One Good Reason Disney Sacrificed Freeform in its New Charter Deal

Disney may have sacrificed carriage of Freeform (nee ABC Family, Fox Family, The Family Channel, CBN, Christian Broadcasting Network) in part because it was easier to give up carriage of a linear channel which had an "ironclad" obligation to carry The 700 Club, the conservative evangelical Christian talk show for 2 hours every day (currently 11PM and 9AM ET).

In the recent past, "shelf space" for fully distributed basic cable TV channels was perhaps the most valuable asset in the media. Basic cable networks with inexpensive programming like MTV, could run at greater than 50% margins. Cable cord cutting has reduced those margins, in some cases pretty dramatically. Programming companies, like Disney, have been prioritizing entertainment investments in growing on-demand services like Disney+ and Hulu over the declining "linear" TV business of 24 hour scheduled channels. Disney CEO Bob Iger has discussed its options for the linear services in a recent interview on CNBC; they "might not be core to Disney".

The Disney-Charter deal, which saw the inclusion of Disney+ and ESPN+ in Charter's Spectrum "cable TV" packages, despite the fact that they had not, to date, been considered cable TV services. The services clearly have some attractive programming. Charter had asked for it to be included in its deal for free for Charter customers; the announcement of the deal made it clear that Charter is paying a "wholesale" rate for them. Depending on what that rate is, the inclusion of these services in Spectrum's cable video packages could represent a lot of value to Charter or a lot of value to Disney. Most likely, it is a little bit of both.

What is clear is that the Disney linear services that were carried by Spectrum systems in its expired deal, but not in the new one (Baby TV, Disney Junior, Disney XD, Freeform, FXM, FXX, Nat Geo Wild, and Nat Geo Mundo), were no longer growing assets for Disney nor highly valued by Spectrum. 

Cable operators have been pruning their cable lineups to control the cost of their video service which have looked expensive and bloated next to the much cheaper streaming services over the last decade. It was very clear that the streaming services were also getting more and more of the high profile new original programming, because the programming companies had been rewarded by the stock market for the growth of their streaming services, despite the fact that these services were all highly unprofitable.

Whether these straight-line trends towards streaming and away from cable video will continue now that the fast growth of streaming has ended, investment in streaming programming is being cut back, and streaming retail prices are going up sharply, is less clear.

I believe consumers' move from cable to streaming was much more about the relative value they offered than the "inevitability" of the newer technology.

Charter Switches from EBUs to Billables for Subscriber Reporting

Close observers of cable MSO financials noted a significant change stuck in the footnotes of Charter's 4Q15 and year end financial statements:

(e) Charter revised its methodology for counting customers who reside in residential multiple dwelling units ("MDUs") that are billed under bulk contracts.  Beginning in the fourth quarter of 2015, we count and report customers based on the number of billed units within each bulk MDU, similar to recent reporting changes at our peers and reflecting the completion of all-digital which requires a direct billing relationship for all units which receive a set-top box.  Previously, our methodology for reporting residential customers generally excluded units under bulk arrangements, unless those units had a direct billing relationship.  Prior year information has been revised to reflect our revised methodology.

emphasis added to highlight the following: The use of billable subscriber counts -- pioneered by Comcast in 1Q2013 -- leads to generally higher numbers than EBU counts. It is a rosier picture to investors.

The corresponding footnote in 3Q15 read as follows:
(h) Included within commercial video customers are those in commercial structures, which are calculated on an equivalent bulk unit ("EBU") basis.  We calculate EBUs by dividing the bulk price charged to accounts in an area by the published rate charged to non-bulk residential customers in that market for the comparable tier of service. This EBU method of estimating video customers is consistent with the methodology used in determining costs paid to programmers and is consistent with the methodology used by other multiple system operators.  As we increase our published video rates to residential customers without a corresponding increase in the prices charged to commercial service customers, our EBU count will decline even if there is no real loss in commercial service customers.

