A few weeks ago, CBS (click ticker for report: ) and Time Warner Cable (click ticker for report: ) took their disagreement over carriage fees to another level, as both firms’ existing carriage fee agreement expired, effectively blacking out Time Warner subscribers from viewing the network.
Since then, we’ve seen really no signs of the companies coming to any sort of agreement. The Federal Communications Commission (FCC) warned on August 9 that, if the two firms didn’t reach an agreement, the government could get involved and force a resolution. Such an event would be an incremental negative to CBS because we doubt the FCC would see a reason why consumers should be forced to pay more for a network they can otherwise access for free.
And it appears consumers might be doing just that. CBS won last week’s national ratings war and reported that it has lost about 46,000 viewers (last week’s average viewers: 5.55 million), or less than 1% of its total audience. Therefore, either Time Warner subscribers (3.2 million) weren’t watching CBS in the first place, or they have resorted to using the traditional TV antennae. We tend to believe they simply hopped over to the antennae since it really isn’t a large inconvenience for many viewers.
On the flip side of the situation, CBS local viewership has experienced a fairly steep viewership decline in the wake of the blackout. Viewership for KCBS-TV channel 2 Los Angeles declined 33% at the 5PM hour and 25% at the 11PM hour from the previous week. That’s a large swing for a relatively stable news market, and a decline in viewership impacts local station revenue generation. Smaller, local advertisement spending may shift toward stations with strong local viewership, away from the CBS affiliates. Whether this will have a large impact on CBS’ top and bottom line remains to be seen.
Though we have heard much from individuals on both sides of the battle, it is hard to quantify where the balance of power lies. Though some consumers have left Time Warner for competitors such as DirecTV (click ticker for report: ), we think it is hard to say if the blackout caused the change or simply provided a catalyst for those who were going to switch services anyway.
Without question, if the CBS blackout is causing inflated and unmanageable subscriber churn, Time Warner will be forced to accept higher retransmission fees. However, if churn remains relatively in-line with historical rates and expectations, then there is no pressure on Time Warner to accept higher fees. In fact, if CBS’ ratings are only down marginally and Time Warner’s not losing any customers, then what incentive is there for a deal?
Well, for CBS an incremental viewer is positive for overall viewership, but it also provides a nice revenue stream ($12/yr x 3.2 million customers = $38 million) as well as superior local viewership (it seems). For Time Warner, not having CBS simply makes options such as DirecTV and Dish Network (click ticker for report: ) marginally more appealing. If this is the case, we’d anticipate the carriage fees to remain similar to where they are today.
However, it’s still a bit too early to tell whether or not people are really impacted by the CBS blackout. For one, there may be a large difference between how consumers react to not being able to watch Mike & Molly reruns versus not being able to watch a favorite NFL football team during the first week of the upcoming season. If the FCC doesn’t intervene and we see no agreement reached, the NFL season could be the catalyst that decides who caves.
Valuentum’s Take
Though the argument may seem relatively small, we think the future of retransmission fees will have a large impact on which part of the industry captures the greatest economic rent (the greatest piece of the industry profit pie). If Time Warner caves to higher fees because it needs the programming, then we think the content owners such as CBS and Disney (click ticker for report: ) will be the winners, while content distributors such as Dish, DirecTV, Time Warner, and Netflix (click ticker for report: ) will be net-losers (over the long haul).
At this point, we tend to believe the FCC will side with the content distributors since limiting carriage fee increases will almost certainly be a net-positive for consumers. Let’s also remember that the unbundling of content may be significantly more expensive for consumers than it would be for bundled content. Oftentimes, the goal of regulation is to protect consumers, and they are undoubtedly the loser with higher retransmission fees.
Our favorite idea in the space remains DirecTV. We think its valuation (currently discounted relative to peers) reflects exaggerated fears surrounding the “cutting the cord” phenomenon. Nor do we believe the market is accurately valuing the firm’s growing Latin American business. Limited or no growth in carriage costs will be a marginal positive for DirecTV. At this time, we believe shares of the firm are worth $80, and we hold the name in the portfolio of our Best Ideas Newsletter.