For the past year or so, a battle between tiny Internet TV start-up Aereo and the big broadcast TV networks has been brewing in the court system. CBS (NYSE:CBS), ABC parent Disney (NYSE:DIS), Fox parent News Corp. (NASDAQ:FOX), and NBC parent Comcast (NASDAQ:CMCSA) have joined with smaller broadcasters to claim that Aereo is violating their copyright privileges. However, last summer, a district court judge denied the networks' request for a preliminary injunction against Aereo, and that ruling was upheld on appeal by the 2nd Circuit last month.
The broadcast networks claim that they are still confident of winning in court when the lawsuit goes to a full trial. Nevertheless, at least two of the networks are starting to make backup plans. Executives for Fox and CBS have stated that they may stop broadcasting over the air if the courts do not force Aereo to shut down. This could mean that the 11 million households who rely on broadcast TV rather than a pay-TV service will soon be left out in the cold. What is the likelihood that the TV networks will follow through on this threat?
The Aereo business model
Whereas cable and satellite TV providers are required by law to pay fees to the broadcast networks for the right to retransmit their programming, Aereo's service is designed to get around this requirement. Aereo designed tiny TV antennas that are placed on circuit boards in data centers. Users of the service are given control of an antenna when they sign in and can tune into any of the available broadcast stations and receive the video stream over the Internet. Aereo also includes a DVR service that allows users to record shows and watch them later (the functionality also allows users to pause or rewind shows they are watching "live").
Aereo thus appeals to people who want to watch live network TV on mobile devices as well as people who cannot get a good broadcast signal for their regular TVs (although you have to live within the official broadcast service area to use Aereo's service). Essentially, it allows you to outsource the antenna reception necessary to receive broadcast TV, while also layering on DVR functionality.
Is Aereo a threat?
At first glance, it may seem odd that the major networks are up in arms over Aereo's service. After all, the networks are already broadcasting their content for free. Aereo is just allowing users to get that content without installing a bulky antenna, while also enabling users to watch TV "anywhere," including on mobile devices. The problem for the networks is that pay-TV operators have to pay retransmission fees in order to offer broadcast networks on their services, whereas Aereo is free-riding. As a result, the TV networks are worried that cable providers and other pay-TV services will create Aereo-like setups as a pretext to stop paying retransmission fees.
It is not clear just how much money is potentially at stake. The district court judge who ruled in favor of Aereo last summer agreed with the networks that the retransmission fee revenue stream totals "billions of dollars." On the other hand, broadcast-TV stations generally receive a retransmission fee of just $1 to $2 per household, according to Bloomberg. Given that there are just over 100 million U.S. households with some variety of pay-TV (cable, satellite, or telecom), it is hard to reach a figure beyond $1 billion to $1.5 billion in industrywide retransmission fees. This picture is further complicated in the case of Comcast, which owns a major network (NBC), but also operates the largest cable service in the U.S., with nearly 22 million TV subscribers. Comcast could potentially save hundreds of millions of dollars in payments to other broadcasters if it could avoid paying retransmission fees. It is quite possible that this would fully offset any loss of revenue for the NBC subsidiary.
The big threat
Regardless of the exact amount of disputed revenue, the broadcast networks could theoretically reassert control over their content by ending their public broadcasts. Instead, like cable TV channels, they would only be available through pay-TV services. Fox and CBS executives have already threatened to do this unless the courts side with them. Going off the air would protect the retransmission fee revenue stream, and could even allow them to raise those fees. Research firm SNL Kagan has estimated that ESPN (a cable-only channel) earns $5.54 per subscriber on average in transmission fees, far more than any of the broadcast networks.
On the other hand, broadcast networks have made their signals freely available to the public for decades for a good reason. There are still 11 million households accessing broadcast stations by antenna. The growing availability of content via online video services -- such as Netflix and Hulu -- could lead even more households to drop their pay-TV services in favor of broadcast TV and cheaper online video services. The 10% of households using broadcast TV probably watch the broadcast stations more than pay-TV households, which have access to dozens or even hundreds of extra channels. If these 11 million households represent 15% of broadcast TV viewing, shutting them out would naturally impact advertising revenues. According to SNL Kagan, CBS earned more than $4 billion in ad revenue last year, while Fox earned more than $2.5 billion. If a 15% drop in CBS viewership led to a 15% decrease in ad revenue (more than $600 million), CBS would have a hard time making this up through higher pay-TV transmission fees.
Aereo only serves the New York metropolitan area today, but it has announced plans to quickly roll out its service to other cities. In fact, Aereo recently asked the district court in New York (which denied the networks' request to shut Aereo down last year) to bar the networks from suing it in these other cities. While the networks could still prevail in the upcoming trial, they appear to have long odds, given that the district court and circuit court both agreed that Aereo was likely to win on the merits.
The question is thus whether CBS and Fox -- and potentially the other networks -- would follow through on their threats to unilaterally stop broadcasting. This does not seem very likely for the moment. The immediate harm caused by Aereo is fairly minimal, since the networks are already giving their broadcast signals away for free to anybody with an antenna. By contrast, the likely lost advertising revenue from having fewer viewers would be quite significant.
However, in the longer-term, Aereo could incentivize the networks to improve the Internet-accessibility of their content. NBC, ABC, and Fox already provide online access to much of their content through their joint venture, Hulu. All of the networks offer some online streaming of their content through their own websites, as well. That said, these sites do not provide for live (or nearly live) TV; there is typically a delay of one day or more. In one exceptional case, CBS has allowed viewers to stream live NCAA basketball tournament games for free over the Internet.
Either separately or in a joint venture, the major networks could offer live Internet streaming of their programming in a manner that would be totally under their control. The networks could make this service available for free or they could implement a modest charge (or have a mix of free and subscription content, like Hulu). With this infrastructure in place, the networks would be in better position to stop broadcasting over the air. This setup could potentially safeguard the pay-TV retransmission fee revenue stream without giving up lots of advertising revenue by locking out households without pay TV.
I think the Aereo service was a great idea, but I don't have high hopes for this little start-up. Rightly or wrongly, the networks are out to kill it. Unfortunately, since Aereo seems likely to win the battle in court, its death may coincide with the death of free broadcast TV. At least two of the four major networks have already threatened to move to cable/satellite. One way that they could potentially do this without losing lots of advertising revenue is by offering their own live Internet streaming services.
I do not expect the networks to feel much financial impact one way or the other from the ongoing lawsuits. In a worst-case scenario, pay-TV subscriber fees would be cut back, but this is a less important revenue stream for them than ad sales. In a best-case scenario, the networks could improve their profitability if Aereo drives them to create better Internet viewing platforms and they are able to monetize this online viewing effectively. Either way, the long era of free broadcast TV may finally be coming to an end, courtesy of Aereo.
Fool contributor Adam Levine-Weinberg is short shares of Netflix. The Motley Fool recommends Netflix and Walt Disney. The Motley Fool owns shares of Netflix 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.