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How Nine Ate Ten

Neil Boyd-Clark, Arnhem Managing Partner, Resources and Media Analyst

It has taken just two years for the Australian Television industry to buckle under the pressure of subscription video on demand’s (SVOD) arrival, with the announcement this month that Ten Network Holdings has been placed in Voluntary Administration. The continued decline in television viewership and a consequent decline in television advertising expenditure, together with Ten’s position as the third most popular commercial television network in Australia, meant that the company was not able to cover cost and reduce debt. The management of Ten appears to have done a commendable job in renegotiating programming and other costs. However, the unavoidable reality is that the industry has changed since Ten was last resurrected from insolvency and listed on the ASX in March 1998. The pressure from competing high quality video content providers, in particular those based on subscription models, has been unrelenting. This means that even with a substantially reduced cost base, it is unlikely that Ten would be able to survive solely as an advertising funded television network in the long term. A new business model is required.

So what can we learn from television industry changes in other parts of the world? As is the case in many industries, the US has been a hotbed of innovation. The Australian television industry has similarities to the US industry; both have established advertising based commercial television broadcast networks and subscription television operators, as well as subscription video on demand (SVOD) service providers. One of the key differences, is that the commercial broadcast networks in the US are able to generate so called “re-transmission” fees from the subscription operators who transmit the broadcast network content.

When continued loss of viewership and advertising revenue threatened the broadcast television networks in the US, many contemplated closing down their broadcast channels and launching new subscription based channels delivered over the subscription cable or satellite networks, thereby benefiting from the additional “affiliate fees” which subscription channels receive. This opportunity made the negotiation and introduction of “re-transmission” fees between commercial broadcast networks and subscription television operators possible. In Australia, TV industry competitors almost never collaborate. In fact, the free to air broadcasters successfully lobbied government for an “anti-siphoning list” and then for the ability to launch additional digital channels themselves, neither of which has helped their long term prospects. This approach by the Australian broadcast networks was strategically poor as it has constrained their ability to generate subscription revenues and compete more effectively.

However, all is not lost for Ten (as well as Nine and Seven), because once again, developments in the US television industry highlight a potential path for Australia’s commercial television companies. The US television market is undergoing another transformation, with SVOD (mainly Netflix, Hulu and Amazon video) now being joined by so called “streaming TV.” This service offers a limited number of linear television channels (broadcast and subscription TV channels) which were already available elsewhere, but only as part of larger (and more expensive) traditional Pay TV subscription bundles. US television broadcast company CBS launched its “CBS All Access” and “Showtime” streaming TV services. These services offered the mobility of mobile internet at significantly lower price points than the traditional Pay TV players were prepared to offer.

Last year, the leading traditional subscription satellite television provider, DirectTV (now owned by AT&T) launched its own “streaming TV” service called “DirectTV Now,” which offers an SVOD video library and “streaming TV” with more than 60 channels including premium sports channels such as ESPN. Finally, in the last 3 months, Alphabet has launched a subscription “streaming TV” service called “YouTubeTV” and SVOD provider Hulu (owned by Disney, Fox, Comcast and Time Warner) has upgraded their service to a combined SVOD and “streaming TV” service called “Hulu Plus.” These new services combine an SVOD video library and more than 40 channels of live “streaming TV.” In other words, US consumers can now replicate the traditional Pay TV offer in almost its entirety, as well as benefiting from an SVOD library and the mobility of the internet at a range of price points lower than traditional Pay TV.

As a result, it is no surprise that we have seen a decline in traditional Pay TV subscribers in the US. We expect this decline to accelerate as new “streaming TV” services, such as ESPN, enter the market and consumers switch to more flexible and mobile “streaming TV” services.

Source: Company Reports, UBS

Interestingly, despite this loss of subscribers and the margin pressure that traditional Pay TV players have suffered since the introduction of SVOD and “streaming TV” in the US, it appears that these services have expanded the subscription TV industry revenue pie. End consumers seem happy to pay more in aggregate for their premium video content.

