Virtual Cable – the Disruptive threat to cable and Satellite TV companies

[LongHaul]

I view TV content distribution as a commodity so the lowest cost distributor should win over the long run. 

 

One key metric to consider is content cost as a percent of revenue for 2013.

 

          Cable   NETFLIX US STREAMING

Content   45%   67%

 

What this means is that Netflix US Streaming is delivering far more content per dollar of sales than Cable because it is a more efficient model.  However, Netflix at ~$8 per month is at a far lower price point than Cable.  Netflix’s total costs and profit is ~$2.70 per month per user for delivering its content. 

 

Below I look at the economics of a Virtual Cable Co – which I think would be similar to a Netflix streaming for a Cable channel content offering.

 

The estimated cost of a Virtual Cable company to provide a similar cable bundle.

 

                  Existing Cable Co Virtual Cable Difference

Revenue per sub per month $70 $36         -49%

Content Cost                   32   32

Other Costs and profit         38     4

 

That means that a Virtual Cable company could offer consumers a price point of about half off the existing cable company.  Essentially, I think the existing distribution of TV content over cable/Satellite is massively disadvantaged vs a Virtual Cable offering.

 

There are other issues that I didn’t discuss like scale advantages in content – these are real but I think even a smaller player could provide a much cheaper Virtual cable price point than the largest player.

 

Content availability.  I think this is partly an issue.  Some agreements may prohibit some content from being delivered to a Virtual Cable company.  But the Satellite providers had this issue and ultimately overcame it.  I have also read that content players are ready to do over the top (virtual cable).

 

Recent article about Dish’s plans to offer a virtual cable plan for ~$30 per month per news reports.

http://money.cnn.com/2014/08/06/media/dish-network/

 

Unbundling could also happen but I just looked at providing the current bundled cable channels using virtual cable.

 

[Guest longinvestor]

Virtual cable, if it takes hold, would be music to the ears of backbone providers like LVLT. The hurdle to overcome is throttling by the last milers. This issue is currently under the microscope by the FCC and DOJ, in light of the pending mergers of T/DTV and CMSC/TWC. If those mergers go through, the 10 ft hurdles would likely become 100 ft ones for virtual streaming businesses.

[ni-co]

I think looking at it this way doesn't make any sense. You're ignoring the largest lever the cable companies own: their pipes. Cable can command a premium because they bundle content and distribution. NFLX might have lower content cost, but their total cost is artificially low because, momentarily, they get distribution more or less for free because of net neutrality. And, boy, do they profit from it. I think to assume that cable cos are going to watch while over the top TV is reaping all the benefits by using their network is completely naive. NFLX and other OTTs are utterly dependent on the cable companies for distribution.

[LongHaul]

I am not sure about the net neutrality argument. NFLX actually started paying Cable companies and perhaps others for better distribution this year.

 

You can actually completely bypass the broadband of the cable companies with DSL, so the cable providers power is checked on the broadband side.  In addition Google Fiber, Verizon Fios and perhaps others may be larger competitors to broadband in the future.  An interesting sidenote: Google Fiber actually looks profitable because they have gained such huge scale in the markets they entered. 

[loganc]

I am not sure about the net neutrality argument. NFLX actually started paying Cable companies and perhaps others for better distribution this year.

 

You can actually completely bypass the broadband of the cable companies with DSL, so the cable providers power is checked on the broadband side.  In addition Google Fiber, Verizon Fios and perhaps others may be larger competitors to broadband in the future.  An interesting sidenote: Google Fiber actually looks profitable because they have gained such huge scale in the markets they entered.

 

Do you stream content over a DSL connection?  My experience with it has been absolutely terrible.  My parents live in a rural area and have DSL - it is almost like not even having internet.

 

Verizon Fios wasn't economic, so assuming they are going to expand over a huge footprint including rural areas is dubious.  Also, where are you getting your numbers with respect to the profitability of Google Fiber.  I don't believe Google has ever provided hard data on the economics of this project.

[PatientCheetah]

A pure internet only cable would have far higher margin than the current content + internet ones. In the end of the day, cable companies own the pipe and they will maximize the economic value delivered through their pipes. I view cables as application agnostic. On the other hand, satellites seem have an expiration date.

[yadayada]

well prices for internet are already some of the highest in the US. So I doubt they will go up much. In most other western countries you have like unlimited bandwith and super fast speeds for cheaper. this is basicly cable companies bribing politicians to rape their customers without any signs of a free market. I doubt that is very sustainable.  At some point when they pay 10x as much for the same thing americans will scratch their head and get angry about it. Not to speak about powerful companies like google and netflix that will be seriously hurt by this.

