What Happens To Conference Networks If Cord Cutting Accelerates?
Yesterday ESPN sent president John Skipper on a media tour designed to persuade Wall Street that the ESPN sky wasn't falling. Today Disney nearly hit a new 52 week low. Clearly the stock market has an impact in Disney's woes, but at a time when "The Force Awakens" is setting box office records Disney's share price has fallen $32 since football season began. ESPN is the primary reason for that decline. Wall Street has become increasingly wary of the cable bundle's future and of the risk ESPN may face as the bundle declines in the face of substantially escalating sports rights payments. You can read my piece on the danger ESPN faces and why I believe its business model is dead here.
Skipper's comments in the Wall Street Journal were intriguing. I've pulled the quotes that I found the most interesting, but the full article, which I'd encourage you to read, is linked above:
WSJ: Would it be feasible to offer the entire ESPN network online to cord-cutters? Some analysts estimate you'd need to charge $30 a month.
Mr. Skipper: We are still engaged in the most successful business model in the history of media, and see no reason to abandon it. We're going to be delivering our content through the traditional cable bundle, through a lighter bundle, through Dish's Sling TV, through new over-the-top distributors, and through some content that is direct-to-consumer.
WSJ: What kinds of direct-to-consumer offerings?
Mr. Skipper: Last year, we tested this model when we sold the Cricket World Cup direct-to-consumer. We sold 100,000 subscriptions for a hundred dollars apiece. It worked beautifully. We are interested in "multisport"âaggregating a bunch of content and delivering it over the top and charging a subscription fee, or an individual price for an individual game or season.
WSJ: Was the cricket offering profitable?
Mr. Skipper: Yes.
WSJ: In October 2014, you renewed your deal with the NBA and agreed to triple your average annual rights fees. Would you do that deal again?
Mr. Skipper: I have no regrets about that deal.
The most interesting quote here is this one: "We are still engaged in the most successful business model in the history of media, and see no reason to abandon it."
Clearly, ESPN isn't going to abandon its business model, but that's not the threat here, the threat is that consumers abandon the bundle, which kills ESPN's business model whether they abandon it or not. The scary thing is this: ESPN has nothing to do with whether or not its business model will remain viable in future years, it's going to be entirely dictated by consumer behavior. Namely, how quickly do consumers who aren't watching ESPN stop paying for it?
On the same day ESPN argued that ESPN's future was bright, USA Today released Southeastern Conference revenue figures that include the first full year of the SEC Network. The SEC produced $527.4 million in revenue, a whopping gain that reflects the blockbuster success of the new SEC Network. It's likely that each SEC school will receive in the neighborhood of $36 million a year for TV rights, that's up from just shy of $21 million a year in 2013. As the costs associated with launching the SEC Network decline and the costs the league had to pay to buy back local rights are decline as well, the SEC Network is poised to become more and more profitable each year.
If, that is, the bundle remains a viable business model.
Given that the SEC Network is likely to be producing well over $500 million a year in revenue -- split between ESPN and the SEC -- off of 70 million subscribers, what would happen in the future if the bundle substantially declines? And how does the bundle's uncertainty impact the three conferences with their own networks -- the SEC, the Big Ten, and the Pac 12 Network?
Let's dive in and consider what's likely to happen.
1. I think conference expansion and realignment is dead for the foreseeable future.
Why do I say that? Because the number one rule of conference expansion is no one is expanding to take less money. That is, no existing conference is adding members who don't bring in more money to everyone. That's why the Big 12 isn't expanding. Because no one out there brings in substantial money. Not unless the Longhorn Network gets turned into the Big 12 Network some day, and I doubt that ever happens.
Given that the bundle is wobbly right now, what would a school -- or market -- have to be worth for the Big Ten or the SEC or the Pac 12 to expand? The easy answer is this -- much more than any are worth today.
I don't think the next round of realignment will happen for eight years or more. And I'm not even sure it will happen then. That's different than my opinion used to be and it's predicated on my growing belief that the cable bundle as we know it is going to die over the next 5-10 years.
Let's use the SEC Network as an example why.
We can do back of the envelope math on this pretty easily for the SEC Network. Growth in revenue is almost entirely predicated on the SEC Network since ESPN and CBS don't gain materially from adding new teams. The SEC's drastically undervalued deal with CBS isn't up until 2023-24, which seems like a long way away right now. Already, CBS has been a tough negotiator with the SEC over the additions of Texas A&M and Missouri. As a point of fact, the SEC gained virtually no economic value from CBS over expansion. The reason to expand from 12 to 14 wasn't about existing television deals. It was, as Outkick has been telling you for five years, was to start the SEC Network.
Let's make the math easy and say that the SEC will be distributing $200 million a year every year from the SEC Network within the next five years. That's lower than the actual number will end up being, but that's $14.3 million per school a year. That means that any expansion candidate would have to provide at least $14.3 million a year in market value.
Where does market value come from? Cable subscription dollars. The difference between $1.40 per year in market cable subscriptions and .25 cents in out of market. That is, the 11 states with SEC schools pay substantially more a month for the SEC Network than the 39 states without SEC schools. So any SEC expansion -- or conference expansion in general -- would have to come in new states.
The only two states that make sense from a financial perspective -- assuming the SEC wouldn't go to Ohio and add Cincinnati, for instance, which would probably be the most valuable addition the conference could make from a pure dollars perspective -- are North Carolina and Virginia.
So what's the value of SEC teams in North Carolina and Virginia?
We can do the math.
North Carolina has right at 3.2 million cable and satellite subscribers and Virginia has right at 2.8 million cable and satellite subscribers.
