The Disruption of Cable Television Has Arrived

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We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten. Don’t let yourself be lulled into inaction.

– Bill Gates

What is the future of television? This is a question I have asked myself multiple times over the past few years – lately with increased frequency. The answer, I believe, is starting to reveal itself.

Let me begin with a basic premise: viewable content is viewable content, irrespective of the form. It doesn’t matter if you’re watching a broadcast TV show, a YouTube video, or a movie on demand – all of these are just different forms of the exact same thing.

So why then do we have to access them differently? Why do you have to toggle between different TV inputs and navigate different UIs to find something to watch? (First world problems, I realize, but the investment implications here are enormous.)

My answer is this: we are forced to toggle between multiple inputs because we’re in the midst of a transitional period where new competitors are beginning to overtake the incumbent television companies. Multiple inputs are merely a symptom of this transition.

The trend away from traditional television to internet-based content delivery has been enabled by a few key developments (hat tip: Mark Suster):

While this trend has been developing for years, I believe we are just now approaching the tipping point where adoption accelerates towards terminal velocity. What gives me confidence in writing this? Three things:

  1. The growth of Apple TV. I don’t know if investors appreciated it at the time, but in January 2007, just 6 months before the release of the first iPhone, Steve Jobs dropped the word “Computer” from Apple Computer (source). That was a seminal event in the history of the Company, signaling a new era and focus. Every investor should’ve taken note – the signals from Apple are subtle. Which brings me to my point: ~4 weeks ago, Apple revamped its online store, placing Apple TV prominently alongside other product lines (source). Why would they do that? Because Apple TV has become much more than “just a hobby” – the numbers prove it: for several years (’07 – ’08 / ’09), Apple sold only a “few hundred thousand” Apple TVs. Now they are selling ten million. Using Apple TV sales as a proxy for the market (which includes Chromecast, Roku, etc), the data is telling us that the trend away from traditional TV (a trend I call “cord shaving”) is accelerating.
AAPL TV Unit SalesSource: https://twitter.com/asymco/status/439465818867634176/photo/1

 

  1. The growth of quality content. Television isn’t a one-sided market, which is where a lot of previous cable doomsdayers have gotten it wrong. While it is true that consumers have been frustrated paying for overpriced bundles that include tons of content they don’t watch, this hasn’t been enough for most people to drop cable. What’s required is a compelling alternative – content so good that the decision becomes a “no brainer”. And thanks to the streaming libraries of Hulu, Netflix, Amazon Prime, Aereo, etc, as well as the ability to purchase content from iTunes, Amazon Instant, Google Play, and more, we are finally at the point where the quality and quantity of legally accessible content is broad and deep enough to catalyze the switch.

For the streaming availability of the top 250 IMDB shows (USA), click here.
For the streaming availability of the top 250 IMDB movies (USA), click here.
90% of the top 250 shows can be purchased via iTunes / Amazon (source).

  1. The birth of Popcorn Time. The catalyst for this note wasn’t the recent WSJ article about Apple TV (here); it was the release of Popcorn Time. Popcorn Time is like Napster for video – it creates a new way to access the pirated content that is available through torrent-based piracy sites like The Pirate Bay. Instead of requiring users to download files via a BitTorrent client, the Popcorn Time software begins streaming movies immediately after being clicked. Popcorn Time makes video piracy easy for the first time and delivers it in a beautiful, Netflix-like interface.

Popcorn Time

This is an incredibly important point because up until now, piracy has been deemed “too hard” for most consumers. This is a key reason why TV execs and investors have believed their businesses were immune from disruption (see page 34 here). But with the birth of Popcorn Time, piracy is no longer “too hard”. Dorothy Pomerantz at Forbes put it best: “I have never watched a pirated movie. That’s partially because I think piracy is wrong but I am also too technologically inept to work my way around the world of torrents. But Popcorn Time is so easy even I can use it. […] The movies all load quickly and stream in what looks like great quality. Although the app can only be used on computers right now, BTIG analyst Richard Greenfield says he had no problem using Airplay to send the stream to his Apple TV. That’s pretty terrifying.”

The birth of Popcorn Time is a watershed moment for online piracy and I believe it marks the beginning of the end of the traditional Hollywood / TV network business model. Note: Popcorn Time has been open-sourced; it’s not owned by a company that is trying to turn it into a business, it’s owned by the internet community. According to Techcrunch, “There isn’t a single entity here that Hollywood’s lawyers can attack. The developers can go underground and distribute their creations under multiple names. They’re not charging for the program or incorporating ads. Popcorn Time is Napster for video without a company that is trying to turn it into a business. It is the epitome of online guerrilla warfare.”

For these three reasons (the growing number of Apple TV units in the market, the increased access to high quality, legal streaming content and the birth of Netflix-like piracy sites), I believe the market has now reached critical mass and is feeding off of itself.

