German pay TV challenges cablers

Sky Deutschland epitomizes challenges abroad

COLOGNE, Germany -- Pity Brian Sullivan. As the new CEO of Sky Deutschland, Sullivan, who took over Thursday, has to do what no one in 20 years has managed: Make pay TV work in Germany.

Sullivan's bosses at News Corp. have a lot at stake. Analysts estimate that the company has sunk as much as $1 billion into German pay TV, buying a 45.4% stake in market leader Premiere, which they rebranded Sky, and investing in a costly marketing campaign to win subscribers.

Half of the deal has worked. News Corp. parachuted top executive Mark Williams into Munich two years ago, and he shook up Premiere, saving the pay group from imminent bankruptcy, restructuring its debt and cleansing its books of "ghost subscribers," people who were counted as viewers but didn't pay for the privilege.

But while Sky has exorcised the "ghosts," it hasn't replaced them with living, breathing, paying consumers. The German service is stuck at about 2.4 million subscribers; by its own estimates, Sky Deutschland needs 2.8 million-3 million to make money. Last year, operating losses more than quadrupled to about $350 million.

Brian Sullivan

Sullivan, former managing director of the consumer group at BSkyB, says Sky will turn that ocean of red ink into break-even by the fourth quarter of this year, but analysts are skeptical. Unless Sky boosts subscription figures faster, Polo Tang at London-based UBS Media expects its break-even point will "push back, putting further pressure on its balance sheet."

The German pay TV market has broken media bigwigs before.

Premiere was Leo Kirch's Waterloo. The Bavarian mogul bet and lost his broadcasting and rights empire on the promise that German audiences would behave like those in Britain, France or Italy -- they didn't. Germany is Europe's largest and by most measures most lucrative TV market, with about 60 million households, but pay TV here is a niche business compared with the U.K., where News Corp.'s BSkyB has nearly 10 million subscribers, or France, where 6.6 million people pay for Canal Plus' service. Even in Italy, where News Corp. launched Sky Italia only seven years ago, nearly

Five million have signed up.

Just how important German pay TV is to News Corp. is a matter of debate.

In addition to BSkyB and Sky Italia, Murdoch's pay TV empire includes Star TV, which reaches about 300 million viewers across 53 Asian countries, and Latin American service LAPTV, making Sky Deutschland one division in a global conglomerate. In his annual letter to News Corp. shareholders, Rupert Murdoch barely mentioned Sky Deutschland, except to say the German operation "intends to bring the same high service and premium products that have done so well in other European markets to perhaps the continent's richest economy."

But reports that Murdoch is dispatching Chase Carey, his right-hand man, to Munich to act as Sky's new chairman suggest the Germany operation is on his radar. Analysts are divided over the reasoning behind the Carey intervention. Some suggest the veteran executive -- deputy chairman at News Corp. and former CEO of DirecTV -- is being called in to aid and abet Sullivan and his boss James Murdoch, Rupert's son and the head of News Corp.'s European and Asian operations. Others see the chairman appointment as a sign News Corp. is throwing its full weight behind Sullivan's strategy for Sky Deutschland.

Simply put, that strategy is quality, not quantity.

Sullivan argues that pay TV has failed in Germany because the focus has been on extra choice. That didn't work, he says, because Germans already have plenty of choice: The average viewer has cable and can see dozens of channels. Under his reign, Sky instead will emphasize the "highest-quality content and viewing experience," including pushing its HD service, which rolls out this month.

What Sullivan brings to Munich, and what has been lacking in the German pay TV business, is a customer-first approach. At BSkyB, where he oversaw everything from marketing and pricing to product development, Sullivan famously used to pound the pavement with his sales team, knocking on doors to learn what customers liked and what they didn't, what they wanted and what they were willing to pay for.

"Premiere's marketing and customer service were a textbook example of how not to sell pay TV to German subscribers," says Klaus Goldhammer, managing director of Berlin-based consultant Goldmedia. "There is huge scope for improvement there."

Sky so far has ruled out investing in original programming. Although making exclusive, high-end series in-house has been a recipe for success at pay TV operators in the U.S. -- see HBO, Showtime and Starz -- and in Europe with BSkyB and Canal Plus, in Germany News Corp. is focusing on survival first.

But Goldhammer thinks Sky might be too late. Classic pay TV is passe, he suggests. The future for paid content might be online.

In 2006, German telco Deutsche Telekom launched Entertain, a subscriber-based IPTV service. DT now has 1.1 million customers, nearly half of Sky Deutschland's 2.4 million subscribers. While Premiere/Sky's numbers have flatlined, online operations have boomed. IPTV services accounted for nearly all growth in pay TV in Germany last year.

DT boss Rene Obermann has Sky in his sights. Last month, he announced a new target: to make Entertain Germany's No.1 pay TV service in three years' time. Obermann forecasts 3 million subscribers by 2012 and 5 million by 2015. DT plans to invest about €10 billion ($14 billion) during the next three years in Germany; much of it will go to promoting Entertain as an alternative to Sky.

"It is a declaration of war against Sky Deutschland," Goldhammer says. "Telekom's plans are ambitious, but, as opposed to Sky, DT in the past has hit all its growth targets for IPTV."

DT also is willing to shell out for top content, as shown by its multimillion-dollar deal for Internet rights to the Bundesliga, Germany's top soccer league.

So far, DT hasn't tried to compete with Sky Deutschland for movie rights. Sky has deals with all of the studios for German pay TV rights -- there's no major U.S. production, film or TV, that doesn't eventually end up on Sky. Instead, DT has focused on buying VOD rights, an area in which Sky hasn't been as active. But if DT begins bidding aggressively for studio output deals, "I wouldn't bet against Telekom and Entertain," Goldhammer says.

Sky Deutschland spokesman Armin Sieber dismisses Obermann's attack as an attempt to distract investors from Telekom's problems, particularly its collapsing core business in fixed-line telephony.

"It was a brilliant PR move to pick Sky as the enemy, but we don't see Telekom as a competitor," he says. "We are a premium service with probably the best pay TV offering in all of Europe. Telekom is not in that league."

Probably not. But what DT has, and what Sky Deutschland lacks, is a direct link to tens of millions of German consumers. The former telco monopolist is the country's leading Internet service provider and mobile phone company. Although its fixed-line business is shrinking fast, a majority of Germans
still make calls over DT lines. Telekom has exploited its strengths by packaging pay TV as part of triple-play offerings: Customers sign up for Internet, cable TV and phone service, and DT throws in Entertain for next to nothing. Existing Telekom customers can upgrade to pay TV for less than $10, less than half the entry price for Sky.

"It's a head-to-head race between Telekom and Sky," Goldhammer says. "Both are deep-pocketed, global companies, so it's more a question of who can keep their head above water long enough to make money out of pay TV in Germany. Rupert Murdoch was willing to lose a lot of money at BSkyB before he turned it around, but I wouldn't want to be Sky Deutschland's boss right now."
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