Can TV Nets Go OTT? Price Analysis Suggests It's Possible But Not Efficient

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1 Tony Wible, CFA Murali Sankar, CFA November 10, 2014 MEDIA AND ENTERTAINMENT Can TV Nets Go OTT? Price Analysis Suggests It's Possible But Not Efficient PORTFOLIO MANAGER BRIEF The drop in antiquated ratings, poor TV Everywhere development, threat from a long tail of online content, decline in MVPD homes, and rotation of ad spend to increasingly expensive mobile/online products, threaten the existence of less popular cable networks and pressure all owners to consider selling online bundles. The status quo could be more difficult to maintain as an initial shift of momentum has the potential to create a vicious cycle that may have already started with NFLX. While it is not efficient, our analysis shows consumers may be able to curate a cheap OTT package. ANALYST NOTES Looking For A Hedge - Ad revenue and affiliate fees are threatened by audience erosion and a drop in MVPD homes that could accelerate if more OTT content were available. This may ironically trigger TV nets to consider their own OTT services that would manifest the risk. These platforms would provide a hedge if the current ecosystem were not able to maintain the status quo, which is increasingly at risk as the younger demo ages and programming cost escalate. We note that ad revenue may actually thrive in an OTT environment and may allow TV ad sales to bridge over to mobile/online pricing models where ratings are no longer as important as DAU. Vicious Cycle - NFLX and YouTube have pulled viewers away from TV nets, while also triggering a need for more investment in programming. The rise in costs and drop in ad revenue leads to a greater demand for affiliate fees, which creates an unsustainable pressure for MVPDs - especially when one considers that TV ad revenue effectively subsidizes the cost of a video service by $56/ sub/mo. Higher MVPD prices and rising demand for NFLX/YouTube (as per our recent Youth Survey) may perpetuate the cycle. Cheaper But Not Efficient - Ad revenue may actually thrive with an OTT transition but subscription pricing needs to consider adoption rates that could be uneconomical for some networks. Parent companies need to bundle their networks. Our conservative analysis suggest many will need to price between $20-$25/mo. to avoid cannibalization, while the more optimistic analysis points to a more reasonable $10 to $15/mo. The prices highlight the economic value of a MVPD package and suggest OTT would dilute earnings if demand cannot support the relatively high price. We note that our analysis does not account for the very real risk that MVPDs retaliated as they have with others. UBB Could Trump - The cost of a GB may be the single biggest factor that can shape the media ecosystem. ISPs will inevitably need to move to UBB. A higher rate would make OTT services uneconomical and preserve the status quo. However, high rates would face government scrutiny and the street underestimates the power of online publishers direct appeal to voters. Today's UBB test pricing would not materially affect 1080p cord cutters but would lift a monthly data bill to over $200 with 4K resolutions. VIA Long Tail OK - Consumer demand looks to be moving away from long tail cable networks that VIA is identified with. This is a very real risk; however, we estimate VIA would only need to take up pricing on its 10 most popular networks by $0.04/month if it were to shut down its 15 least popular networks, which we estimate contribute $870 million of annual revenue today. PAGE 1 OF 13

2 TWTR and FB CPM per quarter Source: Company reports, Janney Capital Markets PAGE 2 OF 13

3 Parity OTT Pricing using Different Methodologies Source: Nielsen/SNL Kagan, TiVo/TRA, Janney Capital Markets PAGE 3 OF 13

4 Hours Spent Watching Daily Source: Janney Capital Markets PAGE 4 OF 13

5 OTT Vicious Cycle More OTT Demand Lower Ad Revs/ Ratings Higher Production Cost Higher MVPD ARPU MVPD Programming Cost Pressure Higher Affiliate Fees Source: Janney Capital Markets PAGE 5 OF 13

6 Viacom Network Statistics 1 Network not measured by Nielsen; we are assuming a 0.05 rating Source: Nielsen / SNL Kagan, Janney Capital Markets ESPN Household Delivery (in millions) Source: SNL Kagan, TVbythenumbers.com, Janney Capital Markets PAGE 6 OF 13

