Cable's New Business Model: Lower Ratings, Higher Revenue

Illustration by: Taylor Callery

As top channels lose viewers and reality hits age, conglomerates are pumping profits with sub fees and overseas growth — but can it last?

This story first appeared in the Aug. 29 issue of The Hollywood Reporter magazine.

The stats are sobering: Seven of the 10 most profitable cable channels have seen total viewership fall significantly in both primetime and full-day averages during the past 12 months, the exceptions being ESPN, Discovery and TBS. At the same time, THR reported Aug. 4 that cable upfront deals for the 2014-15 season dipped 4.7 percent to $9.7 billion, the first drop since the recession ended in 2009.

But the metric that matters most — profits — keeps climbing. At Disney Channel, cash flow in 2014 will be up 5 percent compared with 2013, estimates SNL Kagan, even though Nielsen says primetime viewership is off 12 percent. Cash flow at USA should be up 5 percent, MTV up 3 percent and FX up 4 percent, yet all have had smaller audiences. In fact, of the top 10 cable channels based on cash flow, just one — ESPN — is expected to decline in 2014 (albeit by less than 1 percent).

It's enough to ask: What's going on in the cable TV business?

Reasons for fear are many: A glut of similar reality programming is fragmenting audiences; several popular cable shows are ending amid a lack of new hits; too many new channels and online video outlets offer original programming; and consolidation among providers — Comcast buying Time Warner Cable and AT&T scooping up DirecTV — will give these mega-entities more leverage in future fee negotiations.

So far, though, those reasons for pessimism have been no match for rising subscriber fees and cost-per-thousand rates, and many analysts say the upfronts were an anomaly and ad revenue is headed higher. PricewaterhouseCoopers, for example, says advertising at multichannel networks in North America will generate $30.5 billion by 2018, up from $24.2 billion in 2013. Plus, in many cases, foreign expansion is more than making up for sluggishness at home. Discovery Communications said June 30 that while its quarterly revenue decreased 2 percent year-over-year domestically, international growth was 23 percent. Taken together, revenue was up 10 percent.

Also, as Laura Martin of Needham notes, while large cable channels might not be adding viewers, some smaller ones are. Investigation Discovery, for example, has averaged 774,000 primetime viewers during the past 12 months, up 16 percent versus the previous year. Conglomerates own lots of channels — Viacom's stable includes MTV, Spike, Comedy Central and more than a dozen others — so declines at some hurt less.

"Viewing is not down if you look at the cable-channel ecosystem. We see it growing 1 to 2 percent annually," says Martin. "ID is so popular that if it grows another 12 percent, 10 smaller channels can decline 4 percent each and still not equal the gain made by ID."

New channels often don't turn profits immediately, but they can become cash cows when nurtured. 21st Century Fox CEO Rupert Murdoch told analysts Aug. 6 that it took Fox News Channel seven years to turn a profit, and now it makes $1 billion annually. Of course, consumers can support only so many new channels. Nielsen says the average U.S. household had 189 channels to choose from in 2013, up from 129 in 2008, but the average consumer tuned in to only about 17, the same number as five years earlier.

"There are a lot of channels that have questionable brand propositions," conceded Disney CEO Robert Iger on Aug. 5. "I think the marketplace will continue to grow for those channels that are best branded, most in-demand, best programmed — and I think we've got those channels."

Iger and other CEOs can't afford to be wrong about their cable channels given how dependent they are on them. Barclays estimates that Disney's ESPN is worth $47.2 billion by itself. Viacom's cable networks are worth $46 billion, compared with $2.4 billion for the film unit, while Turner, owned by Time Warner, is worth $45.4 billion. Even CBS boasts a cable business worth $13.7 billion, more than its $13.2 billion broadcast network, says Barclays.

All of the majors have seen financial growth at their cable networks in 2014, despite ratings issues. But it's not all rosy. In early August, Scripps Networks Interactive, owner of HGTV and Food Network, and AMC Networks, owner of AMC and WE tv, each reported declining quarterly profits. Those dips owed to rising production costs as the channels shift to owning programs, which analysts say is a good strategy.

CBS Corp. CEO Leslie Moonves, for example, boasted to analysts Aug. 7 that the company now owns many of its cable hits: "As our collection of owned Showtime hits grows, so too will our syndication revenue, which is now becoming a very meaningful part of our cable segment."

Even those who fret that larger channels are losing viewers might be exaggerating, say some analysts, because Nielsen won't begin counting viewership on new platforms like mobile devices until the fall season. It could make a meaningful difference: TV viewing in fourth-quarter 2013 essentially was flat at slightly more than five hours a day compared with 2011, but viewing of video on smartphones grew from 48 minutes a day to 67 minutes. In June, 80 million people connected to ESPN via computers and mobile devices to keep up with the FIFA World Cup and other sports, Iger said Aug. 5.

"When you look across platforms, viewership is very rich," says EY analyst Peri Shamsai. "Younger viewers are watching shows on mobile devices, and that measurement information is certainly not coming through yet."

And despite ratings challenges, advertising rates keep rising. Indeed, NBCUniversal CEO Steve Burke said July 22 that USA, the conglomerate's biggest cable channel, needs to raise its CPMs by about 10 percent to be on par with the competition, even as ratings at the network have dropped. In the short term, cable ad sales also are not expected to suffer from competition from online video, according to RBC Capital Markets, which notes that a half-hour TV show can support 16 commercials but the average online video (about four minutes) can support one 15-second spot.

"There are a lot more companies that want to be affiliated with The Walking Dead than with a dog on a skateboard," quips Tony Wible of Janney Capital Markets.

The strongest case for bullishness remains sub fees. Disney Channel, for example, rose from $1.09 per subscriber in 2012 to $1.15 now despite the ratings drop, and 21st Century Fox says its affiliate revenue has surged by 16 percent this year. "Inflation in affiliate fees will continue," predicts Steve Birenberg of Northlake Capital Management. But to help reverse ratings, "there has to be more and more investment in TV production."