Monday, March 24, 2008

Digital TV Transition in the US

On February 17, 2009, the U.S. will embark on one of the most ambitious technology transitions in its history. Nearly 2,000 television stations will cease broadcasting in analog and will begin broadcasting exclusively in digital. And nearly 14M households that currently rely on over-the-air (OTA) broadcast signals from those stations will be faced with a stark choice: buy a digital converter box, or buy a digital TV set, or sign up for Pay TV service, or simply stop watching TV. Viewed charitably, the Digital TV transition can be seen as a modest supplementary economic stimulus package. Millions of Americans will spend an estimated $4B on new converter boxes, new television sets, and new cable and satellite services, a small part of which ($1.3B) will be subsidized by a government coupon program for digital OTA converters. Viewed less charitably, the Digital TV transition can be seen as a tax, and one that overwhelmingly targets the country's poor and Hispanic populations. The digital TV transition has important implications for the companies. For the Hardline retailers, the key question is…how many new TV sets and digital converter boxes will be purchased because of the Digital TV transition? For the Cable and Satellite operators, the question is…how many OTA households will run to the waiting arms of Pay TV providers? And for the Media companies, the question is how will the Digital TV transition change what people watch?

While an estimated 14M homes will lose their sole source of TV reception; an additional 30M homes will lose reception in one or more rooms that are not currently connected by their Pay TV provider. Winners include the hardline retailers, cable networks, and cable and satellite providers, although the magnitudes of the impacts are likely smaller than generally expected. Losers include the broadcast TV stations, and the broadcast TV networks…and a largely unsuspecting broadcast television-viewing public.

The Telecom, Cable and Satellite sector will enjoy a subscribership boost from the DTV transition. Over 2008 and 2009, approximately 1.4M households will enter the Pay TV market as a result of the DTV transition, which is enough to roughly double the annual growth rate of the industry from 2007 to 2009. This impact is enough to push growth rates for the cable operators into positive territory in 2009, despite what are expected to be peak share losses to the TelCos' video offerings. While the absolute number of new subscribers is likely to be relatively low for any one operator, the impact on market sentiment could be significant. In the past, satellite and cable stocks tended to be much more sensitive to subscriber growth metrics than rational valuation would suggest.

For the consumer electronics retailers, the DTV transition will be more incremental than truly material. The retail value of the converter box market is estimated at ~$1.4B and the TV market at ~$1.7B, for a combined total retail impact of ~$3.1B. While this is clearly a large number, it represents only about 2% of the $150B+ consumer electronics market in the U.S., which is much more likely to be driven by the ability of consumers to maintain discretionary spending against multiple headwinds. In addition, given the characteristics of broadcast TV households and the characteristics of "untethered" TVs in pay-TV households, the consumer electronics channel is not likely to get any more than a fair share of this market opportunity.

Note that the average person who is still using rabbit ears or rooftop antennas to get a TV signal is disproportionately lower income (25.3% of OTA TV Households). So, if you think about these, for example, how many of them are going to buy HDTVs or how many of them are going to subscribe to Pay TV? They are also disproportionately Spanish language (over 50% of OTA TV Households), which raises obvious implications for how the think tanks and companies are going to reach them to educate them about the process. Disproportionately, these customers are actually urban customers (40.3% in A Counties). That is, they skew towards aid counties or denser counties. They also skew somewhat young. These are not just elderly customers, though there are quite a few of them who are elderly. OTA households are located disproportionately in the West (54.2% of OTA TV Households).

There are roughly 310 million active TVs in the U.S. This works out to just shy of 2.8 TVs per household on average, with nearly 3.2 TVs in homes that own more than one TV. Next question is how many of those 310 million sets are vulnerable, i.e. they don’t have a digital tuner, and they’re getting their signal from broadcast. One thing to consider here is the first piece of legislation that actually mandated the TVs to begin to have digital tuners in about mid 2004. There was a series of deadlines progressively through March 2007, moving down to smaller and smaller sets. If you just assume the minimum shipments per the mandate, they’re about 107 million cumulative TVs shipped to date that have a digital tuner. The second piece of legislation created a converter coupon program with funding for about 33.5 million coupons. Every household in the country is entitled to two. But once 22.5 million coupons have been issued, the coupons will be restricted to broadcast households only. How that possibly could be enforced is an unknown but that’s the beauty of legislation. It only has to be imagined not executed. There have been 50 approved converter boxes, and there are six retailers already selling converter boxes.