This means that a team in North Carolina would be worth $53.76 million a year in additional revenue to the SEC. (12 months x 1.40 x 3.2 million) (One caveat here, do Charlotte cable subscribers, where the SEC Network is located, really pay just .25 cents a month for the channel despite being that close to South Carolina? I don't know the answer for sure. So it could be less than this.)
Cut that number in half -- ESPN takes its share -- and a team in North Carolina would be worth $26.88 million a year in additional money to the SEC.
The state of Virginia has 2.8 million cable and satellite homes. Adding a team in Virginia would bring in $47.1 million additional dollars a year. Cut it in half for ESPN's share and you're talking about $23.55 million more a year for the SEC Network to have a team in Virginia.
Add those figures to our $200 million distribution and you're talking about the SEC having roughly $250 million to distribute to 16 schools. That leaves each SEC school receiving $15.6 million instead of $14.3 million.
But here's the big caveat, you'd also have to split revenue on the existing CBS and ESPN contracts, which probably wouldn't increase very much. This means every school would likely end up with very similar amounts of money that it already receives now.
It's possible the payments would actually decline.
And nobody is taking less money.
So SEC expansion is dead.
(It also means Oklahoma doesn't pay for itself since it has only 1.3 million cable and satellite subscribers).
Put simply, the only Southern states that make sense for the SEC are Virginia and North Carolina, and neither of those schools makes sense right now.
I think the same is true of the Big Ten, the Big 12, the Pac 12 and the ACC. Especially if, and I haven't even spent any time on it here, you consider the substantial penalties that all these teams would need to pay to exit their existing conferences.
The only move that might make financial sense is Texas and Oklahoma to the Pac 12 -- since it could help substantially with distribution -- but to do that Texas would have to give up the Longhorn Network.
2. Indeed, since all expansion has been predicated on adding new markets for cable networks, if the bundle is under assault, it's possible these conference network revenues could even decline five or ten years from now.
If that happens, could the conference networks reclaim the money by going over the top direct to fans?
I think so, but it would be much more difficult.
Instead of taking lower monthly subscription costs from 70 million bundle subscribers -- the vast majority of whom would never watch the channel -- the SEC would have to go direct to consumers and sell them on the channel. In that model the biggest obstacle -- aside from marketing the network -- is seasonality. Sure, many SEC fans would demand the network for fall football, but would they stay subscribed all year around?
I suspect you would have to set up a business model that charged a premium for the fall -- that is a football subscription alone costs, let's say $90 -- or you get the entire year for $100.
Then the question becomes, would five million households subscribe at an average price of $100 a year in order to produce $500 million in network revenue? I'm not sure. It's possible you'd have to double or triple the cost and end up making your most diehard customers pay infinitely more than they pay now. Remember, the bundle is a great deal for sports fans. Right now the entire SEC Network for a year costs less than $17 a year.
Regardless, SEC Network pricing would get complicated here. Because, for instance, the only SEC game that's free on television is the CBS game of the week. In order to get every SEC football game you'd have to cobble together a package that included ESPN, ESPN2, ESPNU and the SEC Network. Or would ESPN set a pricing structure for an entire season of SEC games that included all of these channels too? If so, how do you allocate the subscription revenue since the SEC sells many games to ESPN for a guaranteed amount and retains joint ownership of others on the SEC Network? Especially since ESPN would have other conference and pro sports rights to sell as packages. This is where a partnership gets complicated for network and conferences. There would be a ton of questions to work out.
3. We may look back on the Big Ten's addition of Maryland and Rutgers as very poor business decisions.
Maryland Rutgers were the last major realignment dominoes to fall.
But these weren't decisions made predicated on launching a new network. (The SEC Network wouldn't have launched without Texas A&M and Missouri, meaning the SEC was leaving hundreds of millions of dollars on the table.) Maryland and Rutgers were added to the Big Ten based on the value they could bring to the Big Ten Network. Both are in large markets where the cable rates could theoretically increase substantially.
But in a debundled universe are there enough Maryland and Rutgers fans to pay for their addition in an over-the-top market?
No way.
So if the Big Ten Network -- which is half owned by Fox -- starts to see money declining from debundling, you have to rely on huge fan bases to make up the deficit.
A good early test for how nervous cable companies are about debundling will come with the Big Ten's rights packages which will be sold this year. How much can ESPN and Fox afford to bid?
4. I don't think the ACC Network will happen.
And if it does happen, I don't think the launch will go very well.
The SEC timed the market perfectly. The ACC Network would enter the market at a time of cord cutting and face a great deal of market resistance, much more akin to what the Pac 12 has found.
If I were in charge of the ACC I'd urge patience in the face of market uncertainty. Do you really want to fight a battle to get your network carried, risk your fans not seeing games, and not produce substantial revenue for taking these risks?
5. What happens with the Pac 12 Network?
Unlike the SEC and the Big Ten, which partnered with ESPN and Fox, respectively, the Pac 12 still owns its network. But it is providing no substantial income to the teams and still faces a tough distribution battle.
The Pac 12 could sell a stake in its network to Fox or ESPN, but would either be in the market to buy right now given how much cord cutting uncertainty there is?
I think the Pac 12, which is by far the least successful of the three major conferences with a network, has to remain with the status quo.
I've been wrong before -- and will be wrong many times in the future -- but given present market conditions I would be very surprised if any major conference expands any time soon.
I'm a huge proponent of the value the cable bundle provides to sports fans, but I don't think the cable bundle is going to exist in its present form in five years.