Charter reported residential basics 4,322,000 up from 4,293,000 at year end 2014 under the billable methodology. However, at year end 2014, Charter reported only 4,160,000 EBUs, so the Residential Basic subscriber count for billable subs was 3.2% higher than for EBUs. That seems a bit odd. Residential subscribers shouldn't vary much from EBUs. The reason that comes to mind of why residential billables would be higher than residential EBUs is if a material portion of the residential subscribers are seasonal accounts who pay a much lower rate in the off-season. However, Charter isn't in most of the big seasonal markets (e.g., Florida with its snowbirds).

Commercial basics were 108,000 up from 104,000 at year end 2014 under the billable methodology. At year end 2014, Charter reported 133,000 commercial video EBUs, so the billable subscriber count was 21.8% lower than the EBU count, which makes sense, since commercial accounts include multiple dwelling units and those typically get a "bulk discount". [In a bulk arrangement, 100% of a building's units get the service -- usually billed through their maintenance -- so that there is no reason for a unit to turn down the service and little churn for the cable company. For that benefit, the cable company provides a price break over the cost of all of those units subscribing independently, and potentially disconnecting.]

As Charter pointed out in 3Q15 "As we increase our published video rates to residential customers without a corresponding increase in the prices charged to commercial service customers, our EBU count will decline even if there is no real loss in commercial service customers." Looking at it from the other side, when bulk rates decline (due to furious price competition from DBS and telcos for these MDU accounts) EBU counts go down even if the MSO holds onto the business.

There is no misleading going on here. The revenues of the companies are not affected by this subscriber-counting change. This is investor spin. As there has historically been so much focus on subscriber growth, it isn't entirely surprising that the biggest MSOs have decided to deploy a measurement system that paints their results in a better light than the one that they used historically (and is still the one that they prefer to use when paying programmers like ESPN and was part of a joint industry consensus in 2002 -- clearly another time).

AT&T Buys DirecTV: Some Macro and Micro Thoughts

A few thoughts on the day after the big merger announcement:

Unlike the Comcast-Time Warner Cable-Charter proposed deal, AT&T's purchase of DirecTV "would eliminate a choice for pay-TV customers in some markets." In those areas where AT&T offers U-Verse service, a consumer likely has a choice of four competitive providers: the incumbent cable operator, Dish Network, DirecTV, and AT&T. If this merger goes through, the four choices go down to three and the new company includes one of the giant providers (as opposed to a combination of two of the smaller ones). While antitrust is far from my area of expertise, it appears that this is exactly the same outcome that doomed AT&T's attempted acquisition of T-Mobile.

While having AT&T and DirecTV under the same ownership would appear to facilitate bundling services for consumers (e.g., in non-U-Verse areas the combined company could offer phone plus DSL plus DBS plus cellphone), unless the DirecTV brand goes away, it would still appear to be the sort of shot-gun marriage that all current and prior telco-DBS "synthetic bundles" are and have been. It's not an elegant solution and "people are abandoning DSL in droves, and buying cable broadband".

When I've read of DirecTV's strong cash flow, but otherwise difficult strategic position (a TV-only provider in an increasingly bundled bustiness) and how AT&T could really use the DirecTV cash to fund its dividend, the story sounded suspiciously like Viacom's 1994 acquisition of Blockbuster to fund the acquisition it really wanted, Paramount Pictures. How did that one work out? Not that well.

Would AT&T apply the DirecTV brand to U-Verse video offering? Maybe that's a better idea. As AT&T's press release on the deal states: DirecTV is "the premier pay TV brand with the best content". The U-Verse brand is probably meaningless. Why anyone has a brand with a hyphen in it is beyond me. It is clunky and not web-friendly (the URL for the service is uverseonline.att.net, although u-verse.com does redirect to it -- why have consumers wonder if they include the hyphen or not. DirecTV's URL is simply directv.com).

This deal should seem like a homecoming for Dan York, DirecTV's chief content acquisition executive. It was just 2 years ago that he left that same role at AT&T.

Programming savings will not be as easy to come by as they are in a typical cable acquisition. DirecTV's distribution rights may be limited to its single DBS system and, if that's the case, would not have the right to simply add AT&T's systems to its affiliation agreements (and take advantage of DirecTV's greater purchasing power). Comcast, by comparison, would very likely have the right to do exactly that with the Time Warner Cable systems. It is always simpler if one does not have to negotiate. DirecTV already has relatively low programming costs as it is a giant pay-TV distributor; the programming cost savings would largely come for the much smaller base of AT&T U-Verse customers.

