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Come Together

Big news out of the pay-TV world last week, as Discovery Communications announced the $14.6 billion acquisition of Scripps Networks Interactive, the parent company of Food Network, the Travel Channel, and HGTV.

Given the ongoing declines in legacy pay-TV subscribers, does a deal like this still work at this price, and if so, how? I have a few thoughts.

1. Pay-TV Is A Global Business, Not A US Business.
The legacy pay-TV market in the US has peaked and is in long-term secular decline. Overseas, however, pay-TV is still growing. As the number of urban middle-class households grows, it creates new consumers that want to tap into the content riches that the US and other developed TV markets have to offer. This phenomenon has been a boon to businesses as diverse as Netflix, the IOC, and the English Premiere League. You can add Discovery to that list as well, as nearly half (46.5%) of its revenue in Q2 2017 came from overseas markets (over half of which – 56% – came via affiliate deals with foreign legacy pay-TV providers).

Scripps Networks Interactive, by contrast, has largely missed out on this bounty. Less than 15% of its revenue in Q1 2017 came from international markets, leaving the folks from Tennessee fully exposed to the declining fortunes of the US market. In this sense, this deal could be a win-win for all of the key stakeholders. Discovery can generate a return on the acquisition to the extent it can upsell the newly acquired channels to its international affiliates. Scripps Network Interactive shareholders obviously get a great deal, selling an increasingly vulnerable US pay-TV business at a significant premium. And the Scripps Network channels potentially get a new lease on life via a large and growing international audience.

2. Only The Strongest Apps Survive.
In the legacy pay-TV model, having a rich portfolio of channels is a good thing. Such channels could be priced separately or bundled together into B2B affiliate deals between content owners and MVPDs. Each side had something to gain from the relationship. Having more channels meant MVPDs could sell a more diverse range of genres to their subscribers. Content providers, in turn, were able to increase revenue per MVPD (five or six channels logically costs more per sub per month than one or two).

Unfortunately, this model does not translate well in today’s TV-as-an-app world, where consumers view video from freestanding apps on connected devices. On the most popular devices (smartphones and tablets), apps must be downloaded from an app store, installed on the device, and placed somewhere on a home screen. On other devices (e.g., Apple TV and native smart TVs), popular apps are preloaded on the device and placed on a home screen, but the consumer still has to affirmatively navigate and launch the app.

In both cases, only the most popular apps get used. This includes all genres of video apps (free online videos, SVOD services, and authenticated TV Everywhere apps from legacy providers). Over the past several years, these trends have created a huge separation between top-tier apps (e.g., YouTube, Netflix, and HBO) and smaller apps (like those from Discovery and Scripps Interactive). These apps are in a constant battle to (1) generate app installs, and (2) engage and retain those viewers who do install the app.

In this context, the Discovery–Scripps Networks Interactive tie-up makes even more sense. Discovery would be well served to combine all of its apps into one uber-app that contains the entire content catalog from all of the combined properties. The result is unlikely to pose a major threat to Netflix or HBO Now, though it could be sufficiently compelling to merit a spot on some user’s home screens. Once accustomed to this new app, fans binging on one show could easily migrate to others, giving smaller shows and niche genres a fighting chance of breaking through to a larger audience and becoming a hit.

Skinny Bundles May Go Hungry.
The premise of the app-based skinny bundle is that those who control it (currently Sling TV, DirecTV Now, Hulu Live TV, YouTube TV, fuboTV, and PlayStation Vue) can pick and choose the content they want to include. As a result, smaller channels (including offerings from both Discovery and Scripps Networks Interactive) have been left out of many early vMVPD bundles.

Unfortunately this line of thinking fails to recognize that there are two sides to every content negotiation. The content providers are not particularly interested in letting any MVPD (virtual or legacy) cherry-pick their best channels, as it results in dramatically lower revenues for the networks. As a result, larger players like NBC Universal and Disney (ABC, ESPN) negotiate deals where MVPDs are forced to buy bundles of channels for a single price (MVPDs that in turn sell bundles to their customers).

The combination of Discovery and Scripps Networks Interactive provides the merged entity with two or more negotiating gambits in response to these moves. The first, as discussed above, is to bundle all channels together into a take-it-or-leave-it offer – that is how business is currently done, and it puts both legacy and virtual MVPDs in a very tough spot. As we discussed last week, Shark Week is pretty popular. If operators lose all of this content, skinny bundles start looking downright puny. If, on the other hand, they take the full network bundle, much of the benefit of a skinny bundle is lost.

Alternatively, the new (larger) Discovery may need to consider a D2C (direct-to-consumer) SVOD offer that could live side by side with Netflix, HBO Now, and MVPD offerings. This would let Discovery control its own destiny and eliminate its long-standing dependency on pay-TV affiliates.

The pay-TV landscape is changing. The affiliate business model is under significant pressure that will only get worse. Discovery’s acquisition of Scripps Network Interactive is a bold (even risky) move designed to create a ‘super-niche’ provider of lifestyle entertainment content. Consolidation was and is inevitable, and Discovery deserves credit here for taking the bull by the horns and doing whatever it can to ensure its survival.

Stick with TDG and stay ahead of the curve.

Joel is a Senior Advisor for TDG and serves as an advisor and Board Member to the video ecosystem and technology companies. He lives near Seattle, WA.