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27 January 2012
U.S. MEDIA Who Bears the Burden of Higher Sports Rights Costs?
Recent headlines about increasing NFL rights fees have raised questions about which parties in the cable ecosystemprogrammers, distributors, or consumerswill bear the costs. With unparalleled ratings, we believe NFL programming is by far the most valuable on air, maintaining essential status for many cable subscribers. As a result, we believe sports programmers have the most leverage in discussions with the Multiple Systems Operators (MSOs) about securing higher subscription fees to offset their rising content costs, although we expect temporary margin compression at ESPN in FY 2015. If the MSOs agree to higher affiliate fees for the sports programmers, we believe the non-sports programmers could be at a disadvantage in competing for affiliate fee increases in what is increasingly a zero-sum game. Three key points: NFL rights fees reach new highs In the last several months, ESPN and broadcast networks CBS, Fox, and NBC all re-signed their respective rights deals with the NFL, locking in significant, total price hikes of ~50-70% through 2022 (and 2021 for ESPN). We believe the value of NFL content has increased substantially in recent years, as a more engaged fan base, captivated by fantasy football interests, has helped NFL programming consistently achieve the highest ratings on television. Given the unmatched value of the NFL, we believe the networks had little choice but to renew their deals, since outsized NFL ratings are crucial for promoting other network programming and justifying higher retrans/affiliate fees from the MSOs. MSOs and consumers will likely shoulder higher sports rights costs To offset the rights cost increases, we believe the sports programmers will actively seek subscription and retransmission consent fee price hikes at least commensurate with their added cost burden. Since NFL content is considered essential viewing for many subscribers, we believe the MSOs will ultimately acquiesce to the demands of the programmers and will attempt to pass on the costs to the consumer. But if a subsequent consumer backlash leads to subscriber declines, we believe the MSOs may end up absorbing some of the programming cost increases themselves. Non-sports programmers may be struggle to secure desired affiliate rates Given the more difficult revenue environment for the MSOsflattish subscriber growth and consumer discontent over rising cable billswe believe non-sports programmers (DISCA, SNI, and VIAB) may have a more difficult time securing affiliate fee increases if sports programmers are already pressuring the MSOs for substantial rate hikes. Should a consumer backlash over video subscription costs gains traction, we believe that nonsports programmers would be the group most adversely affected, a risk we believe is not fully appreciated by the market, and certainly not priced into the stocks.
Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. PLEASE SEE ANALYST(S) CERTIFICATION(S) AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 11.
INDUSTRY UPDATE U.S. Media 2-NEUTRAL Unchanged U.S. Media Anthony J. DiClemente, CFA 1.212.526.1341 anthony.diclemente@barcap.com BCI, New York Chris Merwin 1.212.526.7778 chris.merwin@barcap.com BCI, New York
$15.2
$8.8 $5.8
$8.8
$7.6
NBC
1 2
ESPN, ESPN, NFL agree to eight-year deal, 9/8/11 Los Angeles Times, NFL signs TV rights deals with Fox, NBC, and CBS, 12/15/11
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Avg. Annual Total Amount Amount per ($B) Year ($B) $15.20 $1.90 $8.80 $0.98 $8.00 $0.89 $7.60 $0.84
While there are certainly many benefits to these deals, enough that the networks agreed to lofty 53-73% increase in rights fees, there are plenty of questions about how good these deals really arein particular, how they will be paid for, given a backdrop of flat-to-down video subscribers.
Facing a potential consumer backlash, we expect the MSOs will be in a difficult revenue environment going forward, and therefore will be looking to save on programming costs, rather than increase themdirectly at odds with what the content owners are trying to accomplish. While some are concerned about the emergence of non-sports tiers, a disaggregation of the bundle that would reduce the earnings power of the sports
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programmers, we believe the networks have enough leverage in their relationship with the MSOs to prevent more limited tiers from being offered to the consumer. Ultimately, someone in the value chain will have to shoulder higher rights coststhe programmers, the distributors, or the consumers. And if the MSOs have to absorb a portion of those costs, as we believe they will, we expect the non-sports programmers will have a more difficult time securing affiliate fee increases.
Source: Nielsen Media Research. Note: Data from 1/1/11 11/27/11. Persons 2+ estimates include Live and Same Day time-shifted viewing.
While Monday Night Football ratings were actually down 10% this past season according to Horizon Media, mainly due to unfavourable match ups which were set before the season began, the program was still consistently one of the top 5 most watched programs on TV. But we dont think advertising revenues will be main offsetting factor for higher rights costs; affiliate fee increases should serve that purpose. A past study done by ESPN and Nielsen revealed that people who were medium to heavy sports viewers (which account for 90% of ESPN viewing) showed zero evidence of cord cutting, giving credence to the theory that sports networks can serve as a primary justification for many consumers choosing to maintain a pay TV subscription. 3 We therefore believe that sports programming, and NFL broadcasts in particular, is clearly the most valuable content on air.
