Fox Entertainment Group will announce a new extreme sports and lifestyle channel at BroadbandPlus: The New Western Show that it has quietly pitched to cable operators.
It may be months before the new channel gets on the air, but it most likely will have the widespread cable system carriage it needs to succeed, since Fox can drive a hard bargain, negotiating with its booming branded cable franchises in news, regional sports and entertainment.
But there is more to Fox’s newfound might with the cable industry than meets the eye.
News Corp. Chairman Rupert Murdoch, whose company is 85 percent owner of Fox, and his top lieutenants–including Chief Operating Officer Peter Chernin and Deputy Chief Operating Officer Lachlan Murdoch–have spent the past year building a three-pronged defense strategy to make their companies less vulnerable to the whims of television’s ultimate gatekeepers. Fox is a premier content provider, and cable operators are desperate for new ways to abate the slide in basic subscribers despite the scarcity of space for new programming channels. But that alone is not enough.
“I think the question of cable distribution or pay TV distribution rights is one of the critical issues facing content companies like ourselves as well as the consolidating cable operators,” Mr. Chernin said.
“We spend a lot of time thinking about it. We don’t want to be at the mercy of gatekeepers. But on the other hand, we also have a fair amount of confidence in the strength of our programming. We don’t think too many cable operators could do without our sports, or Fox News or even FX at this point,” he said.
So Fox is striking while the iron is hot. It is leveraging off the growing popularity of its Fox News, Fox Sports, FX and regional sports channels to negotiate favorable carriage agreements for its fledgling efforts, such as the Speed Channel, and new offerings such as the extreme sports and lifestyle channel. The yet unnamed national sports channel will feature daredevil activities such as cliff jumping and snowboarding, sources said. Although Fox officials declined comment on their plans, industry analysts estimate it generally costs between $50 million and $60 million to launch a new national cable channel supported by both owned and acquired content.
New channels
The high development and launch costs make carriage clout critical.
“You will see new channels grow out of Fox Sports World, Fox Sports Espanol as well as some interactive,” Mr. Chernin said. “We’re looking at a bunch of things for 2003.”
Although most of its current carriage pacts aren’t up for renewal until 2004 or 2006, Fox can reopen negotiation to give cable operators more favorable longer terms in exchange for channel space for its new channel launches.
A seat at the table
But the recent ratings and financial success of Fox News and Fox Sports especially aren’t the only reasons why News Corp. and Fox have been able to get a seat at cable’s big table without owning a single system.
In a more discreet maneuver, Fox increasingly is bundling the sales and marketing of its flourishing regional sports channels with the industry’s largest TV station group, which is generating record cash flow even before duopoly economics in nine major markets is fully realized. This “triopoly” approach to creating powerful advertising and promotion platforms is designed to siphon viewers and ad dollars from other local broadcasters and cable operators and give Fox increased leverage in negotiating carriage agreements.
Having spent much of this year touring many of the Fox TV stations, Mr. Murdoch is especially intrigued by duopoly economics, which analysts estimated can yield an initial $100 million in cost savings in its nine major market duopolies just by merging facilities, operations and other resources. As a result, more revenues fall to the bottom line, he said.
Adding a strong regional cable sports channel to the mix in most of those duopoly TV markets promises to change the broadcast economic model in a way that brings a second revenue stream into the picture for advertising-dependent TV stations, he said.
Although there still aren’t many hard statistics to cite in these new “triopoly” arrangements, Fox’s local TV station and regional cable executives talk anecdotally about being able to convince local advertisers to spend two or three times what they normally would just by bundling two local TV stations and regional sports cable channels together.
“It does help when you have that very strong local penetration and the appeal of local sports franchises,” the younger Mr. Murdoch said.
“The future of broadcasting groups has become clear. Second revenue streams have become very important. Just look at these last ratings periods and the growing strength of cable programming. Broadcasters have to think creatively about how we as [an] industry confront that,” Mr. Murdoch said.
“We’re just beginning to learn how to program two stations in a market so they can keep their unique voices, but at the same time leverage off of one another and also the regional sports cable interest we have,” he said. “We’re still learning how best to use what we have.”
