TV is undergoing a transformation. Millions get their television entertainment strictly from streaming video on demand services. More recently, digital pay-TV distributors like Sling TV and PlayStation Vue started popping up to offer an alternative to long-term cable contracts. And some networks -- like CBS (NYSE:CBS) and HBO -- are offering their networks as a stand-alone service.
That trend is only going to accelerate in the next few years: Disney's (NYSE:DIS) ESPN is launching a stand-alone service, Hulu and YouTube plan to launch streaming television services of their own. Turner Networks -- a subsidiary of Time Warner (NYSE:TWX) -- wants to be a part of it, according to CEO John Martin. He said the company plans to eventually sell some of its networks directly to consumers.
A balancing act
Turner generated about $5.3 billion in affiliate fees from traditional TV distributors last year. Through the first six months of 2016, it's already generated almost $3 billion in affiliate fees. That's to say, Turner is seeing rapid growth in its subscription revenue this year despite fewer people subscribing to its networks.
While that's Turner's best subscription revenue growth in three years, the company has still been able to continue growing that income source despite competitive pressures. Importantly, affiliate fees account for more than half of Turner's total revenue. Needless to say, Turner doesn't want to do anything to jeopardize that revenue stream.
At the same time, however, Martin is working closely with the new digital television distributors. Time Warner recently signed a deal to acquire 10% of Hulu, which includes a commitment to include Turner's networks in the upcoming streaming service from the company.
Disney is also looking to get its networks into more of those digital distributors (and owns about 30% of Hulu). Subscribers are cutting the cord or subscribing to cable packages without ESPN, and ESPN has been steadily losing subscribers. Disney CEO Bob Iger says the economics of the digital distributors is about the same as traditional ones.
Turner likely receives similar revenue from digital distributors versus traditional ones as well. Martin says its goal is to "have as many of our networks on as many those packages as possible."
The trick, however, is to balance those revenue streams with a direct-to-consumer offering.
ESPN, for example, is planning a direct-to-consumer product, but it's only going to show content that it doesn't offer on its broadcast networks. As such, it provides a supplemental revenue stream, rather than a largely cannibalistic product.
CBS, on the other hand, offers live CBS (excluding NFL games) in addition to its back catalog of content through CBS All Access. The product is mostly used as leverage to continue increasing its affiliate fees with distributors, but CBS counts 1 million subscribers generating about $100 million per year.
Turner's position is a bit different than both ESPN and CBS. It plans to eventually sell its broadcast networks over the top, and unlike CBS, it's a cable network -- making it more reliant on wholesale subscription revenue from distributors. That makes stand-alone offers more precarious.
Martin admits, "To compete with [pay-TV companies] directly is not a viable road map right now. It's more of an ambition." But he adds, "I think we're going to have to go [over the top]. It could be as much defensive as it is offensive."
So, we might not be able to subscribe to just CNN or Cartoon Network in the next few years, but it's likely we'll see something from Turner within the next decade. As long as Turner's subscription revenue continues to climb as it works with both traditional and digital distributors, there's no need for it to disrupt those relationships.
Bob Iger has made similar comments about ESPN in the past. "I think eventually ESPN becomes a business that is sold directly to the consumers," he said on CNBC last summer. But he shares a similar sentiment with Martin. He believes we won't see "significant change" in the pay-TV industry within the next five years.
Turner is already working on the technology and infrastructure needed to sell its networks directly to consumers. Disney is as well, and it recently acquired a minority stake in streaming software company BAMTech. Ironically, HBO uses BAMtech to power HBO Now despite its relationship with Turner. That represents an opportunity for synergy within Time Warner.
When the opportunity arises to go direct to consumer, Turner will be ready. Consumers just might be waiting for a little while longer.
Adam Levy has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Time Warner and Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.