ESPN Media Zone, Latest ESPN Study of Multichannel Households Shows Net Zero Loss to Cord Cutters, 3/14/11
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Source: SNL Kagan and Barclays Capital estimates. Note: Only includes networks with 40M+ subscribers. Sports networks are shaded. Does not include Regional Sports Networks.
For Disney, we expect the impact of the new rights costs will first hit the P&L in the 4Q of FY 2014, after which point the full impact of higher run rate will be realized in FY 2015. While we expect ESPN will be successful in securing offsetting rate increases from the affiliates, as they have already begun to do, we believe there could be a timing miss-match that will adversely affect margins in 2015. Once all the affiliate fee deals have been repriced and the
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higher run rate for affiliate fee growthwere modelling 7% annually in 2016 and beyond begins to fully offset rights cost escalators of 4%, we believe margin expansion will resume. Figure 8: DIS EBITDA Margin Expansion
1.5% 1.0% 0.5% 0.0% -0.5% -1.0% -1.5% -2.0% 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022
More concerning than temporary margin compression, we believe subscription revenues for non-sports programmers may come under pressure. In what is increasingly a zero-sum game for affiliate fees, we believe the ESPNs of the world will cannibalize a large portion of the available pie for incremental fees paid out by the MSOs, potentially leaving the nonsports programmers at a disadvantage. Affiliate fees, unlike advertising revenues, are particularly important to the media companies as a recurring source of revenues, with built in annual escalators that can drive top line growth in any macro environment. And if carriage negotiations with the MSOs result in lower rate cards or moderated annual escalators, we believe the programmers business model could come under some stress.
MSOs maintain healthy, but likely decreasing gross margins for video
As of 3Q11, most of the major MSOs maintained gross video margins between 55-60% fairly robust when compared to other industries. We therefore believe that the MSOs have ample cushion to sustain the higher programming costs necessary to appease the demands by sports programmers for substantial affiliate fee step-ups.
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At least initially, we expect the distributors will attempt to pass increasing sports rights costs onto the consumer, a successful strategy in the past but one that may be met with more stringent resistance this time around, to the point where consumers cut their cable entirely or seek cheaper alternatives through tiered video offerings. However, investors and analysts have long predicted that the rising cost of video subscriptions would soon reach the elusive inflection point that ultimately leads to a mass exodus from Pay TVand each time theyve been wrong. Will this forthcoming increase finally be the one to push consumers over the edge? Time will tell, but this much we know for certain: the cable and broadcast networks fully believe they can secure their desired affiliate fees/retrans increases, or it is unlikely they would have agreed to the NFLs price hikes in the first place. We believe the residual impact from these subscription fee increases will include some combination of higher cable bills for the consumer, lower video margins for the MSOs, and lower-than-expected subscription fees for the non-sports programmers. In the best case scenario, consumers shoulder the entire burden, the programmerssports and non-sports alikeget their desired rate increases, and the MSOs maintain their video margins. But the downside case, where scripted programmers are left by the wayside, is an outcome that we believe is not fully understood by the market, and certainly not priced into the stocks. Along those lines, we are taking a closer look at potential implications for stocks in our coverage universe.
females, we now believe there is more risk to the significant rate increases that Travel will no doubt seek from the affiliates. Lastly, we believe VIAB may also struggle to secure pricing step-ups, given its lack of any sports programming and lagging ratings at key networks like Nickelodeon. However, with its best-in-class return of capital policy, and a relatively low exposure to advertising cyclical revenues, we find VIAB shares attractive at current levels.
Sports programmers
As previously discussed, we believe ESPN may sustain temporary margin compression in FY 2015; however, we believe the network will be largely successful in negotiating affiliate fee increases from the distributors, given sports programmings status of essential viewing for many cable subscribers, particularly males in the 18-49 demographic. For more detail, please see our DIS note Downgrading to 2-Equal Weight, published on January 10th. For the broadcast networks, we are less concerned about the impact of higher rights fees, given the offsetting impact of retransmission consent fees. For example, we believe CBS could earn in excess of $1B annually from retrans by the time its new rights deal with the NFL expires in 2022more than the estimated annual cost of ~$890M. Combine retrans with the influx of high-margin digital distribution revenues and we think CBS is well positioned to mitigate the impact of rising sports rights fees. While the other broadcasters, ABC (owned by DIS) and Fox (owned by NWSA) are a little behind CBS in securing retransmission consent fees, we believe they too will be able to largely offset higher rights feesmaking the impact of these costs a neutral event for the broadcasters, in our view.
