What If Aereo Prevails at SCOTUS?: Some Q & A

Would a cable operator deploy its own Aereo-style service with an antenna for each customer delivering individual streams for each from its own antenna?

Once (and if) the Aereo service is found to be legal by the Supreme Court, it would represent an attractive alternative to the operators' current options for carrying broadcast channels, which are: (1) pay higher retransmission consent fees, (2) do without popular broadcast channels, and (3) hand out antennas to customers.

It may not be the case that cable operators create their own Aereo-style service. At a recent meeting, an investor interested in retransmission consent told me something that surprised me: cable operators can't deploy an Aereo-style service without negotiating retransmission consent agreements with the broadcasters. Cable operators are considered Multichannel Video Program Distributors (MVPDs) according to the law, however, I assumed that classification applied only to their cable television services, not necessarily to other services that they might offer (e.g., online streaming video services).

Researching the topic further, I learned that cable operators are named specifically as MVPDs in the 1996 Telecommunications Act. As an MVPD, the operator gets certain benefits and takes on certain obligations, one of those obligations is that it is subject to the must carry/retransmission consent structure when dealing with local broadcast stations.

So, by a strict reading of the law, operators may not be able to offer their own Aereo-style service.

One Aereo Antenna, dime for size comparison

So Aereo is of no consequence and an Aereo victory at the Supreme Court would not change anything for cable operators?

I would not move so quickly to that assumption.

An MVPD could enter into an affiliation agreement with Aereo (or an Aereo-style provider operated by a third party) to provide access to its customers via its set-top boxes and apps. Since all modern cable boxes are capable of decoding IP video streams and their software is updated regularly, it appears that an Aereo solution could be rolled out relatively easily. Aereo becomes another app on the box, much like Pandora.

If you think this work-around is "too cute" to be viable, I suggest you read about Dish Network and its relationship with NPS.

Certainly Aereo and likely Aereo-style competitors will exist if the service is found to be legal. Cable operators already affiliate with third-party services for several online streaming video services. ESPN3 is probably the best known example with unique content.

An Array of Aereo Antennas

If Aereo is another app on the box is that really better than giving customers an antenna and telling them to switch inputs to watch the station that isn't being carried?

The Aereo solution offers several benefits versus the clearly-has-been-found-to-be-unattractive antenna option:

• The customer does not have to pick up an antenna (at the operator's office or a store).
• The customer does not have to switch inputs.
• The quality of the signal received by the customer should not vary with the customer's location, the way over-the-air reception from an antenna at his or her premises would.
• The operator does not have to maintain an inventory of antennas

Furthermore, the Aereo app could be integrated into the cable video service in a much more complete way than as a wholly separate app.

 A cable operate could offer the following to its Aereo-style affiliate:

• bundle your service with certain cable TV packages
• integrate your offering with the cable TV electronic program guide
• not count bandwidth usage by customers to view your services against any bandwidth cap we may have with customers (the elimination of the network neutrality rules would allow operators to favor certain IP traffic over other traffic -- this is an obvious place that flexibility could manifest itself)
• incorporate your service with our billing system
• pay you a flat rate for providing us the service or share of the revenue attributable for your service or compensate you on a per-subscriber basis

The cable operator could affiliate with more than one Aereo-style provider to offer additional choices to consumers, for example, perhaps one offers no cloud DVR storage, but a lower cost.

What might be a wise plan for a cable operator?

A cable operator should launch/affiliate with an Aereo-style service well before the expiration of their current retransmission consent agreements.

• This service is an upsell opportunity for the operator's broadband-only customers.
• The process of integrating the Aereo-style app in the set-top box will take some time, better to start the process well before it is "mission critical".

The downside to doing things early, of course, is that it will give the broadcasters more time to plan their response, whatever that may be.

Could an Aereo-style solution replace the carriage of broadcast stations by cable systems?

The short answer is no. The cable operator is still an MVPD and still has to offer the Basic Service Tier (BST). It is a legal requirement that cable operators must sell the broadcast tier to all customers who receive video service. For example, a customer who calls up the operator and just wants HBO or the expanded basic package (i.e., the package with ESPN, CNN, Lifetime, USA) must buy the BST as well.

