Fitch: Pay-TV battles pressurise both sides

Credit ratings agency Fitch Ratings believes that higher programming costs and increasing forms of alternative entertainment will challenge both cable network programmers and pay-TV distributors going forward, suggesting in a market commentary that pay-TV providers face additional costs and a reduced ability to pass those increases off to a mostly more vulnerable customer base that is becoming increasingly resistant to paying higher affiliate fees.

Fitch notes that pay-TV providers continue to grapple with higher affiliate fees, the introduction of and rise in retransmission revenues, and proliferating alternatives to traditional pay-TV bundles. “While online video services do not mirror traditional content, there is a small subset of consumers who could turn to one of these alternatives should cable bill prices continue to inch up,” says the firm.

Fitch points out that last week, Viacom and DirecTV ended the most visible battle, but clashes between AMC/Dish and Time Warner Cable/Hearst have also recently taken place. Both sides have been forced to play hardball as neither can be viewed as capitulating, as that would likely affect bargaining clout going forward.

Fitch views blackouts, such as the one DirecTV was forced into via Viacom, as giving the upper hand to content creators, although DirecTV fared better in the recent public relations war than pay-TV providers had previously. “We believe that providers continue to have more leverage relative to distributors, especially top-tier channels that continue to command audience share/ratings,” says Fitch.

Fitch notes that during subscriber blackouts, both AMC and Viacom made some of their more popular programming available for free online. “We believe this reduces their leverage with cable providers. To be sure, distributors would consider it contradictory to pay additional affiliate fees for content that is available free-of-charge elsewhere. In addition, we note that the Viacom/DirecTV battle occurred at a point in time when Viacom was facing pressure in its ratings at some of its flagship networks like MTV and Nickelodeon.”

According to Fitch, cable network operators face rising programming costs driven by investments in original content and increasing sports rights fees as networks seek to differentiate themselves and attract audiences in an increasingly fragmented landscape. “Heretofore, networks have been able to fully pass increased costs off to pay-TV operators via affiliate fee growth. However, we do not believe content providers will be able to continue to raise affiliate fees in the high-single/low double-digit rates. To the extent that programming cost increases exceed this, we could see some modest margin pressure. We envision two mitigants for this scenario. First, high-margin digital distribution deals for library content would compensate. Second, the margins at cable networks, which exceed 40 per cent, allow for some moderate margin pressure with no material impact to credit profiles,” it advises.

Fitch says that pay-TV providers will likely continue to face moderate gross margin pressure in their consumer video businesses. Although they are pushing back, Fitch still expects affiliate fees to increase at a moderately faster rate than consumers’ cable bills (albeit not at the rate that the programmers would like). “However, by and large, we expect the operating leverage in the cable business model and other cost-rationalisation efforts to enable largely stable EBITDA margins going forward,” it concludes.

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