Pay TV Consolidation: Who Are the Potential Winners and Losers?

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Two blockbuster acquisitions pending before regulators in Washington, D.C., have the potential to make sweeping changes to the media and communications landscape: Comcast’s $45 billion proposed acquisition of Time Warner Cable (TWC) and AT&T’s planned $48.5 billion purchase of DirecTV. If approved, the two combined companies will control half of all U.S. TV-viewing households.

Comcast would solidify its lead as the nation’s largest cable operator with the addition of Time Warner Cable customers. Together, the combined company after divestitures would serve around 30 million video subscribers — the key metric in the pay TV industry — or about a 30% market share of TV-viewing households. In broadband, the two would have an estimated 40% share. Time Warner Cable also would gain closer ties to Comcast-owned NBCUniversal’s networks, film studios, TV stations and theme parks.

AT&T would become the second-largest U.S. pay TV operator with the addition of DirecTV’s 20.3 million video subscribers. Together, the combined entity would serve 26 million TV viewers. DirecTV offers video nationally as the largest satellite TV operator in the country while AT&T, the largest U.S. telecommunications company, operates wired and wireless networks. The carrier also offers its fiber-based U-verse broadband, video and voice services in select markets. AT&T had 116 million wireless subscribers as of the first quarter of 2014.

The rise of two such media titans would influence the way Americans watch TV and access content on the Internet for years, whether at home or on the road using mobile devices, analysts say. Their formation also has implications on the race to provide advanced communications services to businesses. In addition, if the acquisitions are allowed to happen, these media giants will gain more clout to negotiate content deals with Hollywood, and their control of wired and wireless broadband networks will give them greater leverage over online video providers, such as Netflix, that use their network infrastructure to compete with their TV service.

“This transaction will create a world-class blue chip company committed to innovation,” said Comcast CEO Brian Roberts in a February 13 conference call announcing the Time Warner Cable deal. In particular, Comcast’s cloud-based TV guide, faster broadband network and advanced operating system will be upgrades to Time Warner Cable’s systems, he noted. AT&T CEO Randall Stephenson said in his May 19 merger call that buying DirecTV will create a company with a “best-in-class nationwide wireless network, a premier national video service” with a growing Latin American pay TV business.

“Telecommunications consolidation tends to go in waves. Once a major company is acquired, everyone else looks to respond.” Kevin Werbach

The seeds of these acquisitions were planted three years ago when Comcast bought a 51% stake in NBCUniversal from GE. “Telecommunications consolidation tends to go in waves. Once a major company is acquired, everyone else looks to respond,” says Wharton legal studies and business ethics professor Kevin Werbach. “These two deals come on the heels of Comcast’s acquisition of NBCUniversal and AT&T’s failed attempt to acquire T-Mobile.” In 2011, AT&T announced — and then abandoned — its $39 billion buyout bid for T-Mobile after failing to get regulatory approval. Last year, Comcast bought all of NBCUniversal.

According to Werbach, AT&T struck a deal for DirecTV now because getting regulators to approve the transaction could be easier in light of the larger concerns surrounding the Comcast-TWC acquisition. “I wouldn’t say the DirecTV deal was a specific response to Comcast-TWC, as they are different kinds of transactions,” he notes. “AT&T isn’t a major national player in the video market today, whereas Comcast and Time Warner Cable are essentially the two largest players in the same business. However, AT&T may have felt this was an opportune time to get a DirecTV deal approved, since it looks more benign by comparison.”

Gerald Faulhaber, Wharton professor emeritus of business economics and public policy, does not think the proposals for either merger will affect the other. “Certainly, the Justice Department will look at [the two transactions] separately,” he says. However, according to Kartik Hosanagar, Wharton professor of operations and information management, having two large merger proposals on the table at once could prove to be a problem. “It creates greater concern about consolidation and that there won’t be enough competitors left,” he says.

To appease regulators and consumer groups, Comcast and Time Warner Cable leadership have said they are willing to make concessions. If the merger is allowed to proceed, the two companies plan to divest 3.9 million video customers to fellow cable operator Charter Communications, which had also been pursuing a merger with Time Warner Cable but was rebuffed. Comcast also pledged to adhere to the same anti-competitive provisions it agreed to in the NBCUniversal acquisition, including abiding by FCC net neutrality rules overturned by an appeals court in January. They also pledged to continue to offer affordable, standalone broadband service.

