Court Hands Cablevision Competitive Edge

With a victory in a recent court case regarding remote-storage digital video recorders, Cablevision ( CVC) was handed a crucial win that will change the competitive landscape between cable operators and satellite television providers.

The ruling by the U.S. Second Circuit Court of Appeals clears the way for it to proceed with its plans for remote-storage digital video recorder service, or RS-DVR.

In essence, the new service allows customers to store recorded television programming on servers located at Cablevision's facilities, as opposed to recording to a hard-drive within the customers' own set-top box, as current digital video recorders do.

Analysts say the court's decision is a huge win for cable operators, as capital spending will be reduced once a full RS-DVR system is rolled out and the more expensive DVR-specific boxes are replaced. Currently, digital-video subscribers must obtain a new set-top box that is capable of DVR functions.

A transition to a full RS-DVR system will also be a boon for Cablevision and other cable providers, as it will help them ramp up penetration rates of digital video services in U.S. households while encouraging ad-skipping. Those factors will weigh heavily on both satellite television and media companies, which will be at a serious disadvantage by an RS-DVR rollout.

While News Corp. ( NWS) and Disney ( DIS) weren't immediately available for comment on whether they will appeal the decision, Sanford Bernstein analyst Craig Moffett says that such an important case will likely reach the Supreme Court, which will have the task of deciding whether DVRs, in general, infringe on copyrights.

Last week's federal appellate court's decision reversed a lower court's ruling that Cablevision infringed on exclusive rights of several media companies and vacated the judgment against Cablevision.

"In sum, because we find, on undisputed facts, that Cablevision's proposed RS-DVR system would not directly infringe plaintiffs' exclusive rights to reproduce and publicly perform their copyrighted works, we grant summary judgment in favor of Cablevision with respect to both rights," the court said in its ruling.

Since the court's decision, Cablevision's stock has jumped 20% to $31.25, although most of that move can be attributed to the company's announcement that it will explore options to enhance value for its shareholders, including a possible spinoff of its businesses or a dividend payment.

Cablevision originally unveiled its RS-DVR trial in March 2006, trumpeting the cost savings involved in ending the expensive purchasing and deployment of convention DVR set-top boxes.

Several media companies, including News Corp. and Disney, quickly sued Cablevision, and a U.S. District Court found that RS-DVRs violate the Copyright Act by infringing on rights of reproduction and public performance.

"We appreciate the Court's perspective that, from the standpoint of existing copyright law, remote-storage DVRs are the same as the traditional DVRs that are in use today," Cablevision said in a statement.

"DVRs have been one of the largest single drivers of capital spending in recent years, accounting for as much as 10% of capital spending for the major cable operators ," writes Sanford Bernstein's Moffett. "For cable, it potentially means much lower capital spending going forward."

In its second-quarter earnings report posted two weeks ago, Cablevision said that consumer-equipment costs accounted for more than 40% of its total capital expenditures.

Rival Comcast ( CMCSA) said that equipment costs were roughly 58% of total capital expenditures for its second quarter. And Charter Communications ( CHTR) said that second-quarter expenditures rose 12% from a year ago to $316 million due to consumer equipment costs, "specifically due to the purchase of advanced set-top boxes."

Cablevision is already touting the savings for both the company and its customers. "This is a tremendous victory for consumers, which will allow us to make DVRs available to many more people, faster and less expensively than would otherwise be possible," said Tom Rutledge, Cablevision's chief operating officer, in an email.

Winners and Losers

Satellite television companies DirecTV ( DTV) and Dish Network ( DISH), though, stand to lose ground in the battle with cable operators over the appeals court's ruling.

For one, every cable operator will have the benefit of putting a single standard RS-DVR box in every digital subscriber's home, eliminating the high costs related to upgrading to a different DVR box.

Secondly, satellite television companies, which have different network architectures for digital video recording services, will still maintain the more expensive model of DVR-specific set-top boxes.

"The satellite operators will be forced to operate at a significant technological and economic disadvantage," Moffett writes. "They simply cannot cost-effectively offer DVRs in every room for every subscriber."

Analysts also expect the penetration rate of DVR services to rise for cable operators. Moffett says that about 20% on U.S. digital cable households subscribes to DVR services, and as RS-DVR will eliminate the need to change a set-top box in to upgrade, DVR penetration could jump above 60% of digital cable households.

Perhaps more impacted than satellite television providers will be the media companies that brought forth the initial complaint against RS-DVR. Media companies are facing a major loss with the new technology as it will undoubtedly increase ad-skipping, where customers fast-forward through commercials while watching a digitally recorded program. Moffett says that roughly 56% of advertisements are now skipped in DVR playback mode.

"The risks to media companies of accelerated advertising loss are simply too great to expect that this issue will not become an important negotiating point in carriage agreements in the future," Moffett writes. "Armed with the Appeals Court's ruling, however, the leverage in those negotiations is now decidedly with the cable operators."