May 19, 2015

Build Your House on the Rock

Verizon’s announced acquisition of AOL continues to generate conversation, including a great piece from my colleague, Alan Wolk. Neither of these companies is a leading player in the legacy pay-TV business. Verizon remains fundamentally a mobile operator, having long said it never intended to take FiOS nationwide. AOL, for its part, has survived the decline of its traditional dial-up business by evolving into an online advertising platform. And yet everyone (myself included) sees this deal as important to the future of TV.

Why? Two reasons.

1. Broadband is Foundational
There is a famous biblical parable about a wise man that built his house on a rock. The foolish man, by contrast, built his house on sand. The rains fell, the floods came, and the foolish man’s house collapsed. This is an excellent analogy of the original AOL-Time Warner merger.

Back in 2000, AOL acquired with Time Warner in a $164 billion deal that valued the combined companies at over $350 billion. Current Time Warner CEO Jeff Bewkes (who was not CEO at the time of the merger) now calls the deal the biggest mistake in corporate history. The fundamental error of that deal was not its conception of the future (which was largely correct). The mistake was building the business on the shifting sands of AOL’s online consumer business (which subsequently collapsed).

Verizon was also formed in 2000, a product of the merger of GTE and Bell Atlantic (one of the original Baby Bells produced by the DOJ’s breakup of AT&T in 1984). Starting from these humble origins as a landline telephone company in the Northeast, Verizon transformed itself into the leading nationwide mobile operator with 108 million retail customers as of Q1 2015. Equally impressive, Verizon has transitioned from a business focused on mobile voice to a mobile broadband company, with 80% of its postpaid customers on smartphones with mobile data plans. Last but not least, Verizon has largely transitioned its legacy landline business in the Northeast onto its high-speed FiOS network, which also provides pay-TV services for those customers.

My point is simple – the broadband business today is about as rock solid as it gets. By building on a solid foundation, large broadband providers like Verizon, AT&T, and Comcast can afford to make multiple forays into adjacent markets. Verizon’s acquisitions include Terremark (cloud services), Edgecast (a CDN), upLynk (cloud encoding), and Intel Media (the OnCue OTT platform), with the $4.4 billion AOL purchase being the latest in the series. Comcast’s 2014 $375 million acquisition of video ad platform FreeWheel and AT&T’s $48.5 billion acquisition of DirecTV both fit the same pattern. The Verizon-AOL merger is a significant deal, to be sure, but not a bet-the-company move by any stretch.

In each case, broadband providers are looking for ways to grow and extend the value of their franchises. But what, specifically, does Verizon see in AOL?

2. Short-Form Content with Advertising is the Future of Mobile TV
Verizon has been experimenting with mobile video for over a decade, harkening back to the original V Cast walled-garden video service in 2004. A couple basic truths have emerged over that time. First, mobile users strongly prefer short-form content (which TDG predicted would be the case when the service launched). As I’ve discussed previously, average video sessions on smartphones remain extremely short. Second, mobile is about convenience, which makes on-demand content preferable to linear (at least for non-sports content). Third, viewing traditional pay-TV on mobile devices does not require a separate standalone service. Instead, mobile is simply an additional screen within the overall TV Everywhere ecosystem.

When these factors are combined, it is logically obvious why YouTube continues to dominate mobile video usage. YouTube content is primarily short-form, access is convenient, and the service is free (with ads, of course). Mass-market mobile video applications looking to compete for incremental revenue (as opposed to just being extensions of other paid services, as is the case with HBO and Netflix) will likely end up with YouTube-like models.

As video takes a larger share of total mobile usage, Verizon is determined to be more than a ‘dumb pipe’ provider that simply creates billions of dollars in value for Google (i.e., YouTube). In order to make this happen, however, Verizon needs a foothold in both short-form content and the online video advertising market. In that light, the AOL acquisition looks like a classic case of hitting two birds with one stone. Verizon gets access to a ton of short-form content (including the Huffington Post, acquired by AOL in 2011), as well as AOL’s well-regarded video advertising platform (previously Adap.TV, acquired by AOL in 2013).

The result of the Verizon-AOL combination will be mobile video that is even more mobile-centric than today, with interactive advertising specifically designed around the smartphone experience. Legacy TV providers need to follow suit. NBC has some very strong offerings in this area (e.g., The Tonight Show, The Voice, SNL), as does ESPN (e.g., SportsCenter clips and individual game highlights). Other content brands are not so fortunate, holding large libraries of long-form TV shows and movies that don’t translate nearly as well to the mobile format.

The winds of change are blowing hard in the TV industry. Companies with strong broadband businesses (like Verizon) have a solid foundation from which they can innovate and acquire. In this context, Verizon’s acquisition of AOL appears to be an excellent fit that should strengthen Verizon’s ability to monetize (not just enable) the growing mobile video consumption of its massive installed base.

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.

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