However, the NCTA is lobbying to change this mandatory buy-through and their argument on this is a strong one. There is no mandatory buy-through for customers of DirecTV or Dish Network.

Furthermore, PEG (public, educational and government) channels are required to be carried in the BST by law. Additionally, broadcast stations which elect "must carry" (typically the less-viewed stations in a market) are guaranteed carriage on the cable system.

To address the concerns of local franchise authorities, cable operators could still provide the PEG channels to all video customers even if they eliminated the BST. Since those channels do not carry a license fees, the cost of doing would be negligible.

How would a cable operator drop a major broadcast affiliate?

The mechanism of retransmission consent is independent of any of the issues raised by Aereo. At some point, the current retransmission consent agreement between a station and the operator will expire. The station will make an offer for a renewal, usually with an escalating per-subscriber retransmission consent license fee. The two parties negotiate. If they can't reach agreement on terms, the operator cannot carry the station. All the Aereo-style-option does is create an alternative for the cable operator that's better than its current alternatives (BATNA in the parlance of Fisher and Ury). It would likely still be more attractive for the operator to negotiate a retransmission consent agreement than not.

Sometimes there is more in the negotiation than just the retransmission consent. For example, some broadcast stations provide the right to carry their local news programs on VOD as part of a retransmission consent agreement. Without such an agreement, the cable operator would not enjoy those rights.

Could the impact of Aereo go further?

Taking the broadcast service out of the cable TV ecosystem, in addition to sidestepping retransmission consent fees, would also appear to sidestep copyright fees payable for the distribution of such signals. Copyright fees are calculated as a percentage of revenue from the tier in which the signals are carried. If we assume that the current BST costs $20, then the copyright fee an operator would pay is a percentage of that amount times 100% of subscribers.

In the event that an Aereo-style service is available on the cable system and we assume the system is currently paying about $2 in retransmission consent fees, the system could reduce its BST retail price to $18 without harming its gross margin and then would also reduce its copyright fees for the broadcast stations by 10% as well.

Furthermore, if customers do not have to buy through the BST -- which presumably at this point only has the weaker TV stations the $18 tier may not offer a good programming value -- then the number of subscribers on whom copyright fees are payable also goes down. A win all around for the cable operator on the cost side.

Alternately, the cable operator could drop the retail price of the BST, now that it is missing its strongest programming. Since the copyright fees are based on a percentage of revenue, that cost would go down even if the number of subscribers did not.

Furthermore, cable customers would have the option of affiliating directly with Aereo (or an Aereo-style service) for their broadcast stations and use the cable operator only for cable programming services. At a certain price the benefit of doing so would outweigh the hassle to the customer of having to switch inputs.

So Aereo is a big deal for broadcasters?

As one lawyer very familiar with the retransmission consent scheme and its impact on broadcasters told me: Aereo is an existential threat.

I'm not sure that I would go that far, local broadcasters were still profitable before they started generating large retransmission consent fees.

What happens on the broadcast side if Aereo wins?

The broadcasters will lobby to change the law to define Aereo as an MVPD (and as such subject to Must Carry/Retransmission Consent)

If that doesn't work, the broadcasters will threaten to move the broadcast network channels to cable. Actually, Fox's Chase Carey has done this already. There are political issues associated with that -- broadcast licenses were granted for free, political figures would not look kindly on such a move.

If the whole channels are not moved off free-to-air television, the big programming companies will do what they always do, look at where their programming investment will get the best return. If the returns in the broadcast business go down (because there is less retransmission consent money there), more programming will appear on cable channels -- continuing the trend we've seen over the last 30 years anyway (e.g., ABC's Monday Night Football is on ESPN). In Australia, there is a law requiring some sports events to be on free-to-air television.

Update (22 November 2014): DirecTV had considered setting up its own Aereo-style service.

