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BT Takes on BSkyB

LONDON -- I have been a consistent advocate of investing in British Sky Broadcasting (LSE: BSY.L  ) , as I see the company generating mountains of cash as more and more customers are attracted to Sky's unbeatable content.

After all, the company has a virtual monopoly in Premier League football, Test match cricket and a host of other sports, as well as exclusive movie deals with most of the major Hollywood studios, plus an array of the latest TV series appearing stateside.

The other main competitor in the pay TV space, Virgin Media, has carved out its own niche, but it is not really fighting BSkyB -- you might have noticed that the TV channels that Virgin has are largely the same as the channels that are shown on Sky. BSkyB still make money if Sky Sports is shown on the Virgin Media platform.

A new challenger
But now a new challenger has arrived on the pay TV scene: BT (LSE: BT-A.L  ) (NYSE: BT  ) . And, unlike Virgin Media, it looks like it is really taking the fight to BSkyB.

It has already bid for and won rights to Heineken Cup rugby, as well as Premier League football. But what really caught my eye was the fact that BT not only bid for a few Premier League rights: it actually bid for all the Premier League rights available.

This gives a fascinating insight into the ambitions of the company. BT is not aiming to be what it has been up to now, i.e., just a bit-part player in pay TV. No, it is going for the big time. It seems it wants to pull the rug from right underneath BSkyB.

If this is really the case, then things could be shaping up for a humdinger of a battle between these two giants. The billion-dollar question is: Who will win?

British Tele -- um -- vision?
Let's take the challenger first. BT is one of the U.K.'s leading companies, with a market capitalization of 18 billion euros, which this year made a profit of 2 billion  euros-- so it is actually substantially larger than BSkyB.

Its strategy has been basically to diversify away from fixed-line telecoms, firstly into broadband, then into IT and telecoms services, and now pay television.

So far this has worked a treat, with BT's profits and its share price rising steadily higher in recent years. Emboldened by its success, I think it is taking a calculated gamble with its move into pay TV.

The thing is, pay television is all about critical mass. If a company has too few customers, it will inevitably lose money. The key thing is to win enough customers to make the business viable. Once the company passes a certain threshold then it begins to turn a profit, and as the number of customers rises above this threshold, the profit shoots up.

The difficulty is, it is a bit of a chicken-and-egg situation: to invest in content, the firm has to make money, yet at the beginning it will have no money to invest.

That's why any company that intends to build a "pay TV" presence needs a lot of financial muscle. In the early days of BSkyB, the company could take the initial losses because it was bolstered by Rupert Murdoch's then highly profitable newspaper business. In the same way, I think BT could use some of its substantial profits to fund its foray into pay TV.

Will the Sky fall in?
For this reason, I think BT is really serious about its attempt to take on BSkyB. But I also think that BSkyB, as the encumbent, will fight incredibly fiercely to protect its territory.

I suspect, much of the time, BSkyB will be willing to outbid BT, simply because BSkyB has so much to lose. But if it is paying so much for key prizes such as Premier League football, it will have to yield some areas to BT, too.

This way, BT will build up its offer, and will draw customers to it; indeed, the company is already gaining customers faster than Sky. But don't expect an instant profit boost -- I think it will take several years before BT Vision makes significant money.

It is difficult to predict how things will turn out, but I suspect that there is room for three pay TV businesses in the U.K. But, ironically, greater competition may actually mean a worse deal for customers, as the providers have to raise prices to cover their increased costs, and Sky will no longer be the one-stop shop it used to be.

And how will investors fare? Well, I think this puts pressure on the BSkyB share price, and is one of the reasons why I took profits on my holding in this firm, but, over the long term, it could push BT's share price further up, if this company can pull this bold gamble off.

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Prabhat Sakya owns none of the shares mentioned in this article. The Motley Fool has a disclosure policy.
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