Media Companies Threaten to Blast Apart Pay-TV Bundles

Time Warner's Hulu deal, Disney's stake in MLB BAMTech signal congloms' growing OTT appetites

TV Decline Pay TV Placeholder

Despite years-long dread that internet video would suck the life out of cable and satellite TV, the sector has remained fairly healthy. But that could change fast.

As programming costs continue to bulge, big players have been forced to rethink the core building block of pay TV: the bundle. The “fat” package of channels, oft criticized for its bloated price, is giving way to streamlined options, including two alternatives last week, from Time Warner and Dish, that showed how the trend is gaining momentum.

Time Warner reached a deal to take a 10% stake in Hulu after months of talks, joining existing owners Disney, 21st Century Fox, and Comcast. As part of the $583 million cash investment, Time Warner’s Turner cable networks will have a place in Hulu’s live-streaming TV service set to launch in 2017. With the service, Hulu’s four parent companies — which control the bulk of what’s on TV — will directly start competing with pay-TV distributors. In other words, they’ll be fighting for market share with their biggest customers.

Then this week, Disney announced a $1 billion investment in Major League Baseball’s BAMTech along with plans to roll out an ESPN-branded sports-subscription service. While the ESPN over-the-top bundle will exclude programming the sports giant carries on its TV networks, CEO Bob Iger says the BAMTech deal gives Disney the option to take ESPN and others direct-to-consumer if the pay-TV ecosystem starts to collapse.

“Media companies are finally internalizing that this is the way of the world,” says Peter Csathy, founder of media investment and advisory firm Creatv Media. “They either cannibalize themselves, or allow others to eat them. Of those two unsavory choices, they’d rather take door No. 1.”

Despite the risk of angering pay TV’s big distributors, Hulu and its owners see live TV as a differentiator that will boost its paying-subscriber count. At about 12 million, Hulu has lagged behind Netflix’s 47 million U.S. streaming base. As part of its strategic overhaul, Hulu this week said it’s phasing out its free-streaming service, striking a deal with Yahoo to distribute the five most recent episodes of shows from Hulu’s partners eight days after they air on TV.

Flipping Channels
Time Warner’s Hulu stake and Dish’s skinny bundle have implications for pay TV’s future.
$583m Amount Time Warner is investing in Hulu for a 10% stake
$420m Hulu estimated 2016 operating loss on $1.9 billion revenue
$30 Starting price of Dish Flex Pack, 45% less than its next cheapest tier
$281k Dish’s Q2 net subscriber losses (satellite and Sling TV)

Sources: Company reports, Credit Suisse

Among distributors, the panic is perhaps most acute at Dish Network, which is pay TV’s canary in the coal mine since it relies on TV as effectively its sole product. After posting its worst-ever quarterly video-subscriber loss in the second quarter, with a decline of 281,000, Dish wants to attract cost-conscious consumers with Flex Pack, a so-called skinny bundle with about 50 channels, starting at $30 per month.

“Our customers are frustrated with having to pay for hundreds of channels, most of which they never watch,” Dish exec VP Warren Schlichting said in launching the package. The company is already experienced at undercutting itself: Its Sling TV over-the-top bundle is pitched even lower — with an entry-level price of $20 monthly.

Dish’s Flex Pack eliminates ABC, CBS, Fox, NBC, Univision, and other local TV channels from the baseline package, as well as ESPN and other sports nets, and news cablers Fox News Channel and MSNBC. To get those, customers can add individual, themed add-on packs, which cost $4-$10 extra per month. Worth noting: Viacom’s MTV and Nickelodeon aren’t even available on the plan, although Comedy Central is in the core package.

Though many pay TV providers say skinny bundles don’t get much traction, they are proving popular: Verizon last year launched Custom TV — structured similarly to Dish’s Flex Pack — which represented nearly 40% of FiOS video sales in the second quarter.

“The reality is that there’s a whole new generation that’s not going to pay TV at all, so to get a shot at reaching them, you have to go to the skinny bundle and the OTT space,” Csathy says.

Bundle shrinkage is starting to have a real impact. NBCUniversal CEO Steve Burke, on Comcast’s second-quarter earnings call, said the company expects to “continue to trim some of the more marginal channels.”

Time Warner brass spun the Hulu deal and its strategy of pushing more content through OTT channels as being targeted to help grow the overall business. But Turner chief John Martin acknowledged that per-sub pricing in deals with new entrants is lower than with traditional cable and satellite operators.

“We intend to get full value over time” for the Turner network portfolio from OTT services, Martin said last week on Time Warner’s earnings call. “One of the reasons why we’ve been able to garner significant pricing increases is we’ve been starting from a lower base.”

It’s questionable whether programmers will still have the leverage to extract fee hikes from partners as more competitors flood into the market. Hulu and Dish won’t be alone for long: AT&T’s DirecTV is teeing up a trio of OTT services that will shake up the landscape even more later this year. “We’re about to introduce an over-the-top product that we believe will be a game changer,” AT&T CFO John Stephens told analysts on last month’s earnings call.

For Time Warner, diversifying with Hulu makes complete sense, says Steve Beck, partner with management consultancy cg42. “But they wouldn’t be doing that if traditional modes of distribution had not been so exploitative that consumers were seeking alternatives,” he says.