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.
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
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