Could the NFL allow DirecTV to sell Sunday Ticket on U-Verse as well as DBS, but not provide it to other distributors? That could be interesting, but it would have to be negotiated. It is very unlikely that DirecTV would have the right to extend Sunday Ticket to additional platforms under its current (and expiring) deal. Would give U-Verse a leg up that it has never had before, but only a limited footprint in which it could take advantage of it. It would be an odd decision for the NFL: Sunday Ticket would be available from two providers in a minority of the country and one provider in the vast majority of the country. That's not an obvious thing to explain to consumers.

NFL Sunday Ticket is clearly on AT&T's mind. From its 8K filing about the deal: "The parties also have agreed that in the event that DIRECTV’s agreement for the 'NFL Sunday Ticket' service is not renewed substantially on the terms discussed between the parties, the Company may elect not to consummate the Merger, but the Company will not have a damages claim arising out of such failure so long as DIRECTV used its reasonable best efforts to obtain such renewal."

Packaging differences: Would DirecTV try to make the DBS and U-Verse packages of services more similar. Or would the combined company enjoy the dealmaking flexibility of having good-better-best on 2 different platforms and now have more ways to split the baby. In any event, the companies say they don't plan any large packaging changes.

Other perspectives:

• VideoNuze's Will Richmond is not a fan of the backward-looking deal.
• Howard Homonoff sees more work for the federal communications bar.
• Multichannel News's Mike Farrell sees 5 reasons the merger might not fly.
• The Diffusion Group's Joel Espelien thinks that AT&T needs DirecTV to have TV Everywhere video content for its wireless and broadband customers. I think he's totally off-base. TVE is a small portion of video content online and not even used by most pay-TV customers.
• Deadline's David Lieberman thinks Peter Chernin and over-the-top video is the key to the deal. I would tend to doubt that.

Comcast's Offer for Time Warner Cable

A few quick notes about the proposed transaction:

• Comcast's offer of $159 per TWC share is very close to TWC CEO Rob Marcus's proposal to sell the company to Charter for $160.
• Comcast's offer has no break-up fee for either side, Comcast can abandon the deal at any time and Time Warner Cable, presumably, can entertain a better offer from Charter or someone else
• Comcast has also offered to divest 3 million TWC subscribers, presumably to address concerns that the merged company would be too big; the "cats & dogs" of TWC's former national division would be likely divestiture candidates, unless some of them are contiguous to existing Comcast systems.
• Comcast has made bold offers before and walked away when investor support for the deal was not there (its 2008 offer for Walt Disney)
• Because Comcast and Time Warner Cable have few systems which compete directly with each other, there would be little direct impact on consumers -- their number of choices of providers would not be reduced. Consumer Reports looks at it this way. Comparing the impact on competition to the stillborn AT&T T-Mobile deal is off-base.
• The deal is good news for the channels of NBC Universal, which now are more likely to gain carriage on Time Warner Cable's systems. NBCSN and Golf Channel, which are carried on digital in Time Warner Cable's New York City system (link is to .pdf), will likely end up with parity (expanded basic) carriage with ESPN.
• The vendors that sell to the companies (non-NBCU programmers, hardware companies, billing systems providers) who will now be dealing with a larger customer and fewer attractive alternatives if they say "no" are the biggest losers if the deal goes through.
• Charter is likely a loser if the deal closes. If it sees increasing its scale a business imperative, the biggest available target will be off the market. Cox and Cablevision are the next biggest available companies and they have rebuffed multiple offers to sell. The cable companies smaller than them (e.g., Mediacom) are much smaller with fewer than 2 million subscribers. Charter would have to buy nearly all of them to increase its scale as much as a Time Warner Cable deal would have.
• Another loser might be Apple. TWC appeared to be creating an app for the Apple TV box; Comcast hasn't been, seeing its X1 guide as preferable.
• Closing price of CMCSA on 13 Feb 2014 (the date the deal was announced) = $52.97. TWC = $144.81. CMCSA x 2.875 (stock exchange ratio) = $152.29. Implies some uncertainty about the deal closing.
• Cablevision will still be the largest cable operator in the New York DMA by subscribers, but the combined Comcast-Time Warner Cable will be a major player in New York and the dominant provider in virtually all of the other top 25 DMAs (exceptions: Cox-Phoenix #12, Charter-St. Louis #21, see Rich Greenfield's chart @ https://twitter.com/RichBTIG/status/433960562309861376/photo/1
• Slate's take on the deal negotiation -- it's not very different from any other time you call the cable company

