October 9, 2014

Hoop Dreams

Major news this week from the NBA, which announced new nine-year video distribution deals with ESPN (ABC-Disney) and Turner Sports (Time Warner). The deals will run from 2016 to 2025 and bring in some $2.6 billion a year for the NBA (nearly three times current revenue). This unique deal is a bold combination of old and new forces.

On the one hand, Turner and ESPN represent the cable TV status quo. Both networks have broadcast NBA games on their traditional linear channels for over a decade now, and both will continue to do so for years to come. On the other hand, the new deals include a unique set of digital and on-demand rights, including the prospect of an all-new OTT offering with the NBA as an equity partner.

Given the importance of sports to the entire pay-TV ecosystem, this is major news that says a lot about the future of TV over the next decade.

I have three key observations…

1. Sports Content is King
In 2007 the NBA was struggling on TV. The NBA Finals had its lowest ratings ever. The audience was fragmenting – game two ran against the series finale of The Sopranos on HBO and the results were not pretty. Reasonable people argued that traditional mass-market team sports had peaked and were destined for decline. The theory was that young people raised on the X Games and 200 channels of TV simply could not be bothered to follow basketball. In 2007 Turner and ESPN renewed their original 2002 deal for an additional eight years. The annual price was only 22% higher than the earlier deal. This was a very favorable deal for broadcasters that basically held league revenues flat over the period (adjusted for inflation).

How quickly times can change. Today, the NBA is a marketing juggernaut and the television industry knows it. Fans are following their favorite teams more closely than ever, via team-specific blogs and websites, along with video offerings like NBA League Pass that streams games that are not otherwise on TV.

Under the new video deal, nationally-featured games will be broadcast live on pay-TV during prime viewing hours every day of the week during the season, with particular days allocated to NBA.TV (operated by Turner), TNT (Turner), ESPN (Disney), and ABC (Disney), respectively. If there was any doubt, live sports are now unequivocally the cornerstone of the US TV industry. The NBA knows it and, as illustrated by this new deal, so do the media companies paying the tab. Given that 50% of this new revenue goes to the players, it is reasonable to assume that by 2025 ‘max deals’ (i.e., the highest salaries allowed by the league’s arcane salary cap rules) for superstar players will approach $50 million per year. It’s good to be king.

2. Live Broadband Sports is Here
The NBA’s new deals clearly anticipate the continued evolution of both Turner Sports and ESPN from “cable TV stations” into broadband video companies that also offer live linear feeds to legacy services. Turner Sports, for example, acquired the popular online sports site, The Bleacher Report, in 2012 for nearly $200 million. In particular, the new deal portends the ability of Turner to produce NBA content (likely focused on Vine-style short highlights clips) for The Bleacher Report site. In addition, the new rights expressly call out the ability to deliver games on a quantum basis—live, delayed, and on-demand—across all of TNT’s online platforms and screens. Wow. Premium sports events like the NBA used to be trapped on legacy pay-TV by virtue of rights deals that blocked exactly these sorts of uses. No more.

Perhaps most interesting, and as previously noted, the new deal with ESPN explicitly anticipates a new OTT service that would make NBA games available to viewers outside of the pay-TV (TV Everywhere) framework. The NBA’s existing League Pass service is very limited in this regard and excludes games that are already on the national broadcast schedule with NBA.TV, TNT, or ESPN (which includes many of the best matchups), as well as all playoff games (those that really matter). A true OTT service that included all NBA games, both regular season and playoffs, would be a huge win for basketball fans, and a huge change in the decades-old windowing system that has kept the best live sports on legacy TV platforms. Pardon the pun, but this could be a real game-changer for the TV industry.

3. Pay-TV Operators Are Vulnerable
Time Warner and Disney had exclusive negotiating rights with the NBA in the period leading up to this deal. And, as with all such rights, they would have expired if the parties had not been able to agree on a new deal. But they did, and the massive price paid clearly validates the value of NBA games in the open market. As a result, however, some of the most important sports rights in America just got locked up for more than a decade and, of special note, existing pay-TV operators were not at the bargaining table. (Recall that Time Warner Cable was spun out from Time Warner Inc. as an independent company in 2009).

The fact that incumbent operators were not involved in this arrangement is especially important. It means they will pay for these massively expensive new rights. And when TNT and ESPN charge operators these increased fees, operators will in turn increase the monthly fees paid by their subscribers. In fact, this NBA deal alone could raise the average American’s pay-TV bill by a couple dollars per month. Add to this increased costs associated with NFL, MLB, and college sports rights and you have a disastrous scenario, which could fuel direct-to-consumer OTT offerings from major networks and lead to greater incumbent subscriber loss.

Increasing monthly fees is not an easy sell in an era of Cord Nevers, Cord Cutters, and Cord Shavers, and it appears that the pain of explaining this cost increase to consumers will fall on pay-TV operators, this despite the fact that they do not actually benefit from these deals. To the extent that more and more basketball fans get their NBA content from Turner and ESPN’s online properties, these deals hurt operators. We believe this scenario will play out with increasing frequency in coming years between content owners and pay-TV operators, with the operators generally getting the short end of the stick. Once again, it’s good to be king, and pretty tough if you are not.

Conclusion
The evolution of the TV industry has always been incremental, playing out over long cycles. The NBA’s new deal with Turner Sports and ESPN is a microcosm of how television will evolve over the next decade. Big money for sports. Big growth (and investment) in broadband video, including new OTT services outside the traditional pay TV ecosystem. And big challenges for legacy pay-TV operators who find themselves caught between a rock and a hard place.

Stick with TDG and stay ahead of the curve.

Joel Espelien 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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