The catalyst to a la carte pricing may be coming up soon

By: Brian Mulligan, CEO, Brooknol Advisors July 5, 2014 1:13 pm

From TheFieldsofGreen.com/USA Today

In August 2012, respected economist Peter Hooper and I were able to share the stage at the Aspen Sports Conference, which is attended by owners of professional sports teams, television executives and league commissioners. Our topic was “The Economics of Sports.”

Peter predicted the U.S. economy’s Gross Domestic Product (GDP) would grow in the 2 percent range annually for the foreseeable future. I had conducted an analysis and found that programing costs to Multi-System Operator and Satellite Providers (MSOs) have risen well over double digits over a 10-year period and that those providers have only been able to pass along about half of those costs to the consumer. Nearly every leader of a major MSO told me their programming costs were increasing by at least $1 billion annually, and consumers, who are paying close to an average of $100 a month for video services, were not going to be able to absorb those costs.

While most sports leaders in the audience were enjoying the ever-rising revenues of network fees, cable revenues, value created by their own Regional Sports Networks (RSN) and the flame-proof attitude of “You can’t TIVO sporting events, thus revenues will grow at double digits in perpetuity,” I pointed out to the richest per capita crowd I had ever addressed that the situation was untenable. I warned that if programming costs kept rising and consumers started complaining to their Congressman or president, the sports leaders were going to hear words no business ever wants to hear, “We are from the government and we are here to help.”

And that “help” could be government imposed à la carte pricing for non-broadcast channels, specifically or most meaningfully for sports channels. Sports channels are the most expensive bundled cable channel cost in a cable bill. Anyone who doesn’t think the government can intervene in entertainment/media should remember what the government did to record companies in mandating below-market fixed pricing to radio broadcast stations for music or mandatory below-market advertising pricing for political ads or “must carry/retrans” rules for broadcast stations to MSOs.

When something is perceived to be unfair to one group of people at the expense of another for a non-essential good or service, the government often legislates its own view of fairness. If the benefit is lower cost to the consumer, as is likely in the case of à la carte pricing, it is even more likely that the government would intercede.

To implement such a radical change in the way business is done, the government needs two things: 1) the situation to reach a tipping point (the situation is so untenable the government needs to step in); and 2) a catalyst. Both are present.

First, the signs of the tipping point. Sports programming costs are growing too fast and are not going to be able to continue to grow at double digits in a 2 percent GDP growth environment. The reason is that it has and will continue to materially damage cable and satellite companies’ video margins and/or consumers simply can’t afford the ever-increasing bills for channels they don’t watch. Thus an à la carte pricing may be in sports channels’ future, as well as other niche cable channels.

Anecdotal signs, in addition to the macro signs noted above, are as follows: The group that bought the Dodgers paid a large amount for the team and has spent even more on high-quality players. The results on the field have been positive. The owners of the Dodgers have smartly sought to get a return on its investment by starting its own Dodger Channel (an opportunity long overdue).

However, timing is not great. Because of the tough economic times in L.A. (double the nation’s unemployment rate), only one MSO (the one who bought the entire cable broadcast rights, specifically Time Warner Cable (TWC)) has agreed to the team’s terms. A protest at DirecTV headquarters, which has refused to carry the new sports channel, drew only 40 protestors. That is not a typo. The No. 1 video provider in L.A. produced only 40 protesters in support of the Dodger channel. The Dodgers owners are fine because TWC must fund the cost of the channel at approximately $300 million a year for 25 years for total of over $8 billion.

Embattled Clippers owner Donald Sterling says he has a $3 billion cable TV contract for the Clippers on his desk, and savvy L.A. businessman Magic Johnson (who also has an interest in the Dodgers) said that wouldn’t surprise him. Let’s assume it is roughly for $150 million per year for 20 years. That would be a 500 percent increase from the Clippers last regional MSO deal of $30 million a year.

I realize the Clippers are on the upswing, but consumers in L.A. just ponied up for the new Laker TV contract. How are consumers in a struggling economy going to be able to pay for this new Clipper and Dodger channel bills? Especially if only 80 percent of cable consumers are interested in sports programming, as reported in CityWatch on June 3, 2014.

