Analyst Report: Why HBO’s TV Everywhere Economics Don’t Make Sense


Time Warner and HBO remain adamantly opposed to licensing content to digital distributors like Netflix, instead choosing to double down on traditional pay-TV distribution with TV Everywhere services. But doing so means giving away content the network could be making incremental revenue on through those digital licensing deals — not just with Netflix, but with other online distributors too.

Last October, independent research firm SNL Kagan put HBO’s subscriber count at around 28.5 million, but that number has declined over the past year. Parent company Time Warner has admitted that the premium cable network lost some 1.6 million subscribers in 2010, due mainly to distributors like DirecTV not providing promotional offers to new subscribers. The good news for HBO is that those are non-paying subscribers; the bad news is that it means subs aren’t choosing to keep HBO when their promotional packages are up.

Does Netflix undervalue cable content?

HBO reportedly charges its distributors around $7 per month per subscriber. That’s high compared to basic cable networks like ESPN, but also much higher than other premium cable networks like Starz and Showtime. At that price, Netflix would be unlikely — and frankly unable — to pay for the full linear feed of HBO’s content. However, just as it has struck deals with Starz, Epix and other premium cable networks to distribute certain portions of their on-demand content for its streaming service, Netflix would gladly pay for portions of HBO’s programming — that is, if the premium cable network were willing to make that content available.

But HBO is loathe to do so, and Time Warner boss Jeff Bewkes has made it clear that he believes other programmers have undervalued their content while doing deals with Netflix. The easy target is Starz, which gave Netflix access to about 2,500 streaming titles in a three-year deal worth $25 to $30 million a year.

Since then, however, Netflix has been writing bigger and bigger checks to its content partners; its deal with Epix is reportedly worth close to $200 million a year for 3,000 on-demand video titles, and Netflix also recently struck deals with Disney and CBS for library TV content valued at about $150 million to $200 million a year each. And when hundreds of millions of dollars are at stake, it’s difficult to accuse a distributor of not paying enough for content.

Instead of striking a similar deal with Netflix, HBO’s strategy is to provide more on-demand content to its traditional distribution partners: pay -TV operators like Comcast, Verizon, AT&T and Cox. But HBO’s big bet on TV Everywhere is unlikely to pay off; by tying itself so closely to cable, it’s limiting the potential revenue it could garner from alternative distribution platforms.

Could HBO make more money elsewhere?

But let’s consider the actual economics of HBO’s strategy. Epix struck a Netflix deal worth about $200 million a year for its on-demand library of about 3,000 titles. HBO, due to its strong history of creating scripted content like The Sopranos and Sex and the City, could likely charge more. For arguments sake, let’s say that HBO could expect $250 million in a one-year deal like the one Disney struck with Netflix last year. With 28.5 million subscribers, HBO would need to make about 75 cents per subscriber per month, an increase of more than 10 percent over its current average revenue per subscriber, to justify passing up on such a deal.

In Time Warner’s fourth-quarter earnings call, the company reported combined cable revenues from HBO and Turner properties were up nearly 10 percent, due in part to the increased digital rights that HBO is making available through its TV Everywhere offering. On the call, Bewkes explained its cable pricing:

“[W]e don’t separately price or bill for TV Everywhere. We think this is part of the overall definition of any TV network, and basically along with multiplex, high-definition, VOD and now TV Everywhere. It’s part of the pricing that goes across the networks, across the sub basis, across devices, across platforms.”

At first glance, it looks like HBO’s strategy is working. But that ignores the fact that any Netflix revenues would be additive to those increases it gets from TV Everywhere rights. That is, just as Disney has successfully increased the amount it receives from distributors while also making additional cash from Netflix, HBO could also cash in on dual revenue streams.

The big fear for HBO, of course, is that by making its programming available on Netflix, it would give viewers less reason to actually subscribe to the premium cable channel. But that argument doesn’t stand up against anecdotal evidence from other cable networks that do make their shows available through the over-the-top distributor. As Will Richmond at VideoNuze points out, the number of Starz subscribers has actually increased over the last two years, despite the massive growth of Netflix’s subscriber base having access to its content.

Furthermore, there’s strong evidence that making back seasons of TV shows available helps to increase interest in the current seasons of those programs. By putting select early episodes of shows like Dexter, Weeds and Californication on Netflix, Showtime has been able to increase interest in those programs, which continue to run and attract new viewers. HBO could make certain library content available to alternative distributors without the fear of losing its pay TV audience, and could possibly even increase interest in its current shows.

The broader point, though, is that HBO doesn’t have to choose one distribution platform or another, but can have — and could make money from — both traditional cable providers and alternative digital distributors. By not doing so it’s passing on a potentially lucrative digital revenue stream. More importantly, however, HBO is passing up on an opportunity to create a broader distribution platform for its content. As more consumers look to online distributors for their content, that means HBO could risk being left behind, losing both subscribers and potential new revenues if the trend of cord cutting and cord shaving continues.

Related Research: New Business Models for Pay-TV Services

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