A little over a month ago the season finale of Mad Men ran an alarming ad that urged Dish Network (DISH +0.00%) customers to call their provider and beg them to cut a deal with AMC to keep distributing their hit programming that includes Mad Men and the award winning Breaking Bad. The deal was not struck and AMC got dropped. On July 10th, a lengthy pricing dispute between DIRECTV (DTV +0.00%) and Viacom (NASDAQ: VIA)(MTV, Comedy Central, Nickelodeon and 14 others) ended in 20 million DIRECTV customers losing all of that programming. No Snooki and J-WOWW. No Colbert. No Spongebob Regardless of who's to blame, cable providers or networks, it is clear that the delivery of television entertainment is in for yet another massive shift.
DIRECTV was suggesting that Viacom wanted to hike prices 30%, adding $1B in revenue for the network, while Viacom was simply claiming they wanted to negotiate a new deal after the one spanning the last 7 years had run its course. What is very ironic about the spat between DIRECTV and Viacom comes in DIRECTV CEO Mike White's explanation of the dispute. In a gigaom.com interview Mr. White says, the very least we believe Viacom should be willing to give your family the choice to pay for only those channels you watch. Why he would expect that from Viacom when his customers are still expected to bundle channels they don't watch with those that they do is beyond me. Three days ago the two quarreling companies were able to reach an agreement and Viacom channels were restored. An interesting aspect of the extended olive branch was that DIRECTV customers would be able to stream all of Viacom channels on the web. All of this nonsense between content providers (networks) and content distributors (cable companies) has rolled the cable companies into a tightly wound ball, placed them on a rubber tee, and given Apple (AAPL +0.72%) a very large bat.
Remember Sam and Goody? It may be difficult for you, but try. Sam and Goody was a music store that sold CDs for anywhere from $12 to $20. Enter: Apple. Apple offered entire albums for $10 that were downloaded directly to your computer and easily burned to your own CD or uploaded to your new iPod (the one with the actual spinning wheel on it and a hard drive that hummed). They also peeled individual tracks from albums and sold them all separately for $1. You know how much more respect I would have for Coolio if I could have bought Gangsta's Paradise for $1 and not have had to endure other album tracks like Exercise Yo Game and Kinda High Kinda Drunk?
For years cable companies have allowed the rates they pay to distribute network content to creep upward. In order to cover the rent they were paying to distribute network content, cable companies bundled good with bad, sports channels with shopping channels, and man channels with woman channels. ESPN now tops the list of network subscriber fees at $5.06, which is an 87% premium over the next channel (ESPN 3D) and nearly 5 times as expensive as the third priciest channel.
John Skipper, President of ESPN, justifies the cost of his network on CNBC, while there's a lot of attention paid right now to rising programming costs, they have risen fairly consistently over 30 years. They are increasing because sports value is increasing because it's the only thing you have to watch live, and it's unique content. I would largely agree, sports are really the only thing that TV viewers have a strong preference for watching live, but the way that customers are consuming content is rapidly changing.
Apple CEO Tim Cook is licking his chops right now as cable companies and networks shoot at each others feet, failing to see they are aiming all of their bullets in the wrong direction. Apple is going to disrupt the flailing cable industry just as it did the music industry and cable could easily go down in an uneventful battle much the same way Sam and Goody did. Rumors of an Apple television continue to swirl and with them comes the speculation that their offering will be some sort of a la carte platform. In this model customers will be able to pick and choose programming to purchase on a one-time basis or agree to a monthly fee to choose the channels they actually want to watch. Using this list as an approximation tool and realizing it is 3 years old, I was able to put together a package of programs I would be willing subscribe to for around $30. If I adjust this for increases over the past 3 years using ESPN as the base increase, I would still only be paying $37 versus the $120 Comcast charges me per month for its Digital Premier bundle. That is a conservative estimate as well, because most channels were probably not able to negotiate as effectively as the market leading ESPN.
Apple implementing an a la carte cable distribution model would be a major game changer, but this concept is still largely just rumor. Apple is notorious for shrouding new products behind very thick veils. Regardless of Apple's play, these cable/network spats have been a wake up call to the market. Dish Network dropped AMC channels on July 1st and DirecTV dropped all Viacom channels on July 10th. One obvious benefactor of cable squabbling is Netflix (NFLX 0.61%), which has had better than expected traction on its first original show Lillyhammer. The company plans to launch 4 more shows this year and spend $185MM on production in the next 5 years. This is a modest figure when you consider that the budget for The Avengers was $220 by itself, but it shows Netflix's commitment to an adapting business model. Check out Netflix's performance in July versus DirecTV, Viacom, Dish and the S&P.
I wrote an article on March 8th that reported all of the risks facing Netflix. At market close that day Netflix was $108.07, and the bottom since was $62.66 giving a healthy investment gain of 42% in essentially a flat market. Benefiting from cable company missteps, Netflix has been on a 34% upswing since the bottom and is up better than 20% in July. Netflix would transition nicely into Apple's model; they would simply be a subscription option in Apple's cable cafeteria. AppleTV played a major role in delivering streaming Netflix to millions of televisions so it is not a stretch that an actual Apple television would also be advantageous.
Again, Apple's impact on the cable market is cloudy, but tech analyst Mark Moskowitz at JPMorgan says Apple will be the company to, radically alter the TV landscape. Unfortunately for fans anxiously awaiting the TV as some are calling it, Moskowitz posits that the Apple television most likely will not launch in 2012. Also, Apple and Netflix both report earnings after the bell today. Quarterly performance should be interesting for both companies. The real intrigue will surround the guidance Netflix gives in relation to their original content and any hints Apple offers regarding the launch of their television later this year or in early 2013.
