A Reality Check

I just read an article that made my stomach turn. News Corp. (NYSE: NWS) plans to launch a 24-hour reality-TV channel that will compete with Reality Central and Reality TV.

For those who get their helping of reality from, well, real life and not the TV, Reality Central is an effort backed by cable veterans Larry Namer (E! Entertainment Television) and Kay Koplovitz (USA Networks). Reality TV is a foreign channel that airs in the United States on the EchoStar (NYSE: DISH) network. I think this is a sign that the apocalypse is near.

I abhor the whole reality-TV concept. Has our society become so self-absorbed and egotistical that "reality" has become win-at-all-costs? I hope not, because I do not want my daughter growing up like that. OK, I'll climb off my soapbox now because you've probably figured out where I stand on the issue.

It pains me to say this, but when I really think about it, I think this is a good idea that can make money for everyone involved. And here's why.

Content companies such as Fox Entertainment (NYSE: FOX) and Time-Warner (NYSE: TWX) make money by getting the most out of valuable assets. They can sell programming to cable companies. They can sell DVDs to the public. They can air programs and collect advertising revenue. They have many ways of generating cash flows from their valuable content assets.

But with reality TV, the playing field is even better. Basically, these three reality-TV networks can create new content very cheaply and sell it for a premium for others to distribute. News Corp. has another advantage. It can distribute the content through its own network and collect advertising revenue. Or it can dip into its repertoire of past reality-TV shows and find creative ways of selling those older assets. That's a great way to do business.

Recently, I spoke about four ways companies can create value. Content companies create lots of value by extending the life of high-growth assets. The longer a company can keep the cash flows rolling in while none are rolling out, the more value they create.

And there is little risk of holdup. Holdup is when something prevents all of the cash flows from coming in. Holdup risk is reduced because the actors are amateurs and are competing for a prize. What are they going to do, walk off the set? Economics says increasing competition reduces prices. And that's exactly what reality-TV executives have done. A little prize money is considerably less cost than a bunch of expensive actors.

The key risk is the demand assumption. But all three believe there is enough demand for the content to allow them all to make money.

My personal view aside, I think this describes a great investment: low production costs coupled with the ability to create lots of marginal revenue. Please forgive the comparison, but this is analogous to the insurance float at Berkshire Hathaway (NYSE: BRK.A) (NYSE: BRK.B). And just think how much value Warren creates with essentially free money at his disposal!

The bottom line is this: Even though I believe reality-TV shows create no value for society, they teach an important lesson about how to think about investing.

Fool contributor David Meier does not watch much TV. In fact, he hasn't had cable for eight years now. He prefers to read, listen to music, and bad-mouth television. He does not own shares of any companies mentioned.