AT&T and DirecTV extended an olive branch to regulators, too, guaranteeing the availability of standalone broadband and satellite TV service and promising to keep prices the same for three years. AT&T also said it plans to roll out broadband service to 15 million households, mostly in rural areas. The carrier said it would abide by the FCC’s net neutrality rules even if they had been vacated in court, and promised to bid at least $9 billion in the 2015 spectrum auction if there is sufficient spectrum to create wider channels with national coverage.

Still, consumer groups and several politicians, notably Democratic Senator Al Franken of Minnesota, have blasted both deals as anti-competitive and anti-consumer. “The captains of our communications industry have clearly run out of ideas. Instead of innovating and investing in their networks, companies like AT&T and Comcast are simply buying up the competition,” Craig Aaron, CEO of the nonpartisan, nonprofit media reform group Free Press said in a statement on May 18. “These takeovers are expensive, and consumers end up footing the bill for merger mania.”

Consequences for Customers

Despite the voluntary concessions — and the expectations that regulators could impose more — the mergers are triggering fears in the industry that the two behemoths could throw their weight around. In February, Dish Network chairman Charlie Ergen said the Comcast-TWC merger represented a “seismic” shift in the media market. “There is nothing that I can see that is positive about it for anybody in the video, broadband or content business,” he told analysts during a conference call.

“Cable companies can easily argue that recent trends have brought so much more competition [from phone and Internet companies] into their markets that competition and pricing concerns shouldn’t exist.” –Kartik Hosanagar

Other pay TV operators are worried that they would get less favorable content deals from NBC than what would be offered to Comcast-TWC. Smaller, independent networks are concerned that they could be dropped or not carried by Comcast because they compete with NBCUniversal’s cable networks. The American Cable Association, whose members are smaller cable companies, is concerned that if Hollywood cannot extract good prices for its content from Comcast-TWC, it would make up the shortfall by hiking fees for smaller operators. Consumer groups believe the mergers would lead to even higher prices for video and broadband services.

“In general, fewer choices and fewer competitors are bad for consumers,” Werbach says. “That doesn’t mean all mergers should be rejected, but it should give regulators pause as they review these transactions. Communications and media markets are no longer monopolies in the U.S., but there are also generally not a large number of significant competitors.”

Any harmful effects from the mergers would likely be lessened in a digital media world where consumers can get content from many sources, not just broadcasters and pay TV operators. Tech giants Google, Amazon.com and Apple are now significant providers of online video, creating new paths for content. “This video market is changing very radically,” Faulhaber says.

“Cable companies can easily argue that recent trends have brought so much more competition [from phone and Internet companies] into their markets that competition and pricing concerns shouldn’t exist,” Hosanagar notes. Netflix, for example, has more U.S. customers than Comcast and Time Warner Cable combined, Faulhaber adds: In the first quarter, Netflix reported 35.7 million U.S. subscribers.

Moreover, Hosanagar notes that Comcast and Time Warner Cable currently serve separate markets so a merger would not reduce competition and directly lead to price hikes. The merger of AT&T and DirecTV should be even less worrisome to consumers because their businesses are complementary instead of overlapping, he adds. AT&T’s U-verse is available in just a quarter of DirecTV’s coverage area; DirecTV has no U.S. phone or broadband service.

But Hosanagar does see a merged Comcast-TWC gaining more power over suppliers such that it could “dictate terms” to them. But then again, major broadcasters that produce content, such as ABC, CBS and FOX, remain powerful, Werbach points out. ABC is owned by Disney and CBS also owns Showtime and other properties. Rupert Murdoch’s 21st Century Fox owns the FOX broadcast network. The Comcast and AT&T acquisitions “may create more of a counterweight to larger broadcasters, who have been extracting concessions that dramatically increase consumer costs as through retransmission consent negotiations,” Werbach adds.

As for smaller, independent content providers, he says that regulators will place conditions on Comcast and AT&T to stop them from unfairly shutting them out. When it comes to content delivered over broadband, “today, the Internet still provides a platform open to anyone,” Werbach notes.

Cable and satellite firms and phone companies that provide TV service have long complained that broadcast and cable networks keep raising the cost of programming through so-called affiliate fees, which are then passed along to consumers in the form of higher subscription rates. In addition, television broadcasters charge pay TV operators fees for the right to retransmit their over-the-air TV signals. These retransmission consent negotiations sometimes get so contentious that networks have pulled signals from pay TV operators if talks break down. For example, last year, CBS was blacked out on Time Warner Cable for a month.

