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Analysis of UBS Media & Comms Conference - Some like it Hot

As part of our increasing focus on ‘Digital Entertainment 2.0’, here is an analysis of UBS’s recent Global Client Conference:

The top brass of the Media and Communications industries gathered in New York last week for the final investor jamboree of the decade and the word on everyone’s lips was “online”, and specifically, whether it was a creator or destroyer of value for the industry.

It was apparent that it is far too early in the game to pick winners and losers. Perhaps more importantly, the playbook of the move online in the video world will be completely different from the music and newspaper industries where significant value was, and still is, being destroyed.

The Price is Right

Leslie Moonves of CBS drove this point home, with the example of NCIS Los Angeles which was recently syndicated to the cable channel, USA Network, for US$2.35m per episode including streaming rights. That you might pay US$50m for a 22 episode series which has already been aired on one of major broadcast networks gives an indication of just how valuable hit TV shows have become.

On the other hand, Hulu is expected to make a relatively meagre US$240m in total revenues in 2010 for huge volumes of broadcast content, of which an estimated 70% is returned to content owners. Three of the main broadcast networks (Disney-ABC, Newscorp-Fox and GE-NBC Universal) are shareholders in Hulu and serve up the majority of the content. The challenge for Hulu is to ramp up its revenues and become more relevant to the revenue line through increasing penetration (in October at c. 22m unique visitors, 654m minutes and 1.1bn Ads) and extension beyond the laptop (the launch of Hulu Plus at $8/month for devices connected to the TV).

The End of the Rainbow

In the short term, the biggest pot of gold that the major broadcasters are after is a share of the basic channel fees charged by Cable MSOs, DSAT operators, and telcos, which represent the traditional partners of content owners. Chase Carey of Newscorp was very clear that as audiences fragment, a sole reliance on advertising revenues is foolhardy. And deals are being done on the quiet outside of the big public spats as represented by Fox vs Cablevision. CBS alone has done over 40 retransmission deals over the last two years and expects US$250m in revenues by 2012 alone. With the largest payTV operator, Comcast, buying NBC, it is a racing certainty that everyone will be paying broadcasters a lot more money in the near future.

The biggest questions therefore become how much will they pay, and what will be in the bundle. The $64,000 question, in fact. I’ve seen estimates of fees in the range of 25c-US$1/per channel/month which could bring a huge bill of up to US$5bn. Interestingly, CBS said they were bundling some online streaming rights as part of the license. And Newscorp said it was in everyone’s interest to continue to serve the 10m US homes which get TV over-the-air for free - but you can be certain that it will be a very basic service with none of the HD bells and whistles.

The situation in the USA is unique with both a high penetration (90%) of payTV and no state broadcasters supported by a telly tax. It’s a situation not really matched elsewhere in the world. It will be interesting to see how broadcasters move away from a complete reliance on fragmenting audiences and advertising fees. I suspect that we will see a combination of moving secondary channels to payTV and charging, whether pay-as-you-view, subscription, or licensing for on-demand content.

Here, There and Everywhere

While the jury is out on cable cutting and shaving, what seems to be more certain is that authenticated TV Everywhere will be rolled out in 2011. Warner is committed to having HBO Go on all devices and through the majority of distributors during the first half of 2011. The message seems to be far from worrying about HBO, investors should be more positive - with subscribers flat during the recession, viewing up and revenue up because of pricing power with the distributors. It doesn’t seem the much vaunted Netflix threat has affected HBO much.

In fact Jeff Bewkes swatted off any noise about Netflix like dealing with a pesky bluebottle. He compared their measly little offers of US$50k-US$100k per episode to the millions on offer from syndication deals. He also stressed that the Starz deal is up for renewal in 2011. This is a crucial deal which gave Netflix access to Sony and Walt Disney Pictures movies. The noise on the jungle grapevine is that Netflix got the streaming rights for US$25m/year compared to a market value of US$200m.

In the same week on the other side of the USA at a Barclays conference, the departing Netflix CFO said not to worry about content, as no single deal accounts for more than 20% of overall viewing. He also said that they were structuring deal values to manage margins over time. A quick back of the envelope calculation show how much Netflix can afford to pay for streaming & DVD rights. Currently, 16m paying subs @ US$9/month - low cable payout case 40% of revenues = US$700m/annum - high Hulu payout case 70% of revenues = US$1.2bn. Even if the base doubles within a couple of years to 32m paying subs, Netflix will only have an annual content acquisition budget of around US$1.5bn to US$2.5bn.

