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Will Aereo Threaten Broadcasters and Their Owners?

Steve Birenberg

The big excitement recently in media stocks has been the court victory for Aereo over the major broadcast networks. Aereo is an over-the-top delivery service for broadcast networks (and maybe eventually cable networks) that allows a consumer to subscribe to a service that brings ABC, NBC, CBS, FOX, the CW, independent broadcast stations, and Spanish langauge stations to customers' smartphones, tablets, Macs, PCs, and Internet connected TVs. Right now, Aereo is only offered in New York City but the company, which is owned by Barry Diller's IAC/InterActiveCorp (IACI), plans to expand to at least 20 more cities this year.

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Victory in this phase of the legal case makes new markets more likely to be rolled out for Aereo as funding may be easier to access with less legal risk. It is worth noting, however, that the legal victories so far for Aereo merely avoided an injunction to shut down the service (a death blow had it been granted). A full jury trial remains ahead. Analysts seem to believe that the legal language in Aereo's two victories so far is pretty strong and good enough to gain a victory at the all-important jury trial. The legal process could take another year or two to play out. This will limit Aereo's ability to expand and cause havoc for broadcasters.

The worry for broadcasters and their owners -- Disney (DIS) owns ABC; CBS Corporation (CBS) owns CBS; News Corp (NWSA) owns FOX; Comcast (CMCSA) owns ABC; and GE (GE) partially owns NBC -- is that Aereo threatens the retransmission fees that cable and satellite companies pay for the right to deliver CBS, NBC, FOX, and ABC channels into our homes. Aereo grabs the signals over the air and redistributes them, thus avoiding paying any fees to broadcast networks. These fees have grown rapidly and represent almost 100% profit margins. Essentially, these fees are turning the economic model of broadcast networks into cable networks with a dual revenue stream of fees from distributors and advertising.

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Retrans fees have grown form nothing to $1 billion per year and could easily double or triple in the next few years as fees paid to broadcasters come inline with fees paid to cable networks. Broadcast networks still get much bigger ratings than cable networks so eventually retrans fees for broadcasters should catch up and surpass the fees for cable networks. Right now, CBS might get $.50 - $.75 per subscriber per month from Comcast while TNT may bring in $.90, for example. This inflation in retrans and affiliate fees (cable nets get affiliate fees) is the major reason why your cable TV bill steadily rises. Retrans fees for broadcasters and sports networks are the primary drivers of the price increases

In theory, Aereo could shift leverage in retrans negotiations toward the cable and satellite companies and away from the broadcasters. The concept would be that distributors might provide Aereo-like service to their customers and refuse to pay retrans fees. Or distributors might just not include broadcasters in all of their bundles and let subscribers know they could buy them elsewhere.

I do not think the threat from Aereo is as great as the new reporting would suggest. This is because I still subscribe to my couch potato thesis: Despite all the changes in technology impacting TV viewing, most people still want a simple solution. They want to sit down with one remote and an easy-to-manipulate TV and just watch their favorite shows. Yes, there is a generation of sophisticated young adults who may not find Aereo or other over-the-top solutions difficult to use and understand. These folks may be "cord nevers" when it comes to cable TV. However, they will age, and for the next decade or more, the impact on the current TV model for broadcasters, cable networks, cable systems, and satellite companies will be modest and gradual.

As a result, I think recent weakness in broadcast stocks (particularly CBS, which is the most exposed to retrans fees since it does not own meaningful cable networks) should be viewed as a buying opportunity. For some similar and some different reasons I think CBS, Disney, Comcast, and News Corp are all buys at current prices. I have a long position in all of them in my hedge fund. I am also long IACI, but not because of Aereo, which is just a tiny part of the story.

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