By Keach Hagey and Amol Sharma
Four of 10 dollars spent by U.S. pay-television operators on
carriage fees would go to 21st Century Fox if its takeover bid for
Time Warner Inc. succeeds, illustrating both the allure of the deal
and its risks as the traditional cable-TV business model faces
mounting pressures.
Combining 21st Century Fox's suite of channels, including FX and
Fox News with Time Warner's TNT, TBS and HBO, would create a giant
with 40% share of the estimated $40.3 billion U.S. cable and
satellite operators spend on carriage fees, calculates
MoffettNathanson analyst Michael Nathanson, more than double Fox's
current 19% share.
The next biggest recipient is ESPN majority owner Walt Disney
Co., which has a 25% market share, while Comcast Corp.'s
NBCUniversal would follow with 10%.
Such sharply expanded presence in the cable channel market has
obvious advantages for Fox. Fueled by subscription fees and
advertising, cable channels have been the main source of revenue
and profit growth for big U.S. entertainment companies over the
past few years.
And programmers have been nervous that the consolidation among
pay-TV companies, such as Comcast's pending bid for Time Warner
Cable and AT&T's pending bid for DirecTV, would reduce their
leverage in negotiating these fees unless they bulk up
themselves.
"If I control more of the market, you are going to find it
harder to live without me, and that way when I come to negotiate,
I'm in a better position," said David Bank, an analyst at RBC
Capital Markets.
On Wednesday, Time Warner confirmed it had rejected a takeover
offer made by Fox last month valued at about $80 billion. Fox,
however, hasn't given up the pursuit.
A successful acquisition would pose risks for Fox. The company
would be doubling down on cable networks as the U.S. pay-TV market
nears a saturation point. Nearly 90% of American households already
subscribe to cable or satellite TV.
Pay-TV operators are struggling to find new customers. In some
quarters in the past few years, the industry has contracted. There
are fears that "cord cutting" will pick up or that young people
will never sign up for cable TV when they become adults. Meanwhile,
the very nature of TV is evolving quickly, as consumers look for
on-demand content--often from streaming-video players like Netflix
and Amazon. Some media executives believe traditional TV channels
will have a smaller role in future years.
If it swallows Time Warner, 21st Century Fox would be far more
exposed than any other entertainment company to these threats. That
would put it under more pressure to look for growth in other
ways.
While the combined company could continue to raise prices on
distributors on a per-subscriber basis, that translates into higher
cable-TV bills for consumers and isn't a long-term answer,
executives at pay-TV distributors argue.
Another possibility: The combined company could be in a position
to solve problems in the rollout of online availability of pay-TV
services, through which subscribers can watch the channels that
they pay for anywhere, either on iPads in the bedroom to
smartphones on the bus, via mobile applications.
Programmers argue that the mobility of their channels--along
with extra goodies baked into their apps, like past season shows
and behind-the-scenes videos--add value to what customers get for
their cable subscriptions. They have argued that such services
justify higher per-subscriber affiliate fees.
Time Warner was an early advocate of this concept, dubbed "TV
Everywhere, " which is designed to protect the pay-TV ecosystem
from competition from less expensive online-video alternatives. HBO
Go, the TV Everywhere app for HBO, is viewed as an industry
leader.
But the effort has been slow to roll out across the industry,
largely because every pay-TV operator must negotiate separate
agreements with each cable channel to get the rights to put the
shows online.
An additional complication is that channels generally don't
control the digital rights to the shows they air, which are
typically held by the production studio that made the show.
That means some channel apps often don't have access to all the
shows that have aired on the channel--a phenomenon that hurts the
channel's brand as more television viewing moves online.
Because both Fox and Time Warner own major film and television
studios that produce many TV shows, a combination of the two
companies could help their TV networks iron out these rights
issues.
Content owners "want to ensure that rights issues are structured
to protect the pay-TV ecosystem," wrote Mr. Nathanson in his
research note. Time Warner and 21st Century Fox "have been aligned
in this thinking and the combination would help drive a more
unified industry standard" for putting content online and in cable
video on demand, he wrote. The same enlarged presence in content
production means that a combined Fox-Time Warner would be better
positioned to survive a world in which channels matter less and
content matters more.
"We are evolving into a world where Apple and Netflix are
becoming a more important distribution platform," said Mr. Bank.
"The more content you own, the more you are going to be able to set
the agenda through the next half century for how content is paid
for."
Write to Keach Hagey at keach.hagey@wsj.com and Amol Sharma at
amol.sharma@wsj.com
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