George Mannes

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Media Spotlight Swings Away From Content

George Mannes

In the never-ending debate in the media business over whether ultimate power resides in the companies that create entertainment or the companies that distribute it, three top sell-side analysts have recently dared to make a decision.

And though each analyst puts a different spin on his or her conclusions, the vote is unanimous: For now, at least, distribution is the winner.

That means good news for owners of direct broadcast satellite systems and cable operators -- in particular, Comcast (CMCSA), the Philadelphia-based cable operator that, following its acquisition of AT&T Broadband, boasts 21 million cable subscribers, or about 30% of American households.

But it's bad news for content companies that don't own such assets -- for example, Disney (DIS), which, though it owns the ABC network and ABC stations, may lose some of its ability to raise rates for its powerhouse sports channel. Disney, due to report quarterly earnings Thursday, rose a dime Tuesday, to $16.85.

Concentrating

The latest analyst to venture an opinion in the content-distribution debate is Banc of America Securities analyst Doug Shapiro, who issued a report Tuesday. Joining an argument as perpetual as the debate over chickens and eggs, Shapiro says consolidation and technology are bolstering the power of distributors.

That consolidation, giving larger distributors more power in rate negotiations since they control access to larger audiences, won't end with the Comcast-AT&T merger, says Shapiro. Noting that the Federal Communications Commission may soon raise the current ownership cap in the cable industry, Shapiro writes of the possibility that in two years "the vast majority of multichannel distribution will reside in the hands of just two DBS companies and three, or even two, enormous cable operators."

New technology such as the Internet, writes Shapiro, opens up new distribution platforms, fragmenting audiences and the advertising sales pie further. Personal video recorders make it easier for users to skip ads, avoid lower-rated broadcast programming and erode the brand value of individual networks. Not only that, but distributors will likely control these new technologies, giving them another gate with which to control content.

Also a negative for programmers, says Shapiro, is decreasing competition between DBS operators and cable systems. Recently, points out Shapiro, cable operators such as Charter Communications (CHTR) and DBS operators EchoStar Communications (DISH) and Hughes Electronics (GMH) have indicated their aversion to cutting prices to attract new subscribers. "The natural extension of this change," writes Shapiro, "is that the operators will change their focus from the battle for market share to the battle to reduce their costs, with programming at the top of the list."

To illustrate that scenario, Shapiro estimates that if distributors could cut programming price increases from 9% annually to 5% annually through 2006, current stock values could be boosted from 10% to 40% for most operators.

In a report issued last week, Merrill Lynch analyst Jessica Reif Cohen also makes the distribution case, though she rejects making a blanket statement to that effect. Instead, says Cohen, certain programming networks will have a tougher time than others in forcing cable and satellite distributors to pay price increases; key determinants of value for the distribution side will be ratings performance and local advertising sales opportunities for operators.

Dwarfs?

Among content providers, says Cohen, the biggest risk is faced by Disney, whose monthly subscriber fees for cable operators are said to be the highest by far of any cable channel, and whose fees are believed to rise about 20% annually.

As the company's contracts with individual operators come up for renewal, writes Cohen, "we believe it will be much more difficult for ESPN to pass these huge increases through to the cable operator, especially the larger, consolidated system operators." Also likely to face difficulties will be News Corp.'s (NWS) Fox Sports properties. (Merrill or an affiliate has received investment banking fees from both News Corp. and Disney.)

Ultimately, says Cohen, cable network affiliate fees could shift to a "pay-for-performance" model, varying based on audience size.

In a Dec. 31 report, Morgan Stanley analyst Rich Bilotti concludes that distribution assets will appreciate more quickly than content assets over the next three years, a "tectonic shift" creating conditions last seen in the late 1980s.

One factor behind the valuation shift, says Bilotti, is the Comcast-AT&T deal, whose bargaining power he summarizes neatly: "Comcast could survive the deletion of one channel, but most programming networks could not survive the loss of a carriage agreement covering 21-22 million subscribers." Also driving up distribution value, he says, is a trend forecast as well by Shapiro: content conglomerates will move to acquire and consolidate distribution assets. Finally, says Bilotti, advertising growth will be 4% to 6% annually for the next several years, "not likely to be strong enough to offset the loss of pricing power for content."