Even if Comcast ( CMCSA) fails in its bid for Disney ( DIS), don't expect media mergers to go away.
The temptation is just too great. What's tempting, more precisely, are media mergers combining a content creator such as Disney with multichannel television distributors such as Comcast, the nation's largest operator of cable TV systems. As reflected by public comments last week from Disney President Bob Iger and other media executives, combining a programming company with a distribution company gives the resulting operation the opportunity to incubate new channels worth billions of dollars. Additionally, having content and distribution under the same roof gives a conglomerate valuable bargaining chips. It can use this leverage in negotiations with other media companies over key issues, such as the cost of programming to be carried by a distributor. And as illustrated by last week's public dispute between Viacom ( VIAB) and EchoStar ( DISH), operator of the Dish Network DBS service, negotiations between unaffiliated content and distribution companies can be fierce, motivating each party to scrounge up all the bargaining chips it can. "It is clear that these negotiations are getting more tense," says one media investor, speaking on condition of anonymity. In this contest, he says, a content company gains power by owning a distribution channel, and a distributor gains power by owning a content producer.
The Urge to Merge
So how exactly do content and distribution benefit by being under the same roof? Why, for example, did Rupert Murdoch's News Corp. ( NWS) recently take a controlling stake in Hughes Electronics ( HS), operator of the DirecTV DBS service? First off, you can increase the value of in-house programming by putting it on the distribution systems you own. If Comcast, after acquiring Disney, one day senses a demand for a channel devoted to say, dieting, it can pay someone else for the privilege of running its weight loss channel on its cable systems. Or instead it could favor its own programming: Use Disney brands and personnel to launch the Disney Diet Channel, put it on the lineup in front of its 21.5 million subscribers and hawk it to other distributors, collect advertising sales and subscription fees -- and end up with a channel worth a few billion dollars someday. Some support of this strategy came last week from Disney's Iger, though he didn't pretend to be a fan of Comcast's latest proposal to implement it. "I think there is certainly a way to grow a company by marrying ... distribution and content," Iger said at a Bear Stearns conference. "I think if you basically play favorites too much -- meaning, as the distributor, you give access primarily to your own content or you create a preferred access -- ultimately the consumer is going to speak. And that access that you give on a preferred basis will only work as long as you're delivering the customer value. ... So I think there's a way you can take advantage of your own content, as long as you're doing it with content that is truly good content." Morris Mark, head of Mark Asset Management, says it's difficult to manage content and distribution to facilitate the growth of both businesses, but he has little doubt that News Corp. will succeed with DirecTV, given its previous successful experience. One benefit, he suggests, is that DirecTV can, in conjunction with News Corp.'s Fox, ( FOX) devise new programming especially appropriate for the satellite service. "It certainly puts pressure on the other companies to consider the benefits of integration," he says. (Mark owns Hughes and News Corp. shares.) EchoStar CEO Charlie Ergen -- himself unaffiliated with any programmer -- suggested last week that might change if News Corp.-DirecTV works out. "To the extent that's successful, that'll put a lot of pressure on everybody else regardless of whether Comcast-Disney happens," Ergen said last week. "If Comcast-Disney happens, then you clearly have seen that the momentum has gone to put content and distribution together."
The Power Game
In addition to keeping up with the Murdochs, there's another reason to marry content with distribution: power when programmers and distributors get together to negotiate what channels a distributor will carry, and at what price. To be sure, content allied with distribution -- sometimes referred to as vertical integration -- isn't the only source of such negotiating power. Some distributors, such as Comcast, earn it by dint of their size; with Comcast accounting for 23% of multichannel video households, distribution on Comcast systems can mean a huge increase -- or huge loss -- for a programmer, making the cable operator a need-to-please client. Programmers, in turn, gain power in various ways from the huge popularity of their programming. Witness EchoStar's need to make sure it had CBS channels in time for the NCAA basketball tournament. "CBS is an essential channel," Ergen admitted last week. "We really wouldn't be able to survive without CBS." It was that need for CBS, Ergen said, that forced him to swallow Viacom's condition for taking it: carriage, sight unseen, of Viacom's Nicktoons channel, though Ergen said he didn't want it. As helpful as these elements are, a content-distribution combination doesn't hurt. For a distributor fighting with a content company, owning a programmer itself suggests that, if push comes to shove, it could substitute home-grown programming. For a content company at odds with a distributor, one implication of owning distribution is a diminished need for that third-party conduit. In dealing with other vertically integrated companies, a company can essentially say, "If you don't make unreasonable demands of us today, we won't make unreasonable demands of you tomorrow." Not that these have to be explicitly said. They're understood, says the anonymous buy-sider (who is long EchoStar, partly because of its attractiveness as a takeover candidate in some future media industry merger). "It's the fear factor," he says. "If you know the other guy has a nuclear weapon, whether he uses it or not, it changes how you respond to him."
As one last indication of the value of joining content and distribution, consider some of last week's comments about people who don't have it in the cable/satellite world. Ergen, for one, indicated that adding Nicktoons would mean he wouldn't have room to carry independent -- that is, nonvertically integrated -- programming such as PBS Kids and Oxygen. At the Bear Stearns conference, Viacom Chairman Sumner Redstone expressed interest in buying a cable system, yet said, "We don't need distribution for defensive purposes." One reason he doesn't need it is that Viacom has what's known as "retransmission consent" -- the legal right to tie carriage of what Ergen called the "essential" CBS local stations with Viacom's non-broadcast channels such as MTV, Comedy Central and Nicktoons. If retransmission consent goes away -- Ergen dropped his legal battle over that concept, but remains interested in attacking it legislatively -- maybe Redstone would need defensive distribution. Iger, too, said Disney didn't need a major distribution platform. "A few of us have proven that you can go it alone; you don't have to have distribution," Iger said. "Viacom has proven that. We've proven that. Fox did until recently, and then they went in another direction. Not because they had to have distribution, by the way." Thus, Viacom and Disney -- which each have about $27 billion in revenue -- don't need distribution. Which makes one wonder about all the companies that haven't hit $27 billion yet.