In order to figure out how many TVs are vulnerable, there are essentially two cohorts to think of. Cohort number one is Pay TV households with TV sets that are not hooked up to cable or satellite, and called as untethered TVs. Looking at multiple industry sources on this, the range is around 35 to 50 million TV sets that are out there in households with cable or satellite that are not hooked up. But no one really knows. The mid-point is 42.5 million. There’s a good chunk of those TVs that are used not for watching TV but for playing video games or watching movies, which is estimated at 30%. This leaves about 30 million TVs in Pay TV households that are vulnerable or possibly vulnerable. The second cohort is of those 14 million OTA households that are not hooked up to any kind of Pay TV service. Given the lower income, these have fewer TVs on average than the U.S. and this is estimated to be about 1.5 TVs. So that’s about 21 million TVs. So, combined, we’re talking about something around 50 million TVs in the US.

For cohort one (Pay TV households), possibly around 15% of households will do nothing. These are TVs in a spare bedroom, in a guest room, a TV that was moved upstairs and rarely watched. So, for a long time, people probably don’t have to do anything. Therefore, for 15% of households, that TV goes dark and never gets replaced. The second option, estimated at 33% will call up their cable company or their satellite company and say, "hey hook me up," in this extra room. And surprisingly, that’s a pretty cheap option - Cablevision in New York charges about $20 to hook up an extra room. The cheapest option is the converter box, with an average price point of about $50. The converter coupon is $40, which means the out-of-pocket cost is $10. This is estimated at about 42% of households. For cohort two (OTA households), possibly around 5% of households will do nothing; around 15% are likely to call a cable or satellite provider. That’s a very expensive option, and the vast majority of people – 70% – will solve their problem with a $10 converter box solution. The most expensive is to go buy a digital TV, which is going to run you anywhere from $250 to $10,000 depending on what you buy. And it is estimated about 10% of people may buy a digital TV in both the cohorts.

There’s 21 million sets in OTA households, and about 1 million that’ll be discarded, 3 million that’ll be connected by the cable company, 15 million roughly boxes that’ll be sold and 2 million new TVs. On Pay TV households – the 30 million sets untethered TVs – 4.5 million do nothing. About 10 million call up cable and get connected. Twelve to thirteen million get solved with the converter box, and three million new TV sets are sold. Assigning values for the Pay TV cohort - $20 to get cable hooked up to an extra room. Fifty dollars out of pocket to buy a converter box even though it’s only $10 after the coupon. TV’s cost $400, and the total cost for consumers for Pay TV cohorts is about $2 billion. For the broadcast cohort, it’s going to cost you $240 a year at $20 ARPU per month. So, in total, that's $240 a year to sign up for a Pay TV service and $50 for a converter box. That’s about a $3.8 billion cost to broadcast households. The total market size from the conversion will be somewhere between $3.3 billion and $4.2 billion; and the set top box market is $1.2 to $1.6 billion; and digital TV market is actually $1.3 billion to $2.1 billion in incremental in total revenue – $1.7 billion being the mid-point of that.

So the question for the cable and satellite operators is, how many of these customers are going to come to cable and satellite? There are certain obligations that the cable and satellite operators have when the US goes all-digital as a country. However, going all-digital themselves is not one of them.

The NTCA or the National Telecommunications Cable Association voluntarily, on behalf of the major cable operators, has entered into an agreement with the SEC and the National Association of Broadcasters (NAB)– whereby all the cable operators would agree after the digital TV transition to continue to carry an analog version of the must carry channels. That is, any channel that opts for must carry rather than negotiating for carriage like the big channels do in the given market – the ABCs, NBCs, TBSs and FOXs – they will be carried in both in a digital format and in an analog format. So, they refer to that as the digital Must Carry Obligation. And there are some questions for smaller cable operators whether they are going to be held to that same standard. Today they are, but they’re asking for some relief.

There are also some question marks about low power – LPTA – Class A stations. Nobody had ever heard of LPTA Class A stations before. In fact, they are pure enough even that when the SEC was originally designing the set top box requirements for the digital converters, even the SEC forgot about them and realized only later that they forgot to put a pass through for those stations which don’t go all digital after February 17th. And those stations won’t be viewable at all. So now everybody is scrambling to try and solve that problem.

The satellite operators may or may not face an obligation to do what’s called Carry-One-Carry-All. That is, start carrying all channels in HD TV in a given local market if they carry any channels in HD in a given local market. That would be a tremendous capacity burden that initially was written by the SEC in a proposal that they would be obligated to do that by 2009. Now they’re talking about phasing it in with 15% by 2009, 30% of markets by 2011 and so on.