Comcast's Offer for Time Warner Cable

A few quick notes about the proposed transaction:

• Comcast's offer of $159 per TWC share is very close to TWC CEO Rob Marcus's proposal to sell the company to Charter for $160.
• Comcast's offer has no break-up fee for either side, Comcast can abandon the deal at any time and Time Warner Cable, presumably, can entertain a better offer from Charter or someone else
• Comcast has also offered to divest 3 million TWC subscribers, presumably to address concerns that the merged company would be too big; the "cats & dogs" of TWC's former national division would be likely divestiture candidates, unless some of them are contiguous to existing Comcast systems.
• Comcast has made bold offers before and walked away when investor support for the deal was not there (its 2008 offer for Walt Disney)
• Because Comcast and Time Warner Cable have few systems which compete directly with each other, there would be little direct impact on consumers -- their number of choices of providers would not be reduced. Consumer Reports looks at it this way. Comparing the impact on competition to the stillborn AT&T T-Mobile deal is off-base.
• The deal is good news for the channels of NBC Universal, which now are more likely to gain carriage on Time Warner Cable's systems. NBCSN and Golf Channel, which are carried on digital in Time Warner Cable's New York City system (link is to .pdf), will likely end up with parity (expanded basic) carriage with ESPN.
• The vendors that sell to the companies (non-NBCU programmers, hardware companies, billing systems providers) who will now be dealing with a larger customer and fewer attractive alternatives if they say "no" are the biggest losers if the deal goes through.
• Charter is likely a loser if the deal closes. If it sees increasing its scale a business imperative, the biggest available target will be off the market. Cox and Cablevision are the next biggest available companies and they have rebuffed multiple offers to sell. The cable companies smaller than them (e.g., Mediacom) are much smaller with fewer than 2 million subscribers. Charter would have to buy nearly all of them to increase its scale as much as a Time Warner Cable deal would have.
• Another loser might be Apple. TWC appeared to be creating an app for the Apple TV box; Comcast hasn't been, seeing its X1 guide as preferable.
• Closing price of CMCSA on 13 Feb 2014 (the date the deal was announced) = $52.97. TWC = $144.81. CMCSA x 2.875 (stock exchange ratio) = $152.29. Implies some uncertainty about the deal closing.
• Cablevision will still be the largest cable operator in the New York DMA by subscribers, but the combined Comcast-Time Warner Cable will be a major player in New York and the dominant provider in virtually all of the other top 25 DMAs (exceptions: Cox-Phoenix #12, Charter-St. Louis #21, see Rich Greenfield's chart @ https://twitter.com/RichBTIG/status/433960562309861376/photo/1
• Slate's take on the deal negotiation -- it's not very different from any other time you call the cable company

Update (14 Feb 2014): Mark DeCambre on the website Quartz quotes a Gekko-like Goldman Sachs research note praising the deal for giving pricing power to the new company with the charming pull quote "M&A that drives an industry toward oligopoly is the good kind."
Update (16 Feb 2014): Paul Krugman's column in the New York Times. Barons of Broadband. Pull quote: "The truth, however, is that many goods and especially services aren’t subject to international competition: New Jersey families can’t subscribe to Korean broadband."
Update (18 Feb 2014): Another likely loser with this deal is Netflix. TWC was in talks to carry/sell Netflix to its video customers, something Comcast has rejected. Now, per Bloomberg, "the talks are on hold".
Update (19 Feb 2014): As my former colleague Howard Homonoff astutely notes, Google Fiber's announcement that it will enter additional markets is very good news for Comcast in securing government approval for the deal.
Update (19 Feb 2014): Another loser in this deal may be CBS which would see the TWC systems move from the recently-and-contentiously-negotiated deal to an older, more distributor-favorable Comcast deal, according to this LA Times article. It is standard in cable affiliation agreements for the acquirer to have the right to add one or all "after-acquired systems" to its affiliation agreements and delete the systems from their prior agreement. In fact, Comcast would likely do this for all its agreements that are more favorable than TWC's (and should TWC have any more favorable deals than Comcast, Comcast might be able to move its incumbent systems to those newly-acquired deals).
Update (20 Feb 2014): Bill Niemeyer of The Diffusion Group believes that John Malone may not have really wanted Time Warner Cable for Charter because the Comcast/TWC merger noise creates an opportunity for Charter to act under the radar. Maybe, Dr. Malone does prefer to be out of sight of the regulators, but I find it hard to think that anything Dr. Malone does will go unnoticed.
Update (20 Feb 2014): DirecTV's CEO thinks the deal should get "appropriately scrutinized". In the past, DirecTV has criticized Comcast's dealmaking for its regional sports networks.