Update (14 Feb 2014): Mark DeCambre on the website Quartz quotes a Gekko-like Goldman Sachs research note praising the deal for giving pricing power to the new company with the charming pull quote "M&A that drives an industry toward oligopoly is the good kind."
Update (16 Feb 2014): Paul Krugman's column in the New York Times. Barons of Broadband. Pull quote: "The truth, however, is that many goods and especially services aren’t subject to international competition: New Jersey families can’t subscribe to Korean broadband."
Update (18 Feb 2014): Another likely loser with this deal is Netflix. TWC was in talks to carry/sell Netflix to its video customers, something Comcast has rejected. Now, per Bloomberg, "the talks are on hold".
Update (19 Feb 2014): As my former colleague Howard Homonoff astutely notes, Google Fiber's announcement that it will enter additional markets is very good news for Comcast in securing government approval for the deal.
Update (19 Feb 2014): Another loser in this deal may be CBS which would see the TWC systems move from the recently-and-contentiously-negotiated deal to an older, more distributor-favorable Comcast deal, according to this LA Times article. It is standard in cable affiliation agreements for the acquirer to have the right to add one or all "after-acquired systems" to its affiliation agreements and delete the systems from their prior agreement. In fact, Comcast would likely do this for all its agreements that are more favorable than TWC's (and should TWC have any more favorable deals than Comcast, Comcast might be able to move its incumbent systems to those newly-acquired deals).
Update (20 Feb 2014): Bill Niemeyer of The Diffusion Group believes that John Malone may not have really wanted Time Warner Cable for Charter because the Comcast/TWC merger noise creates an opportunity for Charter to act under the radar. Maybe, Dr. Malone does prefer to be out of sight of the regulators, but I find it hard to think that anything Dr. Malone does will go unnoticed.
Update (20 Feb 2014): DirecTV's CEO thinks the deal should get "appropriately scrutinized". In the past, DirecTV has criticized Comcast's dealmaking for its regional sports networks.

A Milestone: An MSO's Broadband Subs Exceed Its Video Subs

For all the talk of how broadband has become the core service for cable TV operators, famously by Time Warner Cable CEO Glenn Britt in 2011, for many operators, the number of video subscribers has continued to exceed the number of Internet (or high speed data or cable modem customers). Charter, one of the largest US cable companies, hit a milestone in the second quarter of 2013. It reported 3.924 million residential high speed data customers and 3.917 million residential video customers. No other major publicly traded cable operator has ever reported that.


2Q13 Subs in 000       Video  Broadband   Broadband/Video
Comcast               21,776 19,986      0.92 
Time Warner           11,720 11,074      0.94 
Charter                3,917   3,924      1.00 
Cablevision            2,868   2,787      0.97 
TOTAL                 40,281 37,771      0.94 

Counting Bulks with Comcast's CFO

In his opening comments on the Comcast 1Q 2013 earnings call, CFO Michael Angelakis made some curious statements about counting subscribers in bulk-billed accounts:

In addition, we implemented equipment price increases for [D to As] and HD DVRs to this larger base, which in combination negatively impacted our customer base during the quarter. However, about half of our video subscriber losses were due to the methodology we use to count [MDU] subscribers under our bulk contracts and the other half were primarily video-only customers.

As you may know, we count video customers that are billed under bulk contracts on an FCC equivalent or [EBU] basis, which results in fewer customers as rates increase. In order to improve our transparency in how we report and manage these bulk contracts, we’ll be changing our external reporting to a billable units methodology at the end of the year. We believe this change will reinforce our operational focus in this customer segment, and align our video customer account methodology with the rest of the cable industry.