Probably 95% of OTA TV subscribers have telephone service. That gives the cable operators, in particular, a real opportunity. Because the average cost of cable telephony service is about $12 lower than the cost of the RBOCs' telephony service. In fact, in many cases it’s an even bigger difference than that. The cost of the lowest level of cable TV service is about $12 a month. So it leaves the door open for cable operators to offer consumers a solution that is effectively – if you switch your phone service to the cable company, we will solve your TV problem for free – or what amounts to for free. Because you’ll be paying the same thing you were before but now you’ll have cable service. The satellite operators have a harder time with that kind of an offering because they simply don’t have anything else to offer other than the basic packages of television. So it could be that the cable operators pick up a somewhat disproportionate number of these customers because of those kinds of offers.

Inevitably, there are going to be customers who are likely to call their cable operator saying, I understand I have to go all-digital and therefore, I might as well go ahead and sign up for digital service. Now technically, the right answer would be "no, actually you don’t," you’re all set if you’re already connected to cable or satellite for that matter. But inevitably, there are going to be people that are confused, that are seeing the public service announcements who are going to call. Therefore, there is a likelihood of acceleration in digital subscribership simply driven by the confusion of customers thinking they need to do something when they don’t. There is also a likelihood of an increase in the number of customers who want to connect additional rooms in the house because a lot of these cable and satellite customers may have a second bedroom or something where they have a TV that still uses rabbit ears or roof top antenna that now they need to get wired to the coaxial cable to deliver the signal to that TV. That could trigger some additional customer acquisition expense or maintenance expense or they have to deploy trucks to add those extra rooms. So all of those types of things are extremely uncertain, because it’s just very hard to predict how those things are going to play out, but they’re all things to keep in mind. In general, they’re good. Faster growth of digital subscribership is good for everybody. To a degree, they are negative in the sense that there could be higher costs associated with the installations to additional rooms. Those costs by the way would be expensed rather than capitalized in almost all cases.

Broadcast TV consumption is in freefall, and will probably continue in the same direction. Broadcast ratings have dropped by an unprecedented double-digit rate for five continual quarters, and there seems to be no end in sight.

Net Net – winners from the Digital TV Transition include Hardline Retailers, Cable Networks, and Cable & Satellite Providers. Losers include Broadcast TV Stations, Broadcast TV Networks, and Broadcast TV-Viewing Public.
Thanks Bernstein Research, March 2008

