November 1, 2010 – Streaming On-line, On-Demand Video: Over-the-Top, On the Way

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We believe that it is inevitable that internet delivered video entertainment will eventually replace traditional channelized television.  However, there are significant technology, infrastructure, behavioral and industry economic hurdles that must be surmounted before “over-the-top” becomes a widespread reality.  While many suppose that these obstacles will protect businesses dependant on the channelized model, we see evidence that the barriers are rapidly deteriorating and that market forces, already in play, will likely drive change faster than expected by most investors

The most obvious hurdle has been network speeds.  While almost all US households have access to the 1Mbps sufficient for broadcast quality TV, only 12% are able to get the ~10Mbps necessary for HDTV and less than 1% have access to the 50Mbps+ needed for 1080p BluRay quality.  The FCC’s goal of 100M US households with access to 100Mbps by 2020 is, in part, dependent on capex by cable operators under threat in their core business by Internet video.  While these MSOs have obvious incentive NOT to make these investments, we believe that the industry would face severe consumer backlash and onerous regulation were it to take an obstructionist tack

Furthermore, we believe that the long-term potential of wireless networks for residential broadband is unappreciated.  The FCC has targeted 500MHz of spectrum for auction, including 120MHz of broadcast TV frequencies to be cleared near term.  While initial 4G deployments top out at ~5Mbps, the technology roadmap targets 100Mbps within 10 years, with fixed-point speeds of up to 1Gbps technically viable.  We expect 4-6 4G networks to be built out in the US, and that these carriers will successfully compete for residential broadband market share by the end of the decade

Content delivery networks (CDNs) now cache most popular content in geographically dispersed data centers around the country, drastically cutting delay (latency) and disruption (errors) by reducing the number of routers that packets must pass between server and user.  This highly effective architecture is asset intensive and favors scale operators with greater numbers of well coordinated data centers, most of which gain critical mass from their own popular consumer sites – Google, Amazon, Microsoft, etc

Until recently, most American TVs were hardwired to a cable provided set-top-box without access to the Internet.  This is changing.  Many new television models now integrate WiFi and Ethernet connections.  28 million households with game consoles from Sony, Microsoft and Nintendo are also connected with links to video content providers.  New BluRay/DVD players and alternative set-top-boxes like Apple TV and Logitech’s Google TV offer a third alternative.  Finally, the FCC has proposed that cable MSOs begin to provide cheap termination devices, with security but not navigation or DVR functions, for all new installations and equipment upgrades.  Thus, nearly 40 million new households annually would be free to choose internet connected devices

Tablets are also emerging as a significant alternative for video viewing, both in and out of the home.  These devices are inherently connected and are not tied to the channelized entertainment model.  As channel owners work feverishly to exclude their content from the assault on the family TV, the tablet is an effective back-door to the living room couch, and a gateway drug for couch potatoes to get hooked on on-line video

Content availability may be the most contentious issue.  Cable TV is a chain of aggregators, with content owners, networks, and system operators each leveraging their highest value programming to sell bundles at the highest possible price.  As such, users typically find themselves interested in only a small fraction of the programming for which they are asked to pay and fledgling content producers find it very difficult to elbow in amidst all of the bundling.  A benefit of the on-line model is a closer relationship between the content that users actually want and the fees that they pay

As on-line TV rises, the strong hand of the cable industry will weaken and content owners will be tempted to risk its wrath by going directly to the consumer.  A positive cycle has begun by which the growing on-line audience is attracting advertisers, which attracts more and better content, which in turn attracts a larger audience.  With much of the most valuable programming – e.g. sports, American Idol, etc. – not “owned” but contracted by networks, content owners will have increasing leverage, driving up costs for the channelized model and increasing the potential for Internet defections.  First mover advantage in establishing an on-line brand creates an enormous incentive to break ranks, and makes the current industry attempts to control Internet video inherently unstable

We believe that Internet meta-aggregators will gain advantage in the next 2-3 years by giving users tools to find and buy content of their liking, and advertisers the ability to accurately target audiences.  While it will be tempting for companies in control of compelling content to restrict access and to form joint ventures to gain critical mass, we do not think that closed arrangements can gain sufficient scale.  Rather, users will likely distribute their loyalty across multiple providers, requiring navigation and other content management tools provided on an overarching basis.  Given the rivalry amongst the major video programming networks and systems operators, it seems likely that this valuable role will fall to third parties, like Google, Apple and Amazon, who can also leverage their expertise in content delivery.  We also favor CDNs, like Akamai, Limelight, and Internap, and independent content producers, like 19 Entertainment and Lions Gate.  We are concerned about companies with disproportionate exposure to the channelized television model

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