June 5, 2018

Sometimes the Best Move is Not to Play

To OTT or Not to OTT, That is the Question for Many Big Players

After much to-ing and fro-ing, Verizon decided late last month not to launch its own vMVPD service. Instead, it appears Verizon will look at marketing partnerships with existing players that include bundling content from its Oath (aka Yahoo) division. So why are some companies (T-Mobile, AT&T, Hulu, YouTube) jumping into the OTT pool while others (Verizon, Amazon, Apple) are staying out? A few thoughts.

1. Linear TV is not a (standalone) business.
Some businesses inherently work. Others do not. There are hundreds of broadband Internet providers in the country, many of them small rural cable and telco providers. Why do they persist in offering broadband? Because it’s an inherently good business. The customer brings (and pays for) their own devices, apps, and content. The variable costs of servicing a particular customer are often actually quite minimal, meaning that the gross margins are amazing. As long as a given provider can beg, borrow, or steal (metaphorically speaking) the physical (cap-ex intensive) infrastructure, it’s a great business.

Linear TV is a totally different proposition today. Content costs are high, continuously increasing, and largely out of the provider’s control. Don’t like spiraling retransmission fees from the broadcasters? Tough luck. At the same time, the customer’s willingness to pay is much more problematic. Consumers are being trained to expect a package of TV channels for roughly $40/month. Does that price point actually make sense from an OTT provider’s standpoint? Not really. A “normal” bundle (i.e., including all the major broadcasters as well as ESPN and CNN) probably loses money at that price point. Again, that’s just tough luck for the provider.

The bottom line: the P&L for skinny bundle OTT services is basically broken, which leads directly to my second point.

2. Linear TV is a means to an end for some, but a bridge to nowhere for others.
Assuming linear TV makes no money, why would anyone at all offer it? The reasons vary. As discussed in my previous piece, for T-Mobile the reason to enter this business is to get a box in the home that can support 5G plus WiFi. For AT&T, the reasons include evolving the DirecTV brand away from satellite and selling data plans. Once the Time Warner plan goes through these reasons will also include expanding the footprint of HBO and its original content. For Dish Network’s Sling TV, a similar desire to free themselves from satellite applies. For Hulu, the play is differentiation from Netflix and a (currently) unwinnable arms race for original SVOD content. For Sony, Playstation Vue fills a gap in the Playstation ecosystem and ensures that the platform can function as a one stop media shop for videogame fans. For Google’s YouTube TV, the goal is to expand the YouTube brand from free cat videos to paid premium content in a way that generates lots of data that can ultimately be used to start siphoning off TV ad revenue. Time will tell how sustainable some of these reasons are in the face of financial losses, but at least there is a defensible logic there.

For those taking a pass on the space, the cons outweigh the pros, often because the benefits of linear TV services can be leveraged another way. Amazon and Apple, for example, have both decided that providing a marketplace for third party video apps, along with some originals of their own, provides a viable balance between selection, choice, margins, and the ability to unilaterally determine original content spend.

Verizon, by contrast, has realized that its real assets are its 150 million wireless subscribers (i.e., distribution), which leads us to our last point.

3. Verizon is going to auction off a co-marketing partnership to the highest bidder.
The vMVPD market is becoming a Fortnite-style battle royale with few long term winners. Acquiring customers and achieving scale is the difference between winning and losing. Setting aside DirecTV Now (which has its own base of 140 million AT&T Wireless customers to go after), a successful partnership with Verizon could be decisive. How much is that worth to YouTube TV, Sling TV or Hulu? My guess is that Verizon will be delighted to let all of these players bid against each other for the privilege. The result (for Verizon) is likely to be millions of dollars in revenue with (relatively) minimal costs and risk. Nice work if you can get it, and very well played by the folks in Basking Ridge.

Linear TV is turning into a very tough business. As Verizon appears to have correctly determined, sometimes the best move is not to play.

Joel Espelien is a Senior Advisor for TDG and 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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