 

So at some point it will either be deregulated, or google will roll out their own network and keep the price down. So cable companies must be in a bad spot?

[Guest longinvestor]

I think looking at it this way doesn't make any sense. 1.You're ignoring the largest lever the cable companies own: their pipes. Cable can command a premium because they bundle content and distribution. 2. NFLX might have lower content cost, but their total cost is artificially low because, momentarily, they get distribution more or less for free because of net neutrality. 3. And, boy, do they profit from it. I think to assume that cable cos are going to watch while over the top TV is reaping all the benefits by using their network is completely naive. NFLX and other OTTs are utterly dependent on the cable companies for distribution.

 

Let me address three of your statements, not in order:

3. Utter dependence on cable companies: This is partially true and extremely so. Because Netflix moves their content (its all bits), let's say, 999 miles on someone else's network and the last 1 mile on comcast's network. Comcast does nothing more than simply carry the bits for the last mile. They don't sweeten, polish or somehow enhance the bits, simply carry them to the end user who signed a $7.95 per month deal directly with Netflix. Comcast gets paid by the same end customer for the internet service.

 

1. The largest lever the cable companies own,their pipes You call it lever, net neutrality advocates call this last mile duo-poly. You can go around the country and ask households how many choices they have for the last mile into their home. It is seldom >2. It is often 1. The legacy telecom providers T or VZ and the Cable majors CMSC, TW or one of a few others like Charter. This is as monopoly power as it gets. The kind that was once outlawed by the DOJ as recently as the 1980's by the famous telecom act where the Bell companies were broken up. Strangely, we find them all together again, re-monoplized or at least duopolized. There is really no real competition for the last mile and now the last four or five standing last milers want to combine to make that number smaller.

 

2. NFLX might have lower content cost, but their total cost is artificially low because, momentarily, they get distribution more or less for free because of net neutrality.

The part about  low cost of distribution thanks to net neutrality is correct. However, back to my 999 mile to 1 mile bit transport argument. It costs folks like NFLX a tiny fraction of the $2.65 cost out of the $7.95 for the monthly subscription to carry the bits to their customer many times during the month over the long haul pipes of players like LVLT. You say artifically low cost, but it is the result of unfettered competition in the broadband infrastructure everywhere in the internet with the exception of the last mile. Now, with their monopoly status, they are erecting tolls at the last mile and extracting payments from NFLX, LVLT etc. only because they can. There is a legacy arrangement called "peering" between the different network participants which heavily favors the last milers and maintains the veil of opaqueness that they would rather have. This kind of extortion has just come under the microscope of FCC in light of the pending mergers of CMSC/TWC & T/DTV. In fact, LVLT, Google et al have filed briefs with the FCC highlighting the issue of arbitrary tolls and the real potential to stifle the medium of internet as we know it. The US is the least progressive amongst advanced nations when it comes to a vibrant and competitive broadband. It ranks #17 out of 18 advanced nations. Check out Softbank Japan and their CEO, Masayoshi Son's position on this. The UK went through this lack of competition in the past decade and have now effectively opened up the last mile broadband to more competition. It is apparently working well, there was a series of reports on NPR recently which indicate that consumers are greatly benefiting from this.

 

There is a wealth of information on this subject, if you Google search for it. In fact, this is one of the most dominant topics of today, given how dependent we all are on the internet.

 

 

[Guest wellmont]

I don't buy this doomsday scenario. But even if it happened, if "virtual cable", and this is the first time I've heard the term, catches on, consumers will pay through the nose for the bandwidth to stream netflix and whatever other services come out over the top. and they will pay these access $ to their local Cable Co. I read a report once that if Cable Co becomes just an ISP and stopped distributing video altogether, they would become better businesses. because they won't have to pay the escalating cost of content; but will still have a near monopoly on vital internet access (which they will raise the price of). dirty little secret: Internet Access is a Gold Mine for Comcast, Charter, Cox, etc.

[topofeaturellc]

If you think about it once cable companies are all converted to IPTV - they are all really just virtual cable companies bundled together with last mile infrastructure.  Its just 1 and 0s sent over a line on a common protocol.  In theory you could just change the box at your end and get some new provider.

 

I think its an interesting point however I think a few things would need to happen. For starters I think you'd need to see the forced unbundling of TV and broadband with some kind of rate of return regulation on broadband - its a utility - treat it like one.  Competition is mutually assured destruction for the pipes. 