With a US TV ecosystem worth more than $350BN annually, the investment implications here are truly extraordinary; the market disruption will be enormous. My working thesis – one that needs to be tested over time – is that different segments within this market will be disrupted at different times, similar to a cascading waterfall.

To understand why he’s right you must first understand how TV networks generate revenue, which is in two primary ways: (1) via ads – typically 16 minutes of ads for every hour of content, and (2) via affiliate fees – which are payments cable / satellite companies make to TV networks for content; these fees get passed on to the consumer.

As more consumers move away from cable, ad revenues will be negatively impacted (less eyeballs → less ad revenue) as will revenues from affiliate fees (less cable subscribers → less cable company revenues → less affiliate revenue to TV networks). These forces will work to compound the already difficult situation for TV networks as they will be left with less margin to invest in quality content, causing even more attrition. Taken to its logical conclusion, this negative feedback loop leaves TV networks in a very vulnerable position.

While selling content to Netflix or Hulu might provide a bump in revenue in the short term, it will only help accelerate the shift away from live TV over the medium and long term. And as Brode demonstrates, the Netflix / Hulu revenue model results in significantly lower take than the lucrative ad / affiliate fee model that exists today:

Old v Netflix

Old v Hulu

Source: Silver Arrow Investment Management, LLC calculations

Based on the above, it’s in the realm of possibility that networks will see a 50% drop in TV revenues over the coming 10 years similar to what the music industry experienced.

Interactive TVSource: http://www.ericsson.com/res/docs/2012/consumerlab/tv_video_consumerlab_report.pdf

The question remains: what will satellite providers do when the current pay TV model begins to fall apart? This is the question that gives me pause. Take a step back and consider what Netflix is: it’s a content aggregator and it also creates some of its own proprietary content. It delivers this content in a beautiful interface to millions of consumers at scale. Now consider what a satellite provider is: it’s a content aggregator that also delivers content to millions of consumers at scale. The definitions aren’t too different, are they?

If the transition away from cable and satellite TV accelerates, how would the satellite companies respond? Maybe they could follow Netflix and deliver video over the web – they already have tens of millions of subscriber relationships (plus valuable data on viewing history and relationships with content providers). If they did this, they wouldn’t have to deploy satellite dishes and set-top boxes to homes. The cost savings from this shift in distribution could allow DirecTV and Dish to “double their free cash flow” (source: Citi Research; I would note that this includes an assumption of equivalent pricing, which is a future unknown). Just like Netflix was able to transition from a mail delivery model to an internet model, the satellite providers could transition from satellite to the cloud. Interestingly, DTV has started to integrate satellite broadcasting with internet video. It seems as though they are already positioning themselves for the coming shift.

For more on this, there is a fascinating discussion over at The Brooklyn Investor’s blog (here; scoll down to comments section).

Because there are so many moving pieces, the impact of the TV transition on satellite providers remains uncertain.

There will be non-obvious winners and losers as we transition away from cable television – companies like GameStop, for example. But I’ll leave the discussion of specific opportunities within this theme for future buyside notes.

Make no mistake: The disruption of television has arrived. Don’t let yourself be lulled into inaction.


11 Responses
  • Sergio Reply

    This seems pretty on point to me. What do you think will happen to live event broadcasts (sporting events, award shows, parades, etc) and news?

    • analyst Reply

      I don’t have a particularly strong opinion on live event broadcasts. Most people think that sporting events will keep consumers forever linked with their cable company. I’m not so sure; when playoff games are available on Aereo (assuming they are successful and can stay independent), would that suffice for most people? It’s possible. Stay tuned for a future note when I cover the TV networks and the challenges they are facing.

  • Decade Reply

    Charging for volume instead of congestion? A difficult idea to do well. The problem is not just the amount of data, but the timing. Broadband networks have congestion because a lot of people want to watch Netflix at the same time. My multi-gigabytes of OS distributions (or something) are no trouble at all as long as they don’t happen at the same time as everybody’s Netflix.

    On the other hand, if the broadband companies charge for congestion, then customers will be very displeased with the complexity of their bill. And if broadband companies continue to fail to upgrade their backbone connections, then eventually every time will become prime time.

    What we need is competition in broadband ISPs, so that we get meaningful investment and upgrades.

  • EJ Reply

    Do see the growth of wireless broadcast impacting cable companies at all? Lower powered lte microcels can support greater bandwidth density than high powered connections that must serve a large number of simultaneous users. Eventually it seems like the only connection you’ll need is an lte connection that is shared amongst all your devices.

  • EJ Reply

    Ac, I meant wireless broadband.

  • Phil Reply

    Been watching this for a while and am still convinced that it shows there is a huge opportunity for services which help people track where they can find their favorite content and where they can find new content. Not an easy problem to do right.