Comcast's spiffy logo, NBC's peacock was added in December

Let's parse these statements. Comcast is changing its methodology used to count MDU (multiple dwelling unit -- e.g., apartment buildings) subscribers. The industry-standard method for paying programmers is that MDUs are paid on an "EBU basis". EBU stands for equivalent billing unit (or equivalent basic unit). The concept is that if a building gets a package of service that costs $15,000 per month and a residential subscriber with the same package would pay $100 per month, then the building has the equivalent of 150 residential subscribers, irrespective of the number of actual units in the building who are receiving service. Typically bulk-billed accounts get a rate break, in exchange for providing service to every unit (where the cost is bundled into the building's maintenance fees to the tenants), the cable operator will charge the building something less than the full retail price (since it doesn't have to market the service to each apartment individually). Historically for cable operators, the bulk discount was 30% -- a building with 100 units would be charged at the equivalent of 70 residential subscribers.

One of the most competitive parts of the multichannel television business is providing service to MDUs. Individual apartments face a host of issues subscribing to DirecTV or Dish Network, notably the need a place to put a dish antenna that can see the provider's satellites -- a challenge if one does not have access to the roof. The building itself, however, does not have this problem -- it owns the roof. Dish and DirecTV aggressively discount their services for apartment buildings -- as DirecTV notes on its website to building owners: "you can offer your residents the amenity of reduced package prices." Needless the say, bulk discounting often exceeds the old 30% amount. As Michael Angelakis notes, as the residential price goes up faster than the bulk price (which may not be going up at all), the EBU number is declining -- even as the number of units receiving service in the building is unchanged.

So, that describes the "old" method of counting subscribers in bulk accounts. What is the new way? Angelakis said that "we'll be changing our external reporting to a billable units methodology". This sounds to me like the count of actual units in the building getting service, irrespective of the discounting. One thing it definitely will be is a bigger number -- a great way to obfuscate the declining value of the bulk accounts. Comcast does have a history of liking to report bigger numbers. For many years it reported digital boxes it had deployed, rather than digital subscribers the way every other cable operator did. (Typically digital boxes were 40% higher than digital subscribers -- since many digital subscribers had multiple digital boxes. Note the Comcast's definition of a "digital subscription" in its 2001 annual report, it's in notes 5 and 6 on page 6.)

It is contrary to my experience that Comcast's move on counting bulks is "aligned" with the rest of the cable industry, I would have assumed the opposite. Perhaps Comcast is announcing this change now, three quarters before it plans to implement it as a way of enticing others to follow suit.

So, what have we learned? Comcast lost 60,000 basic subscribers in 1Q13 and it is attributing half of that loss, 30,000 subscribers, to lowering the cost of the video service it provides to MDUs, rather than actually serving fewer subscribers. Since we don't know how many Comcast subscribers are in bulk-billed arrangements, we don't know if that number represents a small or dramatic decline in the pricing of service to MDUs.

Updated (7 May 2013): Charter released its 1Q 2013 earnings today which included a few notes about bulks as well. This is the complete text of footnote (o):

Included within commercial video customers are those in commercial structures, which are calculated on an equivalent bulk unit ("EBU") basis. We calculate EBUs by dividing the bulk price charged to accounts in an area by the published rate charged to non-bulk residential customers in that market for the comparable tier of service. This EBU method of estimating video customers is consistent with the methodology used in determining costs paid to programmers and is consistent with the methodology used by other multiple system operators. As we increase our published video rates to residential customers without a corresponding increase in the prices charged to commercial service customers, our EBU count will decline even if there is no real loss in commercial service customers. For example, commercial video customers decreased by 10,000 during the three months ended March 31, 2013 due to published video rate increases.

Apparently, Charter is seeing the same drop in bulks due to effectively lower pricing in the MDU market that Comcast is seeing. Additionally, unlike Comcast, Charter sees counting commercial subs on an EBU basis as "consistent with the methodology used by other multiple system operators".

Intel-evision?

According to an article in the Wall Street Journal, Intel is looking to develop at web-based video service to compete with cable and satellite. Intel's plan is to create a virtual MSO, a business idea that many have been kicking around in one form or another.

Consumers would welcome another choice of video provider. As one measure of customer satisfaction, Consumerist's cheeky "Worst Company in America" 2012 bracket features eight providers of multichannel television (Comcast, DirecTV, Dish, Time Warner Cable, Charter, Verizon, AT&T and CenturyLink), among its 32 "contestants".