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Company Ticker Price Diluted Shares (CY'12E) Market Capitalization (CY'12E) Net Debt (CY'12E) Total Other Firm Value (CY'12E) EBITDA 2012E 2013E 2012E Growth 2013E Growth 3-year CAGR ('11A - '14E) EV / EBITDA 2012E 2013E Adjusted Fully-Taxed FCF 2012E 2013E 2012E Growth 2013E Growth 3-year CAGR ('11A - '14E) Fully-Taxed P/FCF 2012E 2013E Adj. Fully-Taxed FCF Yield 2012E 2013E Earnings Per Share 2012E 2013E 2012E Growth 2013E Growth 3-year CAGR ('11A - '14E) P/E 2012E 2013E PEG Ratio 2012E 2013E DIVIDEND YIELD Dividends per share Dividend Yield LEVERAGE Net Debt/ EBITDA 2012E 2013E
CBS Corp. CBS $28.72 657.7 $18,921 $5,875 (8) $24,788 3,463 3,737 10.5% 7.9% 8.6% 7.2x 5.9x 2,075 1,744 30.4% (15.9%) 4.7% 9.1x 10.2x 11.0% 9.8% $2.26 $2.63 18.0% 16.3% 15.0% 12.7x 10.9x 0.85x 0.73x $0.40 1.4%
Walt Disney Co. DIS $39.35 1,797.2 $70,722 $10,957 4,287 $85,965 11,188 12,364 11.4% 10.5% 10.7% 7.7x 6.7x 4,088 4,871 12.4% 19.1% 11.7% 17.3x 14.0x 5.8% 7.1% $3.02 $3.53 15.6% 16.7% 16.3% 13.0x 11.2x 0.80x 0.68x $0.60 1.5%
Discovery Communications News Corp. DISCA NWSA $44.34 382.2 $16,242 $2,822 (716) $18,349 1,989 2,152 7.1% 8.2% 7.4% 9.2x 8.0x 1,049 1,159 (1.1%) 10.4% 5.9% 15.5x 13.8x 6.4% 7.3% $2.81 $3.29 17.1% 17.3% 16.5% 15.8x 13.5x 0.96x 0.82x NA NA $18.82 2,439.2 $46,448 $5,069 (11,476) $40,042 7,154 7,584 8.8% 6.0% 6.9% 5.6x 5.3x 2,776 2,942 (6.7%) 6.0% 1.6% 16.5x 15.6x 6.0% 6.4% $1.51 $1.69 15.8% 12.0% 12.6% 12.5x 11.1x 0.99x 0.88x $0.19 1.0%
Scripps Networks Interactive SNI $45.27 156.2 $7,070 $520 1,654 $9,243 1,105 1,233 11.6% 11.5% 9.7% 8.4x 7.0x 616 716 (2.3%) 16.3% 4.5% 11.5x 9.9x 8.7% 10.1% $3.25 $3.78 13.9% 16.5% 12.5% 13.9x 12.0x 1.12x 0.96x $0.40 0.9%
Time Warner Inc. TWX $37.97 1,014.2 $38,507 $18,060 (548) $56,019 7,213 7,524 6.9% 4.3% 5.4% 7.8x 7.3x 3,076 3,386 27.9% 10.1% 13.9% 12.5x 11.1x 8.0% 9.0% $3.16 $3.39 11.5% 7.4% 8.6% 12.0x 11.2x 1.39x 1.30x $0.94 2.5%
Viacom Inc. VIA.B $48.01 528.3 $25,718 $7,411 (146) $32,983 4,456 4,747 6.4% 6.5% 6.3% 7.4x 6.5x 2,606 2,805 10.3% 7.6% 8.0% 9.7x 8.2x 10.3% 12.1% $4.48 $5.29 14.5% 18.2% 14.5% 10.7x 9.1x 0.74x 0.62x $1.00 2.1%
Regal Entertainment Cinemark Group Holdings, Inc. RGC CNK $12.78 154.5 $1,975 $1,823 (283) $3,514 444 461 1.0% 3.9% 2.9% 7.9x 7.5x 179 199 10.3% 11.2% 9.3% 11.0x 9.9x 9.1% 10.1% $0.46 $0.57 15.5% 23.5% 16.5% 27.7x 22.4x 1.68x 1.36x $0.84 6.6% $20.06 112.9 $2,265 $1,304 (226) $3,343 550 585 12.7% 6.5% 8.5% 6.1x 5.6x 165 179 2.6% 8.9% 8.0% 13.7x 12.6x 7.3% 7.9% $1.45 $1.78 32.8% 22.9% 23.1% 13.8x 11.2x 0.60x 0.49x $0.84 4.2%
National Cinemedia Inc. NCMI $13.60 110.8 $1,507 $762 81 $2,351 233 252 10.3% 7.9% 9.0% 10.1x 9.3x 131 141 2.5% 7.6% 6.7% 11.5x 10.7x 8.7% 9.4% $0.55 $0.69 (4.5%) 26.0% 16.4% 24.7x 19.6x 1.51x 1.19x $0.88 6.5%