We estimate the subscription video content market in the USA has expanded by ~2.0%pa over the last 5 years. At the same time, we have seen a ~6m decline in high value traditional Pay TV subscriber numbers in the US from approximately 103.1m in 2012, to an estimated 97.2m today. The growth in lower value SVOD subscribers in the US has exceeded this loss of traditional Pay TV subscribers by more than 10x, with the result that the overall revenue pie has expanded by ~$10bn. However, we estimate Netflix and Amazon are spending around US$6bn per annum and $3bn per annum respectively on new original content, suggesting that little of this additional revenue is reaching shareholders while the subscriber land grab is on.

Source: Company Reports, UBS, JP Morgan, Arnhem

In the Australian television industry, Nine already offers a free VOD “catch-up TV” and “streaming TV” service via its “9Now” web platform, Ten offers a similar web based service called “tenplay” while Seven offers “PLUS7.” These services are free for consumers, largely because the same live stream content can be accessed for free via regular broadcast TV and the VOD service has not as yet been considered valuable enough to warrant a subscription payment. Each of these services is limited by the existing 30 year old media “Reach rules,” which prevent a media owner in Australia from reaching more than 75% of the population and the fact that the broadcast networks already attract affiliate fees from their regional TV broadcasting counterparts like Prime, Win and Southern Cross Broadcasting.

In addition to the 9Now service, Nine has, together with Fairfax, also successfully launched the SVOD service STAN in competition with Netflix and subscriber numbers are growing. STAN offers its owners a subscription based revenue stream. The service is not as yet profitable, but Nine is the first of the Australian commercial broadcast networks to put itself in a position to become less dependent on advertising revenue alone. Should STAN reach profitability, we would expect the company to expand its content offer over time and eventually try and replicate the SVOD-streaming TV-virtual DVR offer that Hulu Plus has just launched in the US. This would provide a viable, alternative subscription premium video content service to that offered by Foxtel. If Ten is to find a commercially viable way forward, then offering its content on a subscription “streaming TV” service such as an upgraded STAN on an “Affiliate fee” basis may be a solution.

Not to be outdone however, this month, Foxtel responded to a difficult traditional Pay TV subscriber acquisition environment (and the failure of its “Presto SVOD joint venture with Seven), with the relaunch of its own subscription “streaming TV” service called “Foxtel Now” (not to be confused with “Foxtel Play” which was the previous standard definition Foxtel streaming service or “Foxtel Go,” the internet streaming service only available to Traditional Pay TV subscribers using a TV set top box at home). “Foxtel Now” offers a range of subscription channels including premium sport such as Fox Sports, together with an SVOD service at a wider range of price points, but is yet to add the “virtual DVR” offer that is the new standard in the US.
Of course given Foxtel’s existing dominant position in Australian television, together with Lachlan Murdoch’s involvement with Ten as an equity holder and guarantor of its debt, Ten could well end up as part of the Foxtel Play content offer. Currently, Australia’s “2 out of 3” cross-media ownership laws prevent this via Lachlan Murdoch’s ownership of radio network “Nova” and his equity in newspapers via News Corporation. In addition, Bruce Gordon’s ownership of Win Corporation, together with Australia’s media “Reach rules,” prevent him from owning Ten. So, there may be a small window of opportunity, should the media law reform package currently before parliament not pass into legislation, for STAN to upgrade to a “streaming TV” service by adding Ten content. With Fairfax currently under private equity takeover, Nine is in the box seat to acquire the 50% of STAN it does not own and hence, you can see how we might say “Nine ate Ten.”

This article has been prepared by Arnhem Investment Management Pty Limited ABN 17 129 606 775, AFSL 332484. It has no regard to the specific investment objectives, financial position or particular needs of any specific recipient. You should seek your own professional advice in relation to any financial product referred to. You should also obtain the product disclosure statement relating to any financial product referred to and consider the statement before making any decision about whether to acquire the financial product.

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© Arnhem Investment Management, 2017