However, facts are stubborn things (hat tip, John Adams). Multichannel penetration is very high ~90% -- there are relatively few households who do not see it  as a worthwhile purchase, despite the fact that subscription prices increase every year. That suggests that the customer satisfaction issue is likely less the service itself (not that it doesn't have its frustrations - long times on hold, among them), than frustration with the price and general lack of choice. (If it didn't, Charter wouldn't be doing things like this.)

If Intel were to offer a me-too service (i.e., a comparable package of services) at a lower price, it would likely attract some customers. However, multichannel providers are already cutting prices in a de facto way, as they offer sweetheart deals for new customers, particularly in areas of high competition. It isn't easy to compete on the low end with customers churning through the introductory offers in search of the best deal.

The me-too offering would have a competitive advantage if its operating cost of delivering the service were lower than the incumbents. It won't be because of lower programming costs. A new entrant into the market, like Intel, can expect to pay 20% or more greater programming costs than the incumbents. Intel wouldn't have to build the expensive distribution system (laying cable, launching satellites) that the incumbents did, but would be on the hook for the variable cost of delivering bits to its customers. The jury is still out on how much less expensive that would be. However, that does make Intel, like Netflix, highly dependent on the ISPs (who are the cable and telephone companies) to continue to provide unlimited service to their customers.

There are alternatives to a me-too service, of course. A la carte offerings of channels is a popular request, but one that it is hard to imagine the programming community embracing. (LA Times: Don't hold your breath for a la carte cable -- is that clear enough?) Given the high penetration of multichannel television, there isn't much reason for the programmers to look at a different, potentially less lucrative business model, unless they have to do so (as the music industry had to, after rampant piracy ended their chokehold on packaging and pricing). However, the multichannel subscription television market probably has less piracy today than it did in the past, due to the changeover from less-secure analog systems to more-secure digital ones). So, it won't be driven by piracy, at least not today's piracy, but maybe tomorrow's.

This is not the first Intel over-the-top story. GigaOm reported earlier this year that Intel was "in talks to buy Roku". BTW, Roku is now looking to raise some $50 million to expand...hmmm.

It is always interesting to see new entrants to an industry as that's often the origin of the new ideas that shake things up (Walt Disney's theme parks, Apple's iPod, iPhone and iPad). If Intel has that sort of idea, there will be a place in the market for them. There is certainly room for innovation in the distribution of television.

Netflix Streaming Performance by ISP

Today Netflix posted an update on its "tech" blog on the average streaming performance for its customers using various ISPs.

For the first time, Netflix broke out Verizon's FiOS internet service from its DSL offering and AT&T's U-Verse internet service from its DSL. Here's the takeways, none of which is a surprise to those familiar with consumer internet service:

1. Verizon and AT&T's fiber-based services are significantly faster than their DSL services.
2. Verizon FiOS was the top performer with an average speed slightly above 2,500 kB/sec.
3. Places 2-7 were held by cable ISPs, with Charter leading the way.
4. AT&T's U-Verse service scored above all the DSL providers, but behind all but one of the cable modem services (that would be Suddenlink)
5. Clearwire's mobile broadband service had an average speed materially below that of the poorest performing DSL service (Verizon).

It is my understanding that Netflix is looking at this from the basis of the average streaming customer irrespective of the level of internet service which the subscriber gets. At this point most of these providers are offering several levels of broadband service (e.g., Time Warner Cable in NYC has Basic, Standard, Turbo and Wideband with significant price and performance differences between them), so differences between the cable providers might be more reflective of the mix of internet service levels Netflix subscribers are taking than differences in what each ISP is capable of providing.

Netflix first posted a similar report in January 2011 where they described the methodology employed to come up with these figures.

Charter 1Q11 results

Charter had another quarterly decline of basic subs -- down 23,800 (combined residential and commercial).  Basic cable subs to home passed is 36.0% while Internet to homes passed is 29.1%.  Cablevision had a similarly small spread in those figures in reported 4Q10, but both Cablevision figures were more than 20 points higher.

Charter 1Q11 financial results press release