7 High End and Low End of Network-Level Parity Pricing (monthly fees/sub) Source: Janney Capital Markets OTT Price Points PAGE 7 OF 13

8 Share of PT households and Parity Pricing (excl. sports) using Nielsen Ratings $35 $30 $25 $20 $15 $10 $5 $0 Source: Janney Capital Markets Comparing OTT Break-Even to Current Bundled Pricing (excl. sports) Source: Janney Capital Markets PAGE 8 OF 13

9 Parity Pricing using TiVo/TRA Network Reach Source: Janney Capital Markets Broadcast and Premium Advantage VIA s Long Tail Transition PAGE 9 OF 13

10 MVPD Price Pushback STRZA Net Adds and ARPU Growth Source: Company Reports, Janney Capital Markets Ratings Don t Matter As Much The Big Data Variable PAGE 10 OF 13

11 Potential Datacost of Usage Based Billing Source: Janney Capital Markets, using Comcast UBB test pricing PAGE 11 OF 13

12 IMPORTANT DISCLOSURES Research Analyst Certification I, Tony Wible, the Primarily Responsible Analyst for this research report, hereby certify that all of the views expressed in this research report accurately reflect my personal views about any and all of the subject securities or issuers. No part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views I expressed in this research report. Janney Montgomery Scott LLC ("Janney") Equity Research Disclosure Legend Janney Montgomery Scott LLC currently acts as a market-maker in the securities of Comcast Corporation, Walt Disney Company, Netflix, Starz LLC, Time Warner, Inc. and Viacom, Inc.. Janney Montgomery Scott LLC intends to seek or expects to receive compensation for investment banking services from Comcast Corporation, Walt Disney Company, Netflix, Starz LLC, Time Warner, Inc. and Viacom, Inc. in the next three months. The research analyst is compensated based on, in part, Janney Montgomery Scott's profitability, which includes its investment banking revenues. Janney Montgomery Scott LLC ("Janney") Equity Research Disclosure Legend Individual disclosures for the companies mentioned in this report can be obtained by accessing our Firm s Disclosure Site Disclosure Site Definition of Ratings BUY: Janney expects that the subject company will appreciate in value. Additionally, we expect that the subject company will outperform comparable companies within its sector. NEUTRAL: Janney believes that the subject company is fairly valued and will perform in line with comparable companies within its sector. Investors may add to current positions on short-term weakness and sell on strength as the valuations or fundamentals become more or less attractive. SELL: Janney expects that the subject company will likely decline in value and will underperform comparable companies within its sector. Janney Montgomery Scott Ratings Distribution as of 9/30/14 IB Serv./Past 12 Mos. Rating Count Percent Count Percent BUY [B] NEUTRAL [N] SELL [S] *Percentages of each rating category where Janney has performed Investment Banking services over the past 12 months. Other Disclosures Janney Montgomery Scott LLC, is a U.S. broker-dealer registered with the U.S. Securities and Exchange Commission and a member of the New York Stock Exchange, the Financial Industry Regulatory Authority and the Securities Investor Protection Corp. This report is for your information only and is not an offer to sell or a solicitation of an offer to buy the securities or instruments named or described in this report. Interested parties are advised to contact the entity with which they deal or the entity that provided this report to them, should they desire further information. The information in this report has been obtained or derived from sources believed by Janney Montgomery Scott LLC, to be reliable. Janney Montgomery Scott LLC, however, does not represent that this information is accurate or complete. Any opinions or estimates contained in this report represent the judgment of Janney Montgomery Scott LLC at this time and are subject to change without notice. Investment opinions are based on each stock's 6-12 month return potential. Our ratings are not based on formal price targets, however, our analysts will discuss fair value and/or target price ranges in research reports. Decisions to buy or sell a stock should be based on the PAGE 12 OF 13

13 investor's investment objectives and risk tolerance and should not rely solely on the rating. Investors should read carefully the entire research report, which provides a more complete discussion of the analyst's views. Supporting information related to the recommendation, if any, made in the research report is available upon request. PAGE 13 OF 13