Clear Channel Outdoor CCO $12.81 356.4 $4,566 $1,427 --$5,992 767 809 5.3% 5.5% 5.4% 7.8x 7.1x 340 332 (9.1%) (2.2%) (2.4%) 13.4x 13.7x 7.4% 7.3% $0.18 $0.19 29.4% 5.4% 24.7% NM NM NM NM NA NA
Lamar Advertising LAMR $30.43 93.1 $2,832 $1,856 --$4,688 494 513 5.7% 3.8% 4.6% 9.5x 8.8x 242 233 24.2% (3.9%) 8.3% 11.7x 12.2x 8.5% 8.2% $0.25 $0.44 NM NM NM NM NM NM NM NA NA
Interpublic Group IPG $10.25 506.8 $5,195 ($368) 514 $5,341 956 1,123 7.9% 17.4% 12.6% 5.6x 4.5x 518 623 3.6% 20.2% 12.8% 10.0x 7.9x 10.0% 12.7% $0.75 $0.95 19.7% 27.3% 23.0% 13.8x 10.8x 0.60x 0.47x $0.24 2.3%
Omnicom OMC $46.74 270.9 $12,664 $1,055 660 $14,379 2,039 2,154 5.1% 5.7% 5.4% 7.1x 6.1x 1,274 1,347 13.5% 5.8% 8.4% 9.9x 8.9x 10.1% 11.2% $3.63 $4.13 9.2% 13.9% 12.3% 12.9x 11.3x 1.05x 0.92x $1.00 2.1%
DreamWorks Animation SKG Inc. DWA $18.62 81.2 $1,511 ($188) --$1,323 111 128 (7.3%) 14.6% 10.4% 11.9x 9.6x 71 99 2.8% 38.9% 25.0% 21.2x 15.1x 4.7% 6.6% $1.03 $1.15 (4.2%) 10.9% 10.8% 18.0x 16.2x 1.66x 1.50x NA NA
AMC Networks AMCX $41.82 72.3 $3,022 $1,829 --$4,851 490 529 9.7% 8.1% 5.9% 9.9x 8.8x 230 196 (14.8%) (14.7%) (4.7%) 13.1x 15.5x 7.6% 6.4% $2.35 $3.00 20.9% 27.6% 22.9% 17.8x 13.9x 0.78x 0.61x NA NA
10.9% 9.9% 8.3% 14.4x 12.8x 7.3% 8.2% $102.55 $107.00 15.1% 14.2% 13.8% 12.7x 11.1x 0.92x 0.80x $0.54 1.6% 6.5% 4.3% 8.1% 12.9x 12.3x 1.59x 1.52x $28.01 2.1%
1.7x 1.2x
1.0x 0.8x
1.4x 1.2x
0.7x 0.7x
0.5x (0.1x)
2.5x 2.3x
1.7x 1.6x
4.1x 3.8x
2.4x 2.1x
3.3x 2.9x
1.9x 1.5x
3.8x 3.2x
(0.4x) (0.4x)
0.5x 0.3x
(1.7x) (2.1x)
3.7x 3.1x
1.3x 1.2x
Source: Source: FactSet, Company documents, Barclays Capital estimates. Note: All years are calendarized for the purposes of comparable valuation. Figures are in millions except for share values. Prices as of 1/26/12.
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ANALYST(S) CERTIFICATION(S)
I, Anthony J. DiClemente, CFA, hereby certify (1) that the views expressed in this research report accurately reflect my personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this research report.
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DISCLAIMER: This publication has been prepared by Barclays Capital, the investment banking division of Barclays Bank PLC, and/or one or more of its affiliates as provided below. It is provided to our clients for information purposes only, and Barclays Capital makes no express or implied warranties, and expressly disclaims all warranties of merchantability or fitness for a particular purpose or use with respect to any data included in this publication. Barclays Capital will not treat unauthorized recipients of this report as its clients. Prices shown are indicative and Barclays Capital is not offering to buy or sell or soliciting offers to buy or sell any financial instrument. 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