The Future of Video

The real battle for the future of TV is in broadband as online video viewership grows. “Comcast and Time Warner Cable understand this,” Faulhaber says. “This is no longer a video business with a sideline of broadband. This is becoming a broadband business with video as a sideline.” The merger of the two cable companies would expand their broadband footprint. At the end of the first quarter, Comcast served 21 million Internet customers and Time Warner Cable had 11.4 million.

In contrast, AT&T’s purchase of DirecTV does not give it more U.S. broadband customers. The carrier’s fiber-based U-verse network counted 11 million broadband subscribers in the first quarter, which offset a 32% drop in subscribers to its slower DSL network to 5.5 million customers. DirecTV has no U.S. broadband service. As such, the acquisition looks more like a bet on traditional TV technology. “I don’t really understand the AT&T and DirecTV deal,” notes Faulhaber, echoing Wall Street’s concerns. “What is the business model here?”

“This is no longer a video business with a sideline of broadband. This is becoming a broadband business with video as a sideline.” –Gerald Faulhaber

AT&T’s Stephenson has said that buying DirecTV lets the carrier bundle video, broadband, wired phone and wireless services to customers. Moreover, AT&T gets exposure to DirecTV’s pay TV service in Latin America, which is growing faster than its mature U.S. business. AT&T has been rumored to be chasing growth businesses abroad as the U.S. wireless market slows. Buying DirecTV “will help us accelerate growth,” Stephenson noted during the May 19 merger call. The combined company also plans to “redefine” the video business for mobile in a broadband world, AT&T said. “That includes delivering content to consumers across multiple screens, mobile devices, TVs, laptops, the backseat displays of connected cars and even airplanes,” as well as new video options, Stephenson added.

But Faulhaber points out that AT&T already partners with DirecTV to bundle each other’s services. “They have that deal already. What more they intend to get out of this, I don’t know.” The acquisition also brings AT&T back to an old business model it had in the 1990s. Back then, AT&T Broadband, a unit of the carrier’s predecessor company, was the largest cable TV operator in the country. But AT&T sold it to Comcast in 2002 for $47 billion. “It was a big flop for them,” Faulhaber states, noting that AT&T inexplicably is back in the same business today. “The Comcast-TWC [deal] makes a lot more sense to me.”

Buying Time Warner Cable gives Comcast access to customers in key cities including New York and Los Angeles, making it more of a national player. “How can you be a national communications provider and not be in New York or LA?” Faulhaber asks. As a national broadband company, Comcast-TWC could more ably serve big companies that need a national network. “This will let them compete in that market with Verizon and AT&T,” he notes. While cable companies have been selling broadband, voice and video services to businesses for years, the lack of a national presence keeps them from expanding beyond the small- to mid-sized business market.

But it is precisely this concentration of broadband that could cause regulators to jettison the deal. “Going in, I and most observers expected the Comcast-Time Warner Cable merger to be approved, after a long process and some moderate conditions,” Werbach says. “However, the depth of concern about excessive broadband consolidation that has been evident in the debate over network neutrality may change the equation. There is growing sentiment that we’ve gone too far in allowing concentration in this important market.”

Opponents of the deal are worried Comcast could favor its own Internet traffic over that of competitors such as Netflix and Amazon, violating the tenets of net neutrality that call for treating all traffic equally. They are also concerned that Comcast would disadvantage its rivals and other networks in peering arrangements. In peering, interconnecting networks historically routed each other’s Internet traffic for free when the volume is roughly equal, Faulhaber notes. But when one network is pumping much more traffic into another, creating an imbalance that recurs consistently, demands for payment may arise.

Comcast had such a dispute with Level 3 Communications in 2010, which carried heavy traffic from Netflix and sent it to the cable operator. Comcast asked for payment. Faulhaber says Level 3 took the issue to the FCC and accused Comcast of violating net neutrality. But the FCC determined it was an interconnection fight instead. Last year, both sides reached an agreement over payment terms. In February, Netflix struck a deal to pay for a more direct connection to Comcast’s network to speed up streaming as its viewership jumped. Netflix now accounts for 34% of North American Internet traffic during peak periods, according to a May 14 report from networking equipment company Sandvine.

“The debate about network neutrality and peering has highlighted concerns that are relevant even though the two companies don’t currently compete for customers,” Werbach says. He gives the Comcast-TWC deal a 50-50 probability of getting regulatory approval. However, AT&T and DirecTV should have an easier time of it. “AT&T is sufficiently small in video that the combination doesn’t create a dominant player in any one market, unlike Comcast-Time Warner Cable,” he notes. “Other than the general concern about consolidation in telecommunications and media, it’s hard to see a strong reason under antitrust principles why the deal would be anti-competitive. I expect it will go through.”

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