 

Your analysis of Virtual vs Traditional is a little weird right - because implicit in that $70 fee is some portion of the return on capital for the historic investments made in the network.  The Broadband price you pay is also something like that.  The ROC for the historic cable investments isn't great IIRC.

 

The other thing that you would need to figure out is what is in the content owners best interests - fundamentally they need to figure out what maximizes revenues for them and then they will promote that. I have no idea what that answer is.  Do they want "virtual MSOs"? Or something more a la carte?  I honestly have no idea. 

 

I'd guess that in aggregate the status quo will make the content industry the most money. For some of the players tho a la carte would be much better.

 

I suspect that's why you only see high cost channels like ESPN, Disney, HBO, trying to do the "TV Everywhere" thing outside of the MSOs.

[ERICOPOLY]

I would like to just be able to buy a bundle of virtual channels on my Apple TV.

 

Then (if they had it in my area) run my Apple TV over Google Fiber.

 

Comcast/Cox/etc... are just an internet provider that offers a bundle of channels...

 

So they are easily replaceable if a company like Google or Verizon is willing to offer you an internet connection... and they are!.  The cable companies offer nothing that can't be bundled virtually over one of these other pipelines.  In fact, the cable companies offer a pretty crappy user experience.

[moody202]

To me cost of Netflix service is more like $30 a month. $8 I pay to Netflix and about $22 I pay to cable company for additional bandwidth to make sure both my kids can run their Netflix shows simultaneously. I won't be paying this $22 if not for Netflix!

 

I am with Eric....bundle all my channels in my Roku/Apple Tv so I can buy the channels I really want and cable company is just the delivery mechanism.

[Mikenhe]

I'd drop cable tv like a shot but they show the premierleague.. and that's my one tv blindspot...

whats really annoying is that nbc stream everygame - but in order to get the stream you have to also be a subscriber to the tv service......

 

as soon as they break that model......

[topofeaturellc]

I would like to just be able to buy a bundle of virtual channels on my Apple TV.

 

Then (if they had it in my area) run my Apple TV over Google Fiber.

 

Comcast/Cox/etc... are just an internet provider that offers a bundle of channels...

 

So they are easily replaceable if a company like Google or Verizon is willing to offer you an internet connection... and they are!.  The cable companies offer nothing that can't be bundled virtually over one of these other pipelines.  In fact, the cable companies offer a pretty crappy user experience.

 

And the content guys are willing to sell you content.

 

I suspect that ends up being the issue.

[rmitz]

Verizon Fios wasn't economic, so assuming they are going to expand over a huge footprint including rural areas is dubious.  Also, where are you getting your numbers with respect to the profitability of Google Fiber.  I don't believe Google has ever provided hard data on the economics of this project.

 

FiOS Wasn’t economic?  How so?  Do you mean they aren’t economic for rural areas?  That may be true, but the cities have always subsidized the rural areas for these kinds of things.

[topofeaturellc]

Verizon Fios wasn't economic, so assuming they are going to expand over a huge footprint including rural areas is dubious.  Also, where are you getting your numbers with respect to the profitability of Google Fiber.  I don't believe Google has ever provided hard data on the economics of this project.

 

FiOS Wasn’t economic?  How so?  Do you mean they aren’t economic for rural areas?  That may be true, but the cities have always subsidized the rural areas for these kinds of things.

 

I don't think VZ has ever shown numbers, but the general supposition has been that it isn't a reasonable ROI - even in places with decent pop densities.  Look at how much VZ has slowed down the rollout. I live in Manhattan and we don't have it where I live.  The Cable guys who have existing infrastructure basically buy enough people back.  Think about it - It is very hard to have two zero marginal cost commodities competing with one another

[LongHaul]

I have DSL at my house and it works great for Netflix at a slower bandwidth speed option.

 

Google has said they expect to make a profit on their Google Fiber venture.  From the numbers I saw I would guess 10-12% ROIC.  Verizon Fios apparently did not earn a decent ROIC.  I think the main difference was significantly lower customer premise equipment at Google fiber and lower Fiber cost per home passed.  The other major difference is that Google's pricing was low so they may have taken ~50% market share in Kansas city.  The will limit the long term pricing power of cable and DSL internet.

Great article on the subject.

http://www.cnet.com/news/google-fiber-on-track-to-become-major-broadband-competitor/

 

Verizon Coming out with a Virtual Cable service for wireless

http://variety.com/2014/digital/news/verizon-to-join-virtual-mso-fray-in-mid-2015-with-wireless-tv-service-1201303707/

 

At the end of the day the cable co's and Satellite providers lose a big chunk of their profitability to a virtual cable service so too risky for me.