There are other examples, but I think the point is made that certain consumers who don’t care for sports and their channels don’t want to pay the increases in their bundled cable programming package. In this analysis, I am not including portions of sports primarily shown on Broadcast Networks because those costs are bundled with retrans agreements, and sports costs can remain hidden from the consumer. The same issue is true for other bundled channels such as MTV Networks: If I don’t like music, why should I pay for 12 music channels. If I don’t like cooking, why should I pay for food channels?

Some have reported the catalyst for à la carte pricing or unbundled pricing for cable channels will take place in L.A. because of the relatively new and expensive Lakers, Dodgers and the expected Clippers cable contracts (and let’s not forget the relatively new Pac 12 cable channel, among others). The catalyst for à la carte pricing will take place in the New York Federal Courts as the Cablevision vs. Viacom lawsuit for alleged anti-competitive bundling pricing for MTV Networks moves to trial.

My view is the catalyst for à la carte pricing is on two much larger fronts, the Comcast/TWC proposed merger and the DirecTV/AT&T proposed merger. Brian Roberts, CEO of Comcast, is one of the savviest executives in the U.S. Brian’s deal with TWC is about control of the home — broadband, video, phone, home security, internet security and so forth. The proposed combined cable company will pass 70-plus million homes. The most important aspect of the merger is broadband because once in the home, revenues generated from broadband fall to the bottom line of cash flow and Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA).

Further, once you have the credit card or billing relationship, it is easy to get incremental billing revenues on low-cost value added services. The smallest margin (and shrinking every day) is video because of the ever-increasing costs of programming, of which a big part is sports programming. Sports programming is a loss leader for many video services. To be fair, some cord-cutting and retransmission costs also account for decreasing margins of MSOs.

The pricing power of a combined Comcast/TWC to the consumer is meaningful and has anti-trust implications. Anti-trust, read: Increased pricing power to consumers, in the view of Congress, the justice department and the president is the only thing that can hold up the merger. To appease lawmakers, Roberts could agree or may have to offer up à la carte pricing for cable channels (which includes sports channels).

À la carte pricing would lower programming costs and would increase Comcast/TWC’s margins. Without a major concession like a la carte pricing, the deal might not get done. Roberts, as of yet, has given no indication that the merged company would concede to a la carte pricing, which would mean lower cost to the consumers too. Companies with broadcast networks such as Comcast, Fox, and Disney would be able to largely protect their cable channels via retransnegotiations. But it is a Trojan Horse win for the merged company and consumers.

Thoughtful DirecTV CEO Mike White and visionary AT&T CEO Randall Stephenson likewise will need to give concessions to get their merger deal done with Congress, especially in light of some roughing up the two took in front of Congress last week. With the Comcast deal likely going first, à la carte pricing in that merger would then be required in the DirecTV/AT&T merger.

Randall called his video operations a “financial dud” in front of Congress due to the high cost of programming. In fairness, he pointed largely to the high cost of network programming. But network programming costs are not touchable due to FCC regulations and their importance to Congress. On the DirecTV side, White once told me the biggest issue facing DirecTV was the billion-dollar-a-year increase in programming costs. As in the Comcast/TWC merger, à la carte pricing would be beneficial to both the combined ATT/DirecTV in improved margins and lower cost to the consumers — a rare win-win in the world of business and politics.

Who are the biggest losers in à la carte pricing? Owners of teams who at the moment are probably polling lower than congress. A subtle winner in à la carte pricing, and perhaps the most important one, is Congress and President Obama, whose approval polling numbers are at an all-time low and who I assume would love the legacy of delivering lower pricing to consumers for entertainment and sports. And who was Democratic President Obama seen playing golf with recently? The scratch golfer, Republican and CEO of Comcast, Brian Roberts.

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Brian Mulligan is currently the CEO of Brooknol Advisors, a Media, Entertainment and Sports Advisory Company. Mr. Mulligan has held CEO, Chairman, COO or CFO position of virtually every media/entertainment vertical for majors over a 30 year career, from Co-Chairman of Universal Pictures, CEO of Universal Television, Chairman of FOX Broadcasting and Cable, EVP/CFO of a Fortune 50 Company, SVP of MCA INC, EVP of Strategic Planning and Corporate Development Universal, Senior Executive Advisor Boston Consulting, Vice Chairman of Media/Telecom of a Money Center Bank, and worked extensively in/with private equity. Instrumental in over $175 billion of media and entertainment transactions.