Friday, March 14, 2008

AOL Gets Social with Bebo

Here are some expert opinion on AOL-Bebo deal.
Jessica Reif Cohen, Merrill Lynch
AOL announced the acquisition of social networking site Bebo for $850mn in cash. With 4.8mn unique users and 1.2bn monthly page views, Bebo is the third largest social network in the US and a leading social network site in the UK. AOL’s price values Bebo at a low to mid teens revenue multiple (Bebo lacks material profitability). Bebo’s revenue is no more than $50-$75mn currently (and perhaps less) and that EBITDA is negligible. Strategically, the Bebo acquisition seems to be a very good fit for AOL. It will significantly improve its position in social networking and helps drive improved scale for Platform A, its online advertising platform. In addition, Bebo could both benefit from AOL Instant Messenger’s (AIM) huge installed base and potentially allow AIM to finally realize some of its revenue potential. The acquisition also provides AOL with an improved footprint internationally, a key strategic initiative for the company. However, AOL/TWX does not have a strong track record of integrating acquisitions, as highlighted by its struggles to integrate its various advertising platform acquisitions over the past year. There also remains significant concern about the long-term monetization opportunities for social networking in general, as underscored by Google’s disappointing results in this area.
Doug Creutz, Cowen and Company, LLC
Bebo acquisition furthers AOL’s strategy to transform itself into a content-driven advertising platform. While it is unclear how this plays into a potential spin-off of AOL, a break-up is unlikely to serve as a catalyst for TWX share appreciation. The Bebo transaction value reflects premium and hefty growth assumptions. Bebo currently earns annual revenue in the $30MM-50MM range and minimal, but positive, EBITDA. As such, the price AOL paid reflects both a significant premium for entry into the hot social networking space and assumptions on the part of management that AOL will be able to drive significant incremental monetization through its proprietary advertising platform. Bebo is currently the third largest social networking site in the U.S. after News Corp.’s MySpace and independent Facebook, however it lags both by a significant margin. Though Bebo has good technology and experienced leadership, the social networking business is driven by user scale and networking effects. It is unclear how combining a second-tier player with AOL’s struggling business model generates value. The transaction is unlikely to create significant economic value for Time Warner.
Imran Khan (JPMorgan)on the earlier YHOO-Bebo deal
Yahoo! has an agreement with Bebo to manage display advertising for the social networking site in the U.K. and Ireland. Bebo is a privately held social networking site targeted at teenagers and young adults. According to comScore Networks, Bebo was the U.K.’s most popular social networking site in July07, with 10.6M unique visitors in the U.K. and Ireland, and 18.2M worldwide. While the financial terms were not disclosed, this partnership will generate ~$16M in F’08 revenue for YHOO (revenue contribution assumption is based on a $1.00 CPM, 80% TAC and 50% Y/Y page view growth rate).
Jeffrey B. Logsdon, BMO Capital Markets
Bebo is the No. 3 social networking player in the US and has an even better position in a number of other English speaking countries (UK, Ireland, New Zealand, etc.). Bebo intends to launch in other European countries over the next six months. When combined with AIM and ICQ, AOL will now have 80 million unique users in the social networking-communications-entertainment segment. The acquisition compliments and enhances AOL’s Platform A display advertising focus and can leverage its behavioral and contextual marketing opportunities. This deal will likely dampen speculation that the AOL advertising businesses will be sold in the near term.
Benjamin Swinburne, Morgan Stanley
This acquisition is not inconsistent with the restructuring thesis of TWX, a restructuring that may include the monetization of some or all of the pre-existing AOL assets. While online advertising is expected to slow in ’08 versus ’07 in the U.S., social networking growth is expected to accelerate. According to eMarketer, global ad spending on social networking was $1.2 bn in 2007, and should grow to over $2 bn in 2008. This acquisition places TWX in this growing segment of online advertising. Questions remain regarding the near-term appetite for advertisers to shift meaningful levels of their existing budgets to social networking sites (particularly in the current weak ad environment), which is why social networking advertising growth has lagged usage growth. TWX, like NWS and its MySpace asset, hope the targetability of the advertising on social nets (users effectively volunteer their consumer tastes for advertising use) and their existing relationships with advertisers are synergistic. averaged 22 mm unique visitors (UVs) in January according to Comscore. Roughly 80% of its UV’s in January were outside the U.S.’s engagement level modestly exceeds its social networking competitors, averaging over 215 minutes per UV per month in January according to Comscore. In the last year,’s page views have grown 33% to 11.4 bn according to Comscore. At $850 mm, TWX is paying roughly $38 per monthly UV (using January’s 22 mm UV’s) which compares to private market value of MySpace of $35-40 using the average UVs in 4Q07. MySpace has been widely viewed as a successful acquisition, given the search agreement NWS struck with Google soon after acquiring it.
Heath P. Terry, Credit Suisse
With the Bebo acquisition, AOL hopes to grow its presence through the integration of AIM and ICQ, monetize the site utilizing Platform-A, and expand internationally. Bebo has the Open Application Platform in which content and application providers can monetize through advertising. Bebo has recently launched a Polish site and is testing local sites in France, Germany, Italy, Spain and Holland to launch in 5 to 6 months. Social networking is one of the fastest growing areas in the Internet properties, attracting media companies for a high audience engagement level in a new media platform. News Corps acquired Myspace for $580M in 2005 and has a deal with Google for a guaranteed payment of $900M through 2010. Microsoft paid $240M for 1.6% stake in Facebook in 2007. This gives AOL, particularly Platform-A, a rapidly growing inventory to apply its integrated effort in targeted marketing and ad utilization. While Bebo has a growing international presence and a smaller position in the U.S., AOL will face the same early-stage monetization challenge that Google, Microsoft, News Corp and Facebook have. That said, the price paid seems to account for these challenges.
Michael C. Morris, UBS Investment Research
In announcing the acquisition, AOL management highlighted that the acquisition puts the company in “a leading position in social media” and noted Bebo’s “fast-growing worldwide user base.” There are two significant potential benefits from a Bebo-AOL combination: (1) The ability to directly monetize the Bebo inventory through Platform-A. AOL notes that Bebo will allow AOL to offer advertisers even greater reach and marketers significant insights into the desires and needs of consumers. (2) The ability to use AOL’s existing products, most notably AIM, to drive increased traffic to Bebo. AIM has 23.9 million domestic unique monthly visitors versus 4.4 million for Bebo. Providing a direct connection from AIM to Bebo could drive higher Bebo traffic. However, there is a lack of several key pieces of information to connect the dots to true economic growth, because: (1) The company has not commented on Bebo’s current advertising relationship with Yahoo (for video and display advertising, entered in September 2007). When will this end? Will there be any incremental cost to terminating the relationship? (2) Management has asserted that Bebo has a “fast-growing worldwide user base” although comScore indicates that users have only grown 8% over the past six months to 21.3 million monthly unique visitors. Bebo’s Engagement Levels Trail Competitors and Are Flat or Falling.
According to advertising agency, Omnicom, “visits per day” is the metric most highly correlated to return on investment by advertisers as calculated by sales. As a result, sites with higher visits per day have higher engagement and will ultimately be best positioned to command higher CPMs or cost-per-click. Bebo’s engagement, as measured by visits per day, is below that of its primary competitors and has been declining since mid-2007.