Given that the TV Industry is currently collecting US$30-US$50bn on content from current distribution partners (the MSOs, DSATs, and telco industries) and approximately equal that in advertising, Netflix can’t possibly act as a substitute. Therefore, all the effort is in extending streaming rights to current partners.

That is not to say that Netflix can’t exist as a standalone entity, either as a complement to payTV or serving the small percentage of people in the USA who can’t afford a full payTV service. But, the second Netflix starts disrupting the current ecosystem, expect the empire to strike back and start disrupting Netflix. Ultimately, Netflix might end up in the long tail and there is an economic reason why nobody wants to be there.

Fine Young Radical

The only dissenting big media voice came from Robert Wiesenthal from Sony, who is a relative newcomer to the industry and ex-investment banker. Amazingly, he believes the consumer has voted and wants to break the cable bundle, moving to à-la-carte menus. Of course, Sony is in prime position to exploit this with its estimated 50m connected TVs, via Playstation, BluRay and GoogleTV by Mar 2011, and with its Qriocity service.

The message from Sony is not to think about the 5% margin they get on hardware any more, and instead think of the lifetime value of each connected TV to Sony. This requires everyone to take a big leap of faith. The big difference from Sony and other manufacturers is that they don’t see internet connections as a feature, but as a platform. Interestingly, he also added that consumers also want to move from ownership to access, which implies less Apple iTunes music deals and more Spotify subscription type licensing.

On technology, Sony seems to be joined at the hip with Android, both for phones and TVs. The much criticized GoogleTV is just phase I of a long term plan, with the end result being a 1-cord TV with really simple content discovery and acquisition. The traditional twin input technology of the remote control and EPG hasn’t really changed in the last 10 years, which seems incredible seeing the advances elsewhere. Sony also thought the consumer was suffering from box-fatigue and all the new age boxes such as Boxee, Roku, AppleTV faced a limited future.

The only thing that Sony seems to have in common with the other studios is a belief in a new window opportunity for movies between theatrical release and being available on DVD, targeting a certain demographic who don’t want to go the theatre but have fantastic home cinema equipment. Warners already said they will experiment in 2011 with so-called premium VOD 45-days after theatrical release for US$20-US$30. Good luck to them with that, for that price I’d expect waiter service in the home for popcorn & sugared water.

Escape to Victory

Everyone was in agreement that the biggest growth area was outside of North America, whether they were building new payTV territories, such as DirecTV in Latin America, building new channels such as NewsCorp and Discovery, or syndicating content, such as CBS. Obviously, driving payTV penetration is the biggest win for all.

CBS gave an example of the scale in syndicating all its new autumn TV shows, Hawaii-Five-0, Blue Bloods and the Defenders internationally, all of which got in excess of US$2m per episode, which made them profitable before even reaching the screen in the USA and generating advertising revenues.

Additionally, NewsCorp expects to be making over US$1bn per annum in operating profits from its overseas channels in the few years. And that is before counting its distribution business in Italy, Germany, Ireland and the UK.

There will be Blood

The ever quotable Leslie Moonves of CBS dealt with the question of escalating costs with aplomb. “Without a Trace” was costing a US$4m/per episode with CBS owning 50% of the equity in the show. The underlying problem was too many writers and in the cast. They decided to kill it after eight seasons and replaced it with “The Good Wife” which costs US$2m/episode with CBS owning 100% of the equity. The end result was lower costs, similar ratings and bigger share of syndication.

He humorously added that if a cast member was getting too expensive, the best option is to kill them off in the final episode of the season. The best historical industry example was the decision to blow up the Dynasty house in the final episode of a particular series. Whether cast members survived or died was dependent upon contract negotiations which were up for renewal.

The Final Curtain

The big media houses seem to be spreading the message that they are in fine shape and the online challenge will not destroy value, but instead is an opportunity. Hit content will continue to be expensive for the foreseeable future, online-only players will have to pay the going rate going forward, and they are going to protect their current partners. And, if that isn’t enough to buy their shares, think of the international seam of gold waiting to be mined.

For Telco 2.0 and our new ‘Digital Entertainment 2.0’ Initiative all this means that instead of looking at black and white scenarios, we’ll be looking at shades of grey. It means viewing VOD not just in the context of the laptop, but throughout the home including the living room. It means comparing traditional distributors to new aggregators and keeping an eye on content deals. Finally, it stresses the importance of getting to grips with payTV markets throughout the world and noting the subtleties in each geography.

(Ed. - more on this and other related topics in 2011 in our research and events programme).

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