May 1, 2018

The Point of No Return

Tough news out of the legacy pay-TV industry this week, with AT&T (187K), Charter (122K) and Comcast (96K) all reporting significant quarterly subscriber losses. Why is this happening now and what does it mean for the future of TV?

Two thoughts.

1. For Legacy Pay-TV Businesses, Management Tools and Marketing Tactics are Increasingly Ineffective.
All businesses, even the best ones, face continuous challenges. Managing is the process by which businesses learn, adapt, and respond to those challenges. Healthy businesses are those in which management is effective in addressing those challenges. Unhealthy businesses are those that decline regardless of the efforts of management.

The legacy pay-TV business in the US is now unequivocally in the second category. No promotion, no discount, no bundle, no marketing program is going to reverse the declines in legacy pay-TV, whether within individual companies or across the industry as a whole. Take Comcast, for example. Despite a quarter that included both the Winter Olympics and the Super Bowl (both delivering big audiences), the company still lost 96,000 residential video subscribers. That’s how bad things have gotten.

Now ask yourself this: What live event would need to be televised in order for these companies to add linear TV subscribers? An alien invasion? The end of the world? Given the round-the-clock coverage such events would receive on the Internet, I’m not entirely sure even that would do it.

One can see this in company marketing efforts, as well as the way they communicate in their earnings reports and during their conference calls. Operators do not even pretend like they can turn their legacy businesses around. Instead, all efforts are now directed towards other offerings, such as broadband Internet (fixed or mobile) and vMVPD services.

For example, AT&T’s marketing efforts on the video side seem focused on DirecTV Now, which added 312,000 new subscribers in the quarter, bringing total subs to 1.5 million. In order to do this, however, the DirecTV Now marketing message (whether intentional or unintentional) is killing the value proposition of the company’s legacy satellite service. In addition to its discounted pricing, DirecTV Now endlessly hammers away at the idea that its service requires “No Satellite, No Annual Contracts, and No Installation Guy.” Legacy DirecTV, by contrast, requires satellite delivery, a 2-year agreement, professional installation of the dish and STB, and a much higher monthly fee.

With internal marketing friends like these, whose needs enemies?

My point is not to pick on AT&T. Its overall response to the decline of legacy pay-TV (including the intended acquisition of Time Warner) has been bold, even admirable. All in all, it’s doing much better job than others in building a integrated media company that can survive, if not thrive, in the new video economy. I am simply saying that increasingly legacy pay-TV services are being left for dead, even by the folks still running them.

Attempts to accelerate the growth of vMVPDs through improved messaging and promotions may be the right thing for operators to do in terms of the enterprise as a whole, but such efforts are also hastening the demise of their own legacy pay-TV businesses.

2. Boulders Don’t Slow as They Go Downhill.
Currently, legacy subscriber losses are manageable. By this I mean that legacy providers can offset pay-TV subscriber losses in a number of ways, including (1) price increases, which offset video revenue losses; (2) vMVPD subscriber growth, which does the same; and (3) broadband Internet subscriber growth, which generates overall growth in the residential category.

Today, this means that most legacy pay-TV providers are able to more or less tread water in terms of revenue, and some are actually able to grow earnings, albeit slowly. The underlying worry, however, is that the US pay-TV business as a whole is barely treading water in a strong economy (including a one-time historical boost from tax reform) with very low unemployment.

The question that should be keeping pay-TV execs up at night is this: What in the world is going to happen to this business when the next serious downturn arrives? My own view is that today’s “manageable” losses can (and likely will) accelerate into something much, much worse. Instead of 100,000 subscriber losses, one could easily imagine the larger players losing a million subscribers per quarter. At those levels, financial models start to collapse with weaker (or just heavily indebted players) facing insolvency or bankruptcy. The upstream effects on those content providers still holding on for dear life to their monthly-affiliate-fee models would be equally severe.

Soft landings of businesses in long-term secular decline only work in the absence of significant external shocks. Unless the business cycle has been magically repealed, that is probably not a tenable assumption. Legacy pay-TV providers need to “stress test” their business models now and develop both liquidity and cost reduction plans that will allow them to survive the next downturn. Those who cannot should head for the exits via M&A.

Stick with TDG and stay ahead of the curve.

Joel Espelien is a Senior Advisor for TDG and also an M&A advisor with the Corum Group providing sell-side advice to technology companies worldwide. He lives near Seattle, WA.

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