Tuesday, March 11, 2008

Post-Capitalist Society by Peter Drucker

A probing and incisive analysis of the major world transformation from the Age of Capitalism to the Knowledge Society and how it will affect society, economics, business, and politics now and in the years ahead. In Post-Capitalist Society, Peter Drucker describes how every few hundred years a sharp transformation has taken place and greatly affected society - its worldview, its basic values, its business and economics, and its social and political structure. According to Drucker, we are right in the middle of another time of radical change, from the Age of Capitalism and the Nation-State to a Knowledge Society and a Society of Organizations. The primary resource in the post-capitalist society will be knowledge and the leading social groups will be "knowledge workers." Looking backward and forward, Drucker discusses the Industrial Revolution, the Productivity Revolution, the Management Revolution, and the governance of corporations. He explains the new functions of organizations, the economics of knowledge, and productivity as a social and economic priority. He covers the transformation from Nation-State to Megastate, the new pluralism of political systems, and the needed government turnaround. Finally, Drucker details the knowledge issues and the role and use of knowledge in post-capitalist society. Divided into three parts - Society, Polity, and Knowledge - Post-Capitalist Society provides a searching look into the future as well as a vital analysis of the past, focusing on the challenges of the present transition period and how, if we can understand and respond to them, we can create a new future.
The book's thesis is based on a Marxist-like definition of capitalism. A capitalist society, according to the book, is dominated by two classes: a small group of capitalists who own and control the means of production, and the workers who own little. All of the rest of society is organized around this fact. In this view, the age of capitalism peaked around the turn of the century. The reason, according to Drucker, is that "no one has matched in power or visibility the likes of Morgan, Rockefeller, Carnegie or Ford." Apparently, highly visible capitalists are a necessary condition; without them we no longer have a capitalist economy.
Drucker concedes that there are still rich people, but "economically, they have ceased to matter." Why? Because most corporations are run by professional managers, a result of the "Managerial Revolution." Drucker contends that, with the owners of capital no longer directly managing the corporation, it cannot be described as capitalism. The recognition of this separation of ownership from control was a major intellectual issue thirty years ago.
Post-capitalism is, according to Drucker, when "new classes" will rise to dominance. These new classes are the likes of computer programmers and telecommunications specialists. Society will order itself around them because they control what will be the "new central resource," knowledge.
Past financial empires were built on steel, railways, or banking. These industries are no longer where the profits are. Post World War II has seen the rise of the "super rich" in the computer industry, telecommunications, television production and other industries producing information processing hardware and software. This, Drucker says, is evidence of the fact that we are already in a post-capitalist world. Information is the dominant commodity, even more important than the production and distribution of "things." He makes the curious statement, "the actual product of the pharmaceutical industry is knowledge; pills and prescription ointment are no more than packaging for knowledge."
This new central commodity of knowledge is throwing economic theory into turmoil, says Drucker. Conventional models cannot explain current events. "We need an economic theory that puts knowledge into the center of the wealth-producing process. Such a theory alone can explain the present economy. It alone can explain economic growth." Drucker believes that one of economists' basis assumptions is the existence of perfect competition. He believes economists think that information is free and universally available.
Drucker continues, "another of economists' basic assumptions is that an economy is determined by either consumption or investment." He contends that there is "no shred of evidence" that increasing consumption or investment increases knowledge.
Traditional economic theory, according to Drucker, lacks "a common denominator for different kinds of knowledge." He notes that different pieces of land give different yields and are therefore priced differently. He believes we cannot yet do that for knowledge.
Drucker's style is interesting and encrusted with anecdotes from numerous disciplines. He quotes from novelists, economists, politicians, historians and others. The book is a 'Must Read' for all leaders and administrators (current & aspiring).