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Cable's Billion-DollarQuestion NeedsAn Answer

The cable industry is facing a billion-dollar question.
Broadcasters, led by CBS, are closing deals with operators
that will put CBS on course to achieve its goal of getting
$250 million cash for retransmitting its signals. But so lofty
a goal carries a related issue: That tab will have to get paid somehow.
And therein lies the question—or questions. Will these retrans dollars—
estimated to hit $1.3 billion by 2012, according to SNL Kagan—
come out of distributor profi ts? Will cable networks take cuts
or smaller increases in their monthly subscriber fees? Will customers
pay through the nose with skyrocketing cable bills? Or will spiraling
programming costs lead to a change in the way cable channels are bundled and sold to subscribers, as distributors
brace for new video challenges from Apple,
Google and Amazon?

It is, as everyone in the business knows,
a relatively new dilemma. Not long ago,
cable operators were tough, tight-fisted
negotiators, vowing not to pay cash for
retransmission consent as laid out in
the Communications Act of 1992. But
in recent years, broadcasters have been
cashing in. Last week, Time Warner Cable
and The Walt Disney Co. were able to
come to a settlement on a new retransmission
consent deal that included at least 50
cents per subscriber for ABC’s owned stations,
higher fees for Disney’s cable channels
and carriage of several new services.

Even though the deal appeared to be settled
much more peaceably than a slew of divisive
deals of late, it was clear the cable operator felt
that the rules surrounding retrans gave broadcasters
an unfair advantage at the bargaining
table. “We still have to make the very hard decision
of, do you pay what we probably would
think are above-market rates in order to avoid
[disrupting service to customers]?” says Steven
Teplitz, senior VP of government relations at Time
Warner Cable. “It’s a no-win situation. You either
pay more than you should in a normal functioning marketplace, which then leads to rising rates, or the
customer potentially loses programming. So, even [with] a
deal, that doesn’t mean that there’s still not a problem.”

The American Cable Association expressed similar sentiments
in a statement released after the Time Warner deal
was announced, while the National Association of Broadcasters
declared, “This is just one more successful negotiation
that serves to rebuke the pay-TV campaigners who
seek a solution to a non-existent problem.”

No easy answers
At this point, it looks as though cable operators can’t
win a fee battle against programmers, whether those programmers
are broadcasters or cable networks.

Earlier this year, both ABC and Food Network went
dark in disputes with Cablevision Systems, an operator
known for being both stingy and less moved
by public opinion. After three weeks off the air,
Cablevision settled with Scripps Networks Interactive
and restored Food. And in March,
the operator cut a deal with Disney to
put ABC back on its systems just as the
Academy Awards show was starting.

“What we had initially been concerned
about, we thought you would see money
moved from cable channel properties to
the networks. And recent events have not
really borne that fear out. You saw things
like Cablevision. At the end of the day,
both TV properties got the better of the
MSOs,” says David Bank, who follows
media stocks as managing director at
RBC Capital Markets. “So all of a sudden,
the thought was it’s not necessarily
a zero-sum game. It’s either going to
come from the MSOs or the consumer,
and I think for today while there
probably is some margin erosion to
the cable players, there also seems
to be some capacity to continue to
take it out of the consumer.”

Meanwhile, cable networks
are concerned about getting
squeezed as cash flows to the
broadcasters. Also, several independent programmers are backing the American Television
Alliance, a group formed by distributors to try to
change retransmission rules they contend are stacked in
favor of broadcasters.

“The impact of rising retransmission consent demands,
both in the form of increased fees and demands for increasing
numbers of channels for their affiliates, is a decline
in the carriage fees and channels that [multichannel
video programming distributors] can devote to independent
programmers,” said Discovery Communications
in a brief filed with the FCC. “Independent programmers
such as Discovery Communications that are not
affiliated with must-have [broadcast] programming find
it increasingly difficult to gain carriage on reasonable
terms and conditions—or sometimes at all.”

Large cable programmers are packing their channels
with events and original shows viewers won’t want to
miss to make the channels less vulnerable to being
dropped in a rate dispute. Time Warner’s networks, for
example, acquired the rights to NCAA basketball March
Madness (and, in alternate years, the tournament’s
championship game), and TBS is launching Conan
O’Brien’s new late-night snow.

“As broadcasters get additional cash from cable operators,
we still think that the stronger cable networks,
which will be the group we’re in, will prosper as they,
on the broadcast side, bolster their economics. We think
that all our networks are must-have networks with musthave
programming,” said Time Warner CEO Jeff Bewkes
during the company’s earnings call last month.