Fox’s ownership of 21 regional sports channels could be fortified soon by acquiring complete or controlling interest in five East Coast channels it co-owns with Cablevision Systems as a result of a forced realignment of the partnership later this month.
In a more dramatic, much-anticipated move, News Corp. is positioned to become a major player in the U.S. satellite industry, which is cable’s chief nemesis. Early next year, News Corp., which already dominates the satellite scene outside the United States, is expected to renew its pursuit of Hughes Electronics’ DirecTV by at least acquiring General Motors’ 30 percent stake in the company. That controlling stake would give Fox a key alternative domestic distribution platform.
“One way or another, Rupert is in our face to stay,” lamented one major cable executive.
Acquiring and using power
In recent weeks the senior Mr. Murdoch has downplayed the importance of his moves on DirecTV, which were foiled last year in a surprise bidding war with EchoStar Communications, whose proposed takeover has since been nixed by regulators. News Corp. has spent the past year arming itself with $1.2 billion in annual free cash flow, $3.3 billion in cash and $5 billion in support from Microsoft Corp. and Liberty Media (a 20 percent owner in News Corp.) to get the deal done.
“The idea of having a national distribution platform is strategically very sound, but it’s not essential. At the right time and right price it could be interesting,” Mr. Murdoch said at his annual shareholders meeting.
But the fact is, to a global content king who owns such formidable distribution platforms as BSkyB, Asia’s Star TV and Sky Latin America, nothing is more important than commanding or controlling distribution in the world’s most lucrative TV market.
“We don’t need a U.S. satellite presence to have a global distribution strategy,” Mr. Chernin said. “We have huge distribution in the U.S. We have a network. We have the biggest group of television stations, and we have several hundred million cable television subscribers. It’s more an opportunity than a requirement. Would it make life easier for us? Sure.”
The outcome of a DirecTV deal will determine how ambitious News Corp.’s other future acquisitions will be. High-level industry sources said News Corp. officials are eyeing Vivendi Universal’s Universal Studios (as a companion to its 20th Century Fox) and the Sci-Fi Channel (a perfect home for its “X-Files” series) in case they can be dislodged from the entertainment operations earmarked for public spinoff of a hodge-podge unit that also includes Universal music and theme parks and USA Network.
News Corp. also would not mind matching Liberty’s successful Discovery Communications channels with its own National Geographic channel if there were such an opportunity, sources said.
These days, News Corp., which once teetered on the ed
ge of bankruptcy, can afford to do many things. It more than doubled first-quarter group net profits to $295 million in fiscal 2003, from $141 million the year before, on a 5 percent gain in revenues to $7 billion, primarily driven by improvements in its television and cable network divisions.
“We have been very conscious about doing two things over the past year. One is paying tremendous attention to our operating businesses, and two is improving the strength of our balance sheet,” Mr. Chernin said. “Whether things stay bad or get worse economically, it puts us in a great position.”
But for the most part, News Corp. has been keeping its powder dry: passing on the acquisition of Germany’s Kirch Media, buying the Italian pay-TV service Telepiu for a low $700 million and using its 44 percent interest in Gemstar TV Guide to replace management and reverse the company’s failing financial fortunes. Gemstar’s interactive program guide and other related technologies are sleeping giants that will become ever more important and powerful in a digital cable universe overwhelmed by content and services.
Fox’s `sweet spot’
Merrill Lynch analyst Jessica Reif Cohen called the Fox cable networks the “sweet spot” of the Fox Entertainment Group’s growth, which is guaranteed for the next three to five years. The networks’ already respectable cash flow margins will likely double into the 50 percent range.
Insulated from another potential advertising downturn, the Fox cable networks will capture $190 million in incremental affiliate fees in fiscal 2003 over the previous year, she said. Combined growth in ratings, household distribution, affiliate fees and advertising should boost operating income to $345 million, an increase of 73 percent over the prior year, as a majority of those increased revenues fall to the bottom line.
“Fox is benefiting from the powerful