Are retransmission fees inflating a bubble?

Doug Dawson of CCG Consulting had an interesting blog post yesterday on a topic I’ve also touched on (e.g. here, here and here): the distorting effect of the spiraling cost of sports broadcast rights on pay-TV economics. Dawson does some very back-of-the-envelope calculations to estimate that the cost of pro sports rights alone add about $15 a month to the average cable bill. College sports add several dollars more.

Whatever the true number, it was a speculative example offered by Dawson regarding the University of Maryland Terrapins that struck me. As any college hoops fan knows, the Terps recently switched their conference affiliation from the ACC to the Big Ten in pursuit of bigger TV bucks.

As Dawson notes, those bigger bucks are the result of the Big Ten’s more valuable broadcast rights, but the money that pays for those rights come from the ever-growing carriage and retransmission fees that broadcasters and cable networks are able to demand from pay-TV providers, which ultimately are passed on to cable and satellite subscribers.

Dawson then wonders what would happen if that well of retrans money suddenly ran dry:

What nobody wants to talk about is that the wheels are slowly starting to come off the cable industry. A recent nationwide poll said that 21% of households were thinking of dropping their cable TV subscription. They won’t all do that, of course, but it is a very bad sign for the industry when that many people say they are thinking about it. We can certainly expect millions of households per year to ditch cable. The average cable bill nationwide is now over $90 per month and many households are deciding that they just can’t afford it.

And if the wheels come off the whole sports industry will have a major crisis…[W]hat happens to Maryland and to all of the other major universities if in a decade those TV revenues are greatly decreased? It’s bound to happen, but nobody can really say when. But do the math. Cable rates have been increased about 7% per year for a decade, largely driven by programmers like the sports networks. If this goes on for another decade (and the current long terms contracts for programming suggests that it will), then the average cable bill is going to grow from $90 to $165 per month. Along the way to that kind of price a whole lot of households are going to drop out of the system. And when they do, pro and college sports are going to lose a lot of the revenues that have been making them so flush.

That started me wondering whether the entire TV business hasn’t trapped itself in an economic bubble. Live sports may be the most acute example, but it’s hardly the only category of programming being driven by higher carriage and retrans fees. All sorts of deals are being done and money bet premised on an essentially unlimited ability to squeeze more revenue from pay-TV providers.

It didn’t take a big shock to start the system-wide financial collapse of 2008 in motion. All it took was a relatively small percentage of sub-prime loans to default, causing the bonds backed by those dubious mortgages to default in turn. But that set off a run on mortgage-backed assets generally, shaking the foundations of the (under-capitalized) institutions that held them or held credit default swaps on them. When those institutions shook the whole financial system shook and eventually imploded.

The economics of the TV business aren’t anywhere near as abstruse or opaque as the business of mortgage-backed structured finance. But the same sort of cockeyed incentives that inflated housing prices before that bubble burst sometimes seem to be at work in the TV business.

In the housing market, the demand for mortgage-backed securities drove demand for new mortgages to securitize. That created an incentive for issuers to hand out ever-larger loans on ever-more dubious underwriting standards to fill the pipeline, and all that easy credit drove up prices. It was a runaway system that worked so long as prices kept going up but it left a lot of people and institutions on the hook for inflated assets when the bottom finally fell out.

In the TV business, the cost of rights is being driven by the relatively easy money generated by higher carriage and retrans fees. As Dawson notes, however, pay-TV operators are already losing video subscribers, which will inevitably constrain operators’ ability to pass those higher fees onto consumers. The full impact of those subscriber losses is being masked right now by the high margins cable operators are earning from the broadband side of their business. But that may simply be postponing the ultimate reckoning.

When you see college sports programs shopping for conferences based on TV rights fees you have to wonder whether bad incentives haven’t begun to corrupt underwriting standards once again.

What sort of shock might begin to deflate the bubble? A Supreme Court victory by Aereo over the broadcasters might do the trick.