Quick Thoughts: @%!&* Aereo! The Networks Throw a Temper Tantrum

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–          Fox and Univision are threatening to stop over-the-air broadcasts in the wake of an Appeals Court ruling in favor of Aereo’s clever system for delivering the signals to consumers over the web.

–          The threats are empty, given contractual agreements with local affiliates, but bare the anachronism of over-the-air broadcasts, seen by just 10% of TV households yet stifling retransmission fees.

–          The network vote of no confidence in broadcast TV could make station owners more open to monetizing their spectrum in the upcoming FCC incentive auctions

–          TV status quo is seriously threatened by improving on-line alternatives, by rising on-line video ad spending, by high cable prices, and by new technology like Aereo

The network hissy fit over Aereo’s recent win at the US 2nd Circuit Court of Appeals was predictable, but ultimately toothless. On a 2-1 ruling, the Court held that the broadcast networks were not entitled to injunctive relief from Aereo’s service, which uses thousands of individual antennae located in a Brooklyn warehouse to offer $8-a-month steaming of over-the-air broadcasts. While the morality of providing this on-line access via a convoluted technical solution designed to keep each user’s signal separate from the others could be debated, the legality will be settled by the courts, and this decision was an incremental victory for Aereo. Should this ruling be followed by a win at trial and affirmed on further appeal to the U.S. Supreme Court, the company would be able to offer on-line access to broadcast stations and DVR functionality across the country without fear of legal reprisal. Thus, the fighting words from Fox and Univision threatening to stop free over-the-air broadcasts, comments given verbal support from NBC and CBS executives as well. Taken cynically, the threats are fodder for industry lobbyists looking to strong arm Congress into closing the legal loophole that enables Aereo’s existence, in the name of protecting the rights of the 10% of Americans that do not choose to subscribe to multichannel TV service provided by cable, satellite or telco networks.

However, it is hard to take the networks seriously on this. Affiliate agreements with local TV stations require Fox and Univision to provide their programming for broadcast and cannot be broken in a fit of pique. For network owned stations, shutting down over-the-air broadcasts would likely violate terms of their spectrum licenses, allowing the FCC to reclaim them for auction without compensation. All this for a fledgling startup with very little public awareness, at least, very little awareness until the big networks stepped up their rhetoric. The tough talk and law suits appear to be having little effect on Aereo and other bundle-breaking technologies, like Dish Network’s ad skipping Hopper DVR, other than giving them free publicity.

The idea that the Networks would even think about dropping their free transmissions, speaks to the anachronism that is over-the-air television. 30 years ago, broadcast networks and their local affiliates enjoyed a lucrative symbiotic relationship – cable penetration was miniscule, local news generated big ratings, re-runs in syndication dominated viewership out of primetime. The cable industry began 60 years ago as a scheme by an appliance store to sell more televisions by putting a giant antenna on a hill so that the homes in the valley could receive the signal. With the Cable Act of 1984, which loosed MSOs to offer as many out of market channels as they wished, the industry began to pursue its manifest destiny to deliver their growing bundle of channels to any US consumers that wanted it.

Today, only 12% of the 115 million US TV households watch over-the-air broadcasts, with the rest subscribing to cable, satellite or telco multichannel services, and it seems safe to assume that the demographics of these antenna households are less than attractive, on average, to advertisers. Since 1980, the viewership of network evening news programs has dropped by an eyepopping 54%, despite a nearly 50% increase in the total number of TV households in the country over the same time period. While strong local affiliates with popular local news programs as lead-ins to highly competitive network news telecasts were once a powerful profit driver, current industry conditions have rendered local stations nearly irrelevant anachronisms.

The handwriting on the wall has been obvious to investors – until recently, valuations for companies owning local television stations, such as Sinclair Broadcast Group, Belo Holdings, LIN TV and Nexstar had been deeply in the tank, swimming below sea level with their close brethren, the newspapers. However, since the beginning of the year, these stocks have popped – all four of the names mentioned above are up more than 75% YTD. While the local TV broadcasters posted very strong 4Q12 results on the back of political ad spending in an aggressive campaign season, this jump seems incongruous in the face of the bigger picture … unless you consider the value of their spectrum licenses.

Given authorization by Congress in 2012, the FCC has offered local television station owners a share of the proceeds if they relinquish their spectrum for auction in 2014 and agree to move their broadcasts to smaller slots contiguous with other local stations. For stations in major markets, this spectrum could be worth more than $2/MHz POP, meaning a 6MHz channel in one of the top 10 US markets could bring well over $100M at auction, with the station owner taking a yet undetermined, but likely reasonable chunk. For companies with multiple such stations, the expected proceeds could be a meaningful piece of their valuation. While many of these companies and the National Association of Broadcasters (NAB) trade group have talked tough in an effort to drive a sweeter deal from the FCC, the apparent willingness of their network partners to abandon them over Aereo should be a nudge toward taking the deal on the table.

Taking a further step back, the pending incentive auctions of those 700MHz frequency slots currently occupied by the local affiliate stations could open another technological threat to the multichannel television status quo. Upcoming versions of 4G LTE technology will enable cheaper, faster and better wireless broadband, able to compete effectively for residential service as well as mobile, a potential highlighted by Dish Network’s Charlie Ergen in his plays for Clearwire and Sprint. Competitive and capable wireless broadband weakens the cable industry stranglehold over residential internet service, thus strengthening the hand of the on-line video players that are vying for the same audience as the television networks.

Indeed, Netflix recently announced that it had streamed more than 4 billion hours of programming in 1Q13, a 33% step up QoQ and evidence that its strategy of developing original programming, like the highly acclaimed “House of Cards” and the eagerly anticipated “Arrested Development” is working. After this announcement, BTIG analyst Rich Greenfield offered that Netflix had grown bigger than the largest cable network – presumably USA – a fact that likely raised an eerie chill up the backs of broadcast network executives. 25 years ago, when the big 4 broadcasters controlled more than 90% of the audience, cable networks were the upstarts, with HBO resolutely moving toward its own original content. Today, the big 4 must be content with less than 25% of the audience, and cable original programming dominates the Emmy Awards.

With Google’s YouTube, Amazon, Yahoo, Hulu and others following the original programming trail blazed by Netflix, it’s déjà vu all over again. Combine cheaper broadband, strong and improving on-line content, and Aereo’s $8/month access to the sports, events and regular programming provided by the over-the-air broadcast stations, and Cable’s $90/month bundled video offering may begin to look more like a rip off to consumers. This has multichannel operators, like Cablevision and Verizon, talking tough about breaking the channel bundles that are the lingua franca of the cable era network business to give their customers more choice and better value for their monthly fee. This is yet another crack in the foundations of the multichannel model.

Meanwhile, on-line video continues to attract viewers, bringing with them subscription fees and advertising dollars that might otherwise be spent with traditional TV, all of it fueling discomfort in the executive suites of the networks. While Aereo might still be stopped in court or in Congress, technology change will not be stopped and the near 30 year domination of the bundled multichannel television model is nearing its end.

For our full research notes, please visit our published research site.

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