed news. Even at a lower rights fee, the companies will be foregoing a very profitable revenue stream in exchange for the commitment of potentially significant capital to launch a new channel. Equity ownership has a chance to offset capital commitments and likely operating losses, especially if the model can be tweaked by shortening the window to pay TV and developing digital opportunities via video on demand, streaming, and other digital distribution channels. Expect to hear a lot from VIA, LGF, and MGM about "reinventing the pay TV model in a digital world." I remain skeptical that the there is sufficient consumer demand to support a fourth pay TV network.

For the other pay TV networks, a new entrant in the pay TV business would be a negative as the potential subscriber base would fragment. On the other hand, a potential positive is that as other studio output deals expire, there will now be only two bidders for their content since it seems unlikely other studios' parent companies would support the new competitor. This might lower pricing on future rights deals, which were expected to trend significantly lower anyhow.

The other major studios, Sony, Universal, Fox, and Disney will be in a worse position to negotiate new output deals as there will now be more supply of films than demand with just two pay TV networks bidding for product. Many rights deals are expiring in the near future and substantial cost savings were already expected by the networks. I am not sure how much analysts have adjusted their operating profit estimates to account for lower fees in the new rights deals but I suspect they need to come down further now.

The final impact from this deal is on cable, satellite, and telco companies which carry and sell the pay TV networks. Cable has modest capacity constraints and probably isn’t too happy about having to carry another network. In fact, according to Tuesday's Wall Street Journal, cable is leading a push back against creation f the new network with threats to not carry it. However, cable's big competitive advantage over satellite is VOD which is likely to be a major emphasis of the new channel. Furthermore, satellite companies (DirecTV and Dish Network) and Telco TV (AT&T and Verizon) are not capacity constrained and might use the new network as a weapon in the battle for subscribers. Thus, I expect the channel to gain carriage despite the rhetoric. Cable, satellite, and telco companies are the least impacted by the new channel but to the extent they are I would put cable at a slight disadvantage.

Posted by Steve Birenberg at April 22, 2008 08:46 AM in Media