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Vertically Challenged

As Wall Street still waits for more consolidation among video distributors, many such companies are eyeing deals to buy content assets that they had jettisoned just a few years ago to unlock hidden value.

So-called vertical integration, the marriage of distribution and content under one corporate roof — owning the pipe and the water — has always looked better on paper than in practice. For pay TV providers, owning a large block of the content they make available to customers would seem to lead to lower programming costs and greater exclusivity.

But operators found out the hard way several years ago that isn’t necessarily the case. As the industry grew, Federal Communications Commission programming- access rules made it virtually impossible to have truly exclusive content. With that need to make carriage deals as arm’s-length transactions, limiting any possibility for deep discounts, there was little value in keeping programming and distribution together.

Several companies cut the vertical cord by spinning off content assets over the past two decades, including AT&T and Liberty Media in 2001; Cablevision Systems (now Altice USA) with both MSG Networks (2010) and AMC Networks (2011); Viacom and CBS in 2006; and Time Warner Inc. and Time Warner Cable in 2009.

The rationale behind each split was varied, but the transactions shared a common theme: Unlocking the value of content that was hidden inside what was, at the time, a lower-growth distribution business.

As the industry moves toward an over-the-top model, where mobility and slimmed-down content packages rule the day, some believe that putting those assets together makes more sense.

Viacom and CBS will probably be the first to inch toward reconciliation, as both have put together committees of independent directors to look into a combination, with the blessing of largest shareholder National Amusements. Some analysts see that as more of a horizontal move, as CBS and Viacom both produce programming. Nonetheless, some are beginning to warm up to the idea of putting distribution and content together again.


The change of heart comes just as phase one of a continued consolidation wave among distributors winds down. In the wake of megadeals like Charter Communications’s acquisitions of Time Warner Cable and Bright House Networks; AT&T’s purchase of DirecTV; Altice USA’s purchases of Suddenlink Communications and Cablevision Systems; and even Comcast’s abandoned attempt to buy TWC, the thought is that the industry will now turn its M&A attention toward content.

The big difference is Internet video, which has changed attitudes toward vertical integration, Barclays analysts Kannan Venkateshwar and Amir Rozwadowski noted in a recent report.

“In our opinion, distributors have the ability to subsume all content under their aggregation umbrellas, which makes the whole concept of cable networks irrelevant,” the Barclays analysts wrote.

There have already been a smattering of content/distribution deals: Verizon Communications purchased a 24.6% stake in digital content producer AwesomenessTV in April, and Comcast purchased DreamWorks Animation for $3.8 billion in TV in August, to name two.

Technology platforms that help further monetize video also have been a focus with Comcast’s purchases of Visible World and investments in BuzzFeed and Vox Media, and Verizon’s AOL and Yahoo buys. Others could follow suit.

“We would not be surprised if other distributors were to potentially embrace larger opportunities in the content arena over time,” Venkateshwar and Rozwadowski wrote.

There appears to be no shortage of candidates. Speculation has been high that AT&T, fresh off its $48.5 billion purchase of DirecTV last year, is on the hunt for more content.

Not everyone is convinced that vertical integration is making a comeback, though. Telsey Advisory Group media analyst Tom Eagan said that while there could be a few horizontal deals on the horizon — Viacom and CBS being the prime example — he doesn’t expect to see any moves toward vertical integration.

“I think there has definitely been some MVPD horizontal integration, and there’s definitely been some content integration, i.e. Lionsgate and Starz. But we haven’t seen any vertical integration since Comcast-NBC,” Eagan said.


Even Comcast’s 2011 purchase of NBCUniversal — vertical integration’s shining star — now has a slight tarnish because Comcast is conflicted in certain transactions, Eagan noted. For instance, increased retransmission-consent fees benefit the content side of the business, but could hurt the operation’s cable portion.

“There’s more of an internal conflict,” Eagan said.

Comcast has claimed that retrans fees from NBC went from $0 when it bought the broadcast network in 2011 to an expected $800 million this year.

MoffettNathanson principal and senior analyst Craig Moffett also doubted the chances for a vertical-integration wave. In an email, he said the economic theory behind the vertical-integration concept is guaranteed supply or guaranteed distribution. Neither notion applies to media, he said.

“What’s left is mostly just exclusivity, and unless you believe that the program-access rules are going to sunset, exclusivity is illegal,” Moffett wrote. “I get the appeal on a superficial level, and I even get the grass is always greener argument, but the historical evidence for real synergy between content and distribution is extremely thin. If the program access rules do sunset, however, then it’s a completely different ballgame.”

Eagan was also skeptical of the earlier idea that that content companies would seek to combine in an effort to battle larger distributors, such as Charter Communications, which more than quadrupled its size after purchasing Time Warner Cable and Bright House Networks.

“The old-media model was getting beachfronts,” Eagan said. “Every new cable-network channel was a new beachfront to growing higher ad fees and more affiliate revenue. That’s not the game anymore. If you don’t have great content, it doesn’t matter if you have another beachfront.”

