EXCLUSIVE: HBO subscribers dwindling

DirecTV deal impasse just part of the problem

The channel that turned vampire killers into hit television is quietly facing the draining of its own lifeblood: subscribers.

2010 would seem to have the makings of a big year for HBO given the tentpole programs it launched in the first two quarters of the year: "True Blood," which wrapped up its third season Sunday as the network's highest rated series, and "The Pacific," the WWII miniseries that won more awards at last month's Emmys than any other production.

And yet HBO had 28.6 million subscribers in the second quarter of 2010, according to newly released numbers from SNL Kagan, its lowest total in four years and the second of its first back-to-back quarterly declines in at least six years.

So if HBO is so hot, how come its subscriber base is dwindling?

Figuring out what's hurting HBO is a whodunit worthy of one of the net's drama series, with a confusing mix of incriminating evidence and alibis that point to a number of culprits. But the likeliest suspect no one saw coming: DirecTV.

The nation's biggest satellite service has been locked in bruising carriage negotiations with HBO all year, according to people familiar with the talks, and applying pressure to get the desired deal terms by employing an unknown but brutally effective tactic: drastic reduction of the promotional support crucial to "upselling" HBO to subscribers.

Neither DirecTV nor HBO would comment, though the network did issue a statement laying the blame for the depressed subscriber numbers on an entirely different factor: the sudden, unprecedented downturn in U.S. multichannel subscribers SNL Kagan reported last month, to the tune of 216,000 in the second quarter.

"As the driver of the pay category, it is not surprising to see us slightly impacted by the negative effects on multichannel households," said Eric Kessler, co-president of HBO, in the statement. "This kind of fluctuation is common throughout the year. The most important measurement of success is financial and HBO will enjoy another record year in revenue and profit."

The declines are minor, but the fact they're dropping at all is surprising. HBO's smaller pay-TV competitors, Showtime and Starz, saw increases in the second quarter; why HBO would feel the pinch from the multichannel meltdown but not its competitors suggests there may be other factors at play.

Starz and Showtime have both been on a steady rise for years: Showtime has increased by 6 million subs over the past six years, to 18.2 million in the second quarter, while Starz is close behind with 17.3 million, though its rate of increase has been less dramatic.

HBO is in a league of its own on a sheer subscriber basis, and its $1.2 billion in earnings dwarf those generated by its competitors. But that subscriber toll has been hovering between 28-29 million since 2006.

And that is also likely a reflection of the fact that DirecTV is not the first distributor to use the promotional blackout strategy as a carriage negotiation tactic. Not only is DirecTV not the only distributor currently putting the screws to HBO in such a manner -- a source identified a second unspecified cable operator -- but the country's biggest distributor, Comcast Corp., pulled the same move on HBO last year during its own now-resolved negotiations. A Comcast rep declined comment.

Distributors know pay-TV networks' Achilles' heel and they're not above kicking it to get what they want, notes Tom Christie, executive vp affiliate sales at Showtime.

"If you're involved in a nasty negotiation, I have certainly known operators to behave that way in the past," said Christie, who was not speaking specifically of HBO's predicament.

For all the attention original programming like "True Blood" gets, it's the less sexy subject known in the industry as affiliate marketing that is just as crucial a variable in the premium-TV business. Hunky bloodsuckers don't sink their teeth into subscribers' wallets without the efforts of distributors pitching in promotional dollars via direct mail, online ads, local events and the persistent hawking of customer-service representatives over the phones.

So when a distributor the size of DirecTV pulls back on all that, a pay-TV network is going to feel the pain like a vampire at sunrise. No matter how much HBO spends -- even the $200 million forked over for "Pacific" -- bang for the buck can't be maximized without operators there to shill for the show.

"The marketing is hugely tied to how subscriber growth goes," said Deana Myers, pay-TV analyst with SNL Kagan. "There's so many elements to why subscribers sign up. It's not all about original programming."

However, drilling deeper into SNL Kagan stats casts some doubt that DirecTV could be entirely responsible for HBO's slippage. Just as the overwhelming majority of the drop-off in multichannel homes for the second quarter is attributable to cable-satellite actually grew slightly, HBO itself offers a similar story: Only 25,000 HBO satellite customers canceled their subscriptions between the first half of 2010 compared with the same period the previous year, compared to approximately 500,000 on the cable side.

That said, quarterly numbers can be deceiving in the pay-TV business. Contrary to the perception that hit original programs attracted intensely faithful audiences, HBO and its ilk all cop to the volatility of their business, where roughly 5% of their respective subscriber bases could drop out at any given month.

Given that a massive 85% of HBO's earnings is tied up in affiliate fees, a subscriber drop is going to hit the bottom line. But it's also worth noting that the other 15% of HBO's business is booming enough to soften the impact. DVD is one robust revenue stream; an internal estimate put "Blood's" disc haul to date at $100 million. HBO is also squeezing every ounce out of its international distribution, which is slightly broader than its domestic footprint, buying out the majority interest in all three of its joint ventures overseas in recent years.

That diversification of HBO's business is essential given the strong possibility that the network's core business has peaked. There may be no simpler explanation for the absence of subscriber growth. "Thirty million might be where the ceiling is," said Myers.

There are still other factors to consider. Maybe after years of watching HBO programs make their way to DVD, syndication and iTunes, enough of the viewing audience has wised up to the network's distribution lifespan and will patiently forego the subscription window for the more economical options down the line. That's a trend that is only going to accelerate as services like Netflix start to make the kind of deals that eat into the pay-TV window, and ballyhooed products coming to market like Apple TV and Google TV offer the kind the hardware that could make inroads.

HBO's shrinking base will no doubt be seized as evidence in the never-ending debate on the emergence of "cord-cutters," a supposed new breed of consumer ready to throw away their expensive set-top boxes for cheaper offerings on digital platforms. And if you don't buy that this phenomenon is responsible for cutting into the shrinking multichannel market share, perhaps HBO can be chalked up as a luxury more and more consumers are willing to do without during continued economic doldrums in the U.S.

And then there is the theory that would piss off HBO most: The dwindling of HBO's subscriber base may reflect nothing more than its comedown from the heady days of a decade ago, when "The Sopranos" and "Sex and the City" brought the network to what may be its peak performance. Many channels, both premium and basic, have stepped up the competition by ripping straight from HBO's playbook.

"Post that era, I don't believe their shows have been as strong as those two, while ours have come along and proven to be quite good," said Christie. Of course, by the same logic HBO's subscriber toll would have tumbled after "Sopranos" left the air in 2007 but it didn't; it was followed by four consecutive quarters of small increases, culminating with a peak of 29.1 million in the first quarter of 2009 -- after both shows were long gone. Maybe the "Sopranos" magic just took a long time to wear off.

Nevertheless, don't expect original programming to be anything less than the core of pay-TV programming strategies going forward. To wit, the third quarter will bring one of HBO's most ambitious efforts yet, "Boardwalk Empire," and Showtime returns its biggest series, "Dexter," for a fifth season.