[rmitz]

I don't think VZ has ever shown numbers, but the general supposition has been that it isn't a reasonable ROI - even in places with decent pop densities.  Look at how much VZ has slowed down the rollout. I live in Manhattan and we don't have it where I live.  The Cable guys who have existing infrastructure basically buy enough people back.  Think about it - It is very hard to have two zero marginal cost commodities competing with one another

 

It’s probably true that it hasn’t been as profitable as they’d like, but I’d not go so far as to say it isn’t profitable.  I would expect they are using the capital elsewhere, but that doesn’t mean it’s not economic.  Of course it’s all speculation.  I’m happier with FiOS than I ever was with Comcast, but if Google Fiber were available, I’d switch in a heartbeat.  Verizon doesn’t run their network to keep their customers happy, they run it with greatest extraction of rents in mind.

[topofeaturellc]

I have DSL at my house and it works great for Netflix at a slower bandwidth speed option.

 

Google has said they expect to make a profit on their Google Fiber venture.  From the numbers I saw I would guess 10-12% ROIC.  Verizon Fios apparently did not earn a decent ROIC.  I think the main difference was significantly lower customer premise equipment at Google fiber and lower Fiber cost per home passed.  The other major difference is that Google's pricing was low so they may have taken ~50% market share in Kansas city.  The will limit the long term pricing power of cable and DSL internet.

Great article on the subject.

http://www.cnet.com/news/google-fiber-on-track-to-become-major-broadband-competitor/

 

Verizon Coming out with a Virtual Cable service for wireless

http://variety.com/2014/digital/news/verizon-to-join-virtual-mso-fray-in-mid-2015-with-wireless-tv-service-1201303707/

 

At the end of the day the cable co's and Satellite providers lose a big chunk of their profitability to a virtual cable service so too risky for me.

 

do you have a cite for the GOOG fiber numbers? It doesn't really make sense given the FIOS outcome

[topofeaturellc]

I don't think VZ has ever shown numbers, but the general supposition has been that it isn't a reasonable ROI - even in places with decent pop densities.  Look at how much VZ has slowed down the rollout. I live in Manhattan and we don't have it where I live.  The Cable guys who have existing infrastructure basically buy enough people back.  Think about it - It is very hard to have two zero marginal cost commodities competing with one another

 

It’s probably true that it hasn’t been as profitable as they’d like, but I’d not go so far as to say it isn’t profitable.  I would expect they are using the capital elsewhere, but that doesn’t mean it’s not economic.  Of course it’s all speculation.  I’m happier with FiOS than I ever was with Comcast, but if Google Fiber were available, I’d switch in a heartbeat.  Verizon doesn’t run their network to keep their customers happy, they run it with greatest extraction of rents in mind.

 

Absolute profitability is pretty meaningless for something as capital intense as a broadband network.

 

Its not like VZ has all these other tremendous internal investment opportunities they are pursuing instead.

[ni-co]

It's quite simple: How could a company that has to dig up all the streets to put their fibre lines exactly next to the cable pipes become as profitable as the cable company (that paid for this infrastructure 20 or so years ago)? This would only work if the fibre company offered vastly superior speeds so that people were willing to pay up for it.

 

Building what is essentially a second cable network is such a capital intensive undertaking that fibre companies would have to subsidize their prices for years and years with billions of dollars only to keep up with the cable companies. Maybe Google with their vast advertising cash flow could do it. The question is: is it a sensible for them to do it?

 

With regard to net neutrality: Would there even be enough capacity to essentially guarantee everybody unlimited TV access via the internet? How about 4K video bandwidth needs? If not, is it sensible to expect that you can keep paying 30 or 40 bucks a month for your internet connection when everybody and their mother use it to consume TV?

[topofeaturellc]

in theory two competing essentially fungible commodities with zero marginal cost should mean both entities go bankrupt.

[yadayada]

with youtube becoming bigger, and netflix missing out on revenue due to expensive slow internet, you would say that prices don't have much room to go up. If  anything google would roll out fibre and sell at break even and still profit from it in other ways.

[topofeaturellc]

I'd love to see some math on that.  It seems really hard to believe.

 

 

[yadayada]

http://i.imgur.com/Wr6Tlv1.png

 

I would be very surpised if this did not mean people spending less time on the internet on average. Or at least less time on streaming services like youtube and netflix. If only it isn't for the entire population having to collectively wait longer to see their content. Also out of western countries, the US is the least connected.

 

There are probably millions of people in the US who would want netflix, but cannot afford a fast connection + netflix.