  • stuart Reply

    Agreed re: services for searching and recommending content. Some companies have tried (Roku, Rovi) but have failed miserably due to sloppy execution. Rovi is additionally handicapped by their own inexperienced management and their “buy high, sell low” acquisition strategy.

  • Claudio Marcus Reply

    This analysis fails to consider the dynamics of the entrenched TV ecosystem and the strong likelihood they will resist doing things that are against their own economic interest. In particular, the analysis disregards the following three key factors:

    1. MVPDs (Multichannel Video Programming Distributors) make money via consumer subscription, network affiliate fees, and advertising. For Apple TV to become a true set-top replacement capable of streaming live TV channels it will need the approval of MVPDs. While MVPDs may be indifferent to having video streamed as they offer superior delivery and get strong economic returns from their ISP services, they are not likely to sabotage their TV network affiliate revenues. Comcast being the largest ISP in the country (and getting bigger) is notable as it also owns NBC Universal.

    2. OTT services providers such as Netflix and Amazon license content from TV networks willing to charge lower than market rates because it has been seen as providing convenience to consumers and incremental revenues. However, as OTT services gain subscribers MVPDs will demand that the TV networks charge OTT services providers market rates more comparable to those paid by MVPDs. OTT services providers can only sustain substantially lower costs by licensing lower cost content (or risk developing their own content but this means competing on terms favorable to the TV networks).

    3. The fact that piracy of video content is becoming easier is notable but the analysis assumes that there is little that the TV networks and MVPDs can do about it. Besides the potential for MVPDs to detect use of pirated content and prevent or slow access to it, the TV networks and MVPDs are actively pursuing TV Everywhere and content discovery enhancements that will make it easier for consumers to legitimately access the content they want whenever and wherever they want. So far, these efforts have been slow to take-off due to existing license agreements between TV networks and MVPDs, but most such agreements going forward are likely to include enabling broader access.

    This is not to say that we will not see increasing numbers of consumers using alternative means to gain access to content. The point is that the entrenched TV ecosystem is quite likely to remain the dominant developer and supplier of TV content for decades to come, especially as it embraces new consumer-driven capabilities AND protects its economic interests.

    • analyst Reply

      Hi Claudio – Great thoughts. We’re in total agreement on point #1: MVPDs are doing everything they possibly can to protect their network affiliate revenues. We’ll see how it plays out over the coming years. I think your second and third points are less strong. On #2, what your comment misses is the ‘YouTube TV’ content that is disrupting the market. Mark Suster did a great presentation on this, which you can see here: https://www.dropbox.com/s/di360a9fpme4vna/PaidContent%20%20Nov%202011.ppt. If you don’t think ‘YouTube TV’ is for real, you should read up on the Maker Studios acquisition that Disney recently announced. The key takeaway is a quote from Disney CEO Bob Iger: “Short-form online video is growing at an astonishing pace and with Maker Studios, Disney will now be at the center of this dynamic industry with an unmatched combination of advanced technology and programming expertise and capabilities.”

      This comment on the deal is also noteworthy: “Maker is a crystal ball that Disney is buying,” said James McQuivey, a vice president and principal analyst at Forrester Research. “Getting into Maker gives them years of data that they can look back at and say ‘What does this mean for the future of video consumption, and what does this mean for the future of video production?'”

      On #3, unfortunately there is nothing anyone can do about Popcorn Time and its successors.

      Currently, I’m not taking any investment action on TV networks. Set-top boxes, on the other hand… http://buysidenotes.com/2014/05/15/the-demise-of-the-set-top-box-makers/

  • Mike Reply

    Great analysis, I think, and I believe in the macro forces (technology, economics) you cite as disrupting cable and networks, but I have two questions, maybe 3 in light of your excellent follow-up points to Claudio on youtube and short-form video:
    1) saw a good analysis in 2013 basically showing that Netflix and Amazon (and others) are miles away from being able to fill the maw of Americans’ TV appetite. They simply don’t produce a fraction of the content necessary to equal the monthly TV time of Americans, something like 144 hrs…your response? Can short-form and user-generated video fill the gap? I have my doubts, except for the younger generations who have attention spans of fruit flies and may not hunger for 30-60 min serials over 3 min videos of cats on rocket skateboards.

    2) Must TV become less profitable…perhaps NOT. Why can’t addressable ad technology deliver better audience targeting and, ultimately, a more interactive ad experience that allows viewers to click on show elements and ad elements to get more info or make a purchase, making advertising more powerful and, presumably, more profitable for networks/cable?

    • analyst Reply

      Hi Mike – if you want to see the future, look at what teenagers are doing. They are growing up on short-form, YouTube content and this has huge implications for content creators going forward.

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