Still, AT&T is reportedly in the hunt for more content, and has kicked the tires on several media properties over the past year, including Starz (which was purchased by Lionsgate in June for $4.4 billion) and Yahoo (purchased by Verizon in July for $4.8 billion). According to a Bloomberg News report, AT&T CEO Randall Stephenson has a list of 40 to 45 companies that he constantly monitors, including peers and potential targets, as he plans his next move.

Adding more content seems to fit in with AT&T’s mobility strategy, which is further proffered by its planned launch of a new over-the-top service, DirecTV Now, later this year. DirecTV Now will have more than 100 live and on-demand channels targeted at younger viewers. AT&T has signed several content carriage deals in the past few months to fuel the service, including with NBCU, Disney, Discovery Communications, A+E Networks, Turner Broadcasting System and Scripps Networks.


Both AT&T and Verizon have been active in the deal market and see mobility as the future of the distribution business. While Verizon has focused more on digital assets for its mobile go90 service, AT&T could take a more traditional route, with some analysts predicting that Time Warner Inc. could end up in its crosshairs.

Time Warner and AT&T officials declined to comment.

Time Warner has arguably been in play since 21st Century Fox abandoned its unsolicited $80 billion offer for the programmer in 2014. Since then, Time Warner has launched HBO Now, a standalone OTT product for its flagship premium channel HBO, and set an Oct. 19 launch date for FilmStruck, with the Criterion Collection.

But along with cable networks like TBS, TNT, CNN and Cartoon Network, Time Warner also creates a large number or movies and television shows through its Warner Bros. Studios arm. Warner Bros. Television Group produces such cable and broadcast TV hits as The Big Bang Theory, The Flash, Gotham, Rizzoli & Isles, Shameless, Supergirl and Westworld.

Time Warner would attract a high price — Venkateshwar has estimated that a deal could be done for about $97 billion, including assumed debt — which could limit the players willing to make a bid.

Perhaps fueling the deal speculation is the relative sluggishness of content stocks over the past year, as uncertainty around OTT, skinny bundles and declining subscribers have sent some investors for the exits. Disney, which had its stock price rise fourfold between 2010 and early August 2015 from about $31 to $121.69, saw a 20% decline later that month, after it was revealed that its flagship ESPN network had lost about 7 million subscribers over the past few years. While Disney stock over the long haul is up by about three times its 2010 levels, it hasn’t fully recovered from the August 2015 dropoff. Shares were at $92.59 on Oct. 4.

Other content stocks have fared the same: 21st Century Fox, Discovery Communications, and Viacom are all down in the double-digit percentages from last August.

At the same time, distribution stocks — bolstered by continued broadband growth, consolidation speculation and a resurgence in video subscribers — have been on the rise.

Granted, consolidation has reduced the number of publicly traded distributors from six to four with the acquisitions of Time Warner Cable and DirecTV. But the four that remain are up a collective 30% since August 2015, driven by Charter’s consolidation-spurred 28% rise and a 5% gain at Comcast, currently the only vertically integrated cable operator.

Comcast first announced its plans to purchase a 51% stake in NBCUniversal — including the NBC broadcast network and 16 cable channels such as USA Network, Syfy and Bravo — in 2009. In 2013 it went all in, buying the remaining stake in the programmer from General Electric for about $16 billion.

In the past five years, Comcast has managed to rejuvenate NBCU’s content business, with the broadcaster atop the current TV-season ratings among 18-to-49-year-olds for the third straight year and cash flow nearly doubling from $3.7 billion in 2010 to $6.4 billion in 2015. The content side has also helped fuel Comcast Cable’s on-demand efforts.

Nowhere is that more evident than in Comcast’s August airing of the 2016 Summer Olympic Games from Rio de Janiero, where it offered more than 7,000 hours of content through live broadcasts on NBC and 11 cable channels; on-demand, through its X1 platform; and streamed online. Though overall ratings were down for the 2016 Olympics, Comcast still made about $250 million from the Games.

The Barclays analysts see even more synergies for Comcast as the nation’s largest cable operator moves into the wireless business. Comcast has activated an MVNO agreement with Verizon that would allow it to resell that carrier’s wireless service under its own brand, and has said it expects to launch a product next year.


Venkateshwar and Rozwadowski believe that wireless, with its heavy video component, could make content ownership even more important.

“Over the last few years, however, with mobile broadband, smartphones, Internet video streaming, and e-commerce becoming mainstream, as well as consumers and advertisers starting to look across platforms for content, the ecosystem finally is at a place where cross-platform monetization is more achievable,” the analysts wrote.

Pivotal Research Group CEO and senior media & communications analyst Jeff Wlodarczak said it makes sense for Comcast to continue to dip into the content trough, but doubted other distributors would make the plunge.

“It may make sense for Comcast to bolster its existing NBC operations to do deals and potentially realize substantial synergies,” Wlodarczak said. But Comcast and Charter might do better to set their sites on a wireless carrier such as T-Mobile, he argued, adding that such a play would eliminate the telcos’ only advantage over cable and could present huge synergies by allowing the MSOs to offload wireless traffic onto their own WiFi networks.

“The good news for cable is that getting into wireless is a lot easier than the RBOCs getting into cable’s core business, super-fast terrestrial broadband,” Wlodarczak said.