The US Senate Committee on Commerce, Science and Transportation held a hearing this week on “The Cable Act at 20”. This hearing was intended as a follow-up to the Commerce Committee hearing on April 24 which focused upon online video. The hearing highlighted to us that Congress is paying particular attention to the regulatory matters which drive so much of the industry’s structure. This kind of event should be viewed as inevitable, especially when there are beneficiaries of government policy whose privileges come at someone else’s expense. However, the more that time passes, the more likely it becomes that Congress will take up related matters in the form of new legislation.
For a refresher on the topic, retransmission consent and must carry rules are embedded in the Cable Act of 1992, and effectively require cable operators to involuntarily carry local broadcast television signals or, alternately, to negotiate with local broadcasters for the right to carry those signals. These rules replaced a compulsory copyright license (embedded in the 1976 Copyright Act) which allowed cable operators to retransmit over-the-air the broadcast signals without compensating broadcasters beyond paying them for copyright fees. The law was challenged by much of the cable industry, and eventually was affirmed by the Supreme Court in 1997. For some time, our lay-person’s view has been that the under-pinning of the court’s ruling was weak, to the extent that it presumed technology was static. From that perspective, the benefits associated with the ruling are not necessarily perpetual.
Since the Cable Act’s passage, licensees of local broadcasting signals extracted significant value from the rights embedded in the law. Broadcast network groups were able to expand the deployment of their cable networks, as negotiating with a cable operator to launch a new cable network and receive compensation for that new network was initially more mutually advantageous than simply asking cable operators for direct payments. Independent broadcast groups who were unwilling or unable to develop cable networks were able to ensure that they could offer nearly 100% potential reach to local advertisers, substantially improving their ability to generate revenues from their properties. For the most part, cable operators and other MVPDs simply passed the cost along to consumers (and preferably, from the MVPDs’ view, at some mark-up).
However, the topic of retransmission consent has become increasingly pronounced in recent months, not just because of carriage disputes between broadcaster-programmers and distributors which have recurred with regularity over the past decade, but also because of the launch of venture-funded Aereo and the related prospect that a de facto distributor may avoid paying meaningful compensation to broadcast licensees. It’s equally become an issue in the context of assessing the value of CBS (CBS, BUY) and other stocks with broadcasting assets given increasingly widespread expectations for significant direct revenues associated with retransmission consent rights.
Video delivered over IP services should not be a near-term cause for a negative concern to investors or the industry at large. Assuming such services survive court challenges, the negotiating leverage conferred to distributors by virtue of threatening to launch their own white-label IP-delivered video service or by licensing Aereo’s technology seems to us to be limited over a relevant time horizon (i.e. the duration of carriage agreements which could be between three and seven years in length) as:
The real risks are that the retransmission consent regime – weak foundation and all – implodes as regulators or courts revisit the underlying rationales for the rules and their legal basis. In our view the biggest risk to broadcast station licensees is that any of the above factors – including the provocations by the industry in the courts towards Aereo – could indirectly lead to a reversal of public policy and a resumption of the compulsory copyright license. For example, heightened attention to the flaws embedded in the 1992 Act could, in a future legislative session, lead to the adoption of a new law such as the one proposed by Senator Jim DeMint last year (“The Next Generation Television Marketplace Act”). DeMint’s legislation would repeal retransmission consent rules and the compulsory copyright license. This would probably result in a status-quo industry structure in the short-term after it were enacted, although cable operators would incrementally gain leverage in their negotiations vs. present rules, and so stand-offs could become more pronounced as distributors and programmers attempt to assert which side was more powerful. But more practically, the process of turning a bill into a law would involve many uncertainties and many more compromises, such that outcomes could negatively impact broadcasters.
Broadcast licensees would not simply become cable networks if they lost the advantages derived from retransmission consent rules. While it can be appealing to presume that if broadcasters lost negotiating rights as a result of new rules, they would simply return their licenses, sell their TV stations and re-position themselves as cable networks, enabling them to negotiate for carriage on the “open” market. This ignores that advertising revenues could suffer greatly, as the distinction between broadcast and cable would be rendered meaningless.
The reason for this is that there is a meaningful difference today between national broadcast and national cable because broadcast television can claim – and often achieve – substantially more reach vs. cable. This reach advantage is what causes advertisers to pursue negotiations with the relatively small number of broadcast networks first, before negotiating with cable networks in the Upfront marketplace. Because negotiations occur with a relatively small number of sellers who can tacitly collude more easily than if their numbers were greater, relatively high price points can be realized. By contrast, if the four broadcast networks found themselves directly (rather than indirectly) selling against another half dozen broadly distributed cable networks, they would find pricing would become much more competitive and generally fall as advertisers became increasingly indifferent between their suppliers, and as the now-ten broadest reaching networks competed for budgets more aggressively. Common ownership of some of these cable networks (i.e. USA and NBC) did not benefit parent companies in the past because of divergent dynamics (i.e. a head of sales of both networks would give away lower-priced inventory on one network in order to capture volume for the combined group) which can further undermine pricing integrity.
Given these circumstances, we think the become-a-cable-network approach will prove to be unrealistic.
Nothing is likely to change in the near-term, but anything is possible in the long-term. Regardless of noise out of Washington DC or from the courts deliberating on the future of IP-delivered broadcast signals, we see little which will change the prospects for broadcasters to generate revenues from retransmission consent over most investors’ time horizons. We’re unaware of any efforts in the courts to actively challenge the retransmission consent regime, and even if one were initiated today it would be at least five years (if not longer) before any final resolution. Thus, by the time current laws could be over-turned, many other changes will have taken hold across the industry.
For example, we believe it is appropriate to assume that set-top boxes will eventually (and universally) have IP and QAM-based tuners. Consumers will gradually and broadly upgrade their data services for reasons unassociated with television viewing and lead to an installed base of infrastructure with the capacity to deliver IP-based video en masse. Further, compression technology improvements may render many of today’s infrastructure limitations as moot. While we’re looking into our crystal ball, it’s worth calling out that at some point in time, a thumb-drive could offer sufficient volumes of data storage such that any given day’s non-live television programming might most efficiently be delivered to households via the US Postal Service.
For now, we believe it remains reasonable to assume broadcast licensees can generate rising revenues from retransmission consent negotiations. Affiliate deals which are being cut today offer significant long-term visibility, and for many years into the future we expect similar deals to be negotiated between broadcasters and distributors, regardless of technology’s evolution. But change, as in most facets of business and life, is inevitable. These revenue streams are not likely to last forever. With luck on the broadcast licensees’ side, they may be replaced with something even more lucrative (and as long as broadcasters satisfy important public policy objectives, they will probably continue to benefit from implicit or explicit regulatory support).
Under any circumstance, broadcasters benefit from the status quo despite technological change around them, which can’t be stopped under any circumstance. But legal protection is another matter: broadcasters should hope that their efforts to use the law to restrain the growth of technology won’t have the unintended consequence of unleashing regulatory changes which will not prove as beneficial as those regulations which are in place today.
Brian Wieser, CFA
Senior Research Analyst
Pivotal Research Group