Scripps also addressed the situation on its earnings call.
“The issue is real for the distributors in terms of extra demand
for cash from broadcasters, but for us the argument
is a very simple one, in that it’s just a quotient of the audience
that we deliver compared with the percentage of
the revenue pie that we take out,” said Scripps Networks
President John Lansing. “Any network that is not necessarily
delivering the audience, or the high-quality audience as
we are, may face greater pressure because of the demands
coming from the retrans side of the pie.”

Sizing things up

The pressure is, of course, greatest on the smaller independent
programmers. “We all know how this works. Those
that have the most leverage suffer least, and maybe even
benefit. Those that have the least leverage suffer most,”
says Chad Gutstein, executive VP of Ovation.

The issue has come up in Ovation’s discussions with
distributors. “We’ve heard that the increasing costs of
retransmission consent are going to force some difficult
choices that are going to have difficult consequences on
companies like Ovation,” Gutstein says. Those consequences
could include reduced fees, reduced distribution
or roadblocks toward increased distribution.

“The majority of the rise in programming fees placed on
the cable operators from the broadcasters will funnel down
to higher overall monthly subscriber rates or may lead to
dropping some of the fringe cable nets from the lower digital
tiers,” says Justin Nielson, an analyst at SNL Kagan.

Amid a series of finger-pointing statements from both
sides, Hallmark Channel, an independent programmer,
has been taken off AT&T’s U-verse service because of a
fee dispute.

“Whether you’re on the broadcast/programmer side
or the cable side, those without the most leverage will
get nailed,” adds Michelle Ow, Nielson’s colleague at
Kagan. “I think how aggressive cable companies have
been on retrans legislation is indicative of how they are
going to do all that they can, so they don’t get to the
point where it does become a runaway cost and they
move toward a la carte.”

So, how did cable operators lose their
mojo in negotiations with broadcasters?
According to a filing with the FCC
by the American Television Alliance—
backed by Time Warner Cable, Verizon,
Cablevision, Charter Communications,
DirecTV, Dish Network, Mediacom,
Bright House Networks, Insight Communications
and Suddenlink Communications—
retransmission consent and
must-carry were created because cable
operators had monopoly power in their
markets and could prevent over-the-air
broadcasters from serving the public interest
in their communities.

“While Congress stacked the deck in
broadcasters’ favor in order to counterbalance
the perceived threat posed by
the cable industry, it did so to achieve
the public interest goals of localism and
a diversity of viewpoints, not to generate
windfall profi ts for broadcast licensees,”
the filing reads.

But when retrans went into effect
in 1992, the distribution landscape
changed, with satellite and telcos grabbing
bigger shares of the pay TV market.
That enabled broadcasters to play one off the other. If
the cable operator wouldn’t pay, the broadcaster could
urge viewers to switch to satellite or telco, hurting the
cable operator’s business. While the broadcaster was off,
the cable operator would feel pressure from the government
to restore service. And once the broadcaster agreed
to a fee it liked, it could use that to negotiate the next
time a retransmission agreement neared expiration.

“Broadcasters with an increased number of distribution
options are engaging in brinksmanship, thus driving
up programming costs for MVPDs and harming consumers
with higher cable rates and the constant threat of
blackouts,” the filing said.

In addition to distributors, several independent programmers
have signed on with the alliance, including
Discovery, Ovation, C-SPAN, The Africa Channel, Retirement
Living, Outdoor Channel and Si TV.

The prospect of spiraling programming costs is one
reason some operators are looking at new ways of bundling
channels. Multichannel distributors are wary of
any signs that customers want to cut the cord and get
the programming they want via broadband. Earlier this
month, for example, Apple unveiled a new TV service
that allows viewers to rent shows from Disney and News
Corp. for 99 cents.

Time Warner Cable CEO Glenn Britt has said he’s discussed
the notion of creating smaller bundles of channels
for consumers looking for a less expensive cable
television option. Programmers, naturally, are opposed
to the idea—or at least they believe each of their channels
should be included in whatever size bundle the operator
proposes to provide to subscribers.

Time Warner Cable’s Teplitz says smaller bundles and
retrans are separate issues: “To the extent that the rates
keep going up because of retrans, it does feed into that
desire for smaller packages, but they’re not linked in a way
that one is going to solve the problem for the other.”

Each of the options being tossed back and forth may
turn out to be part—or all of—the answer to the retrans
dilemma. But no matter what shakes out, one thing is for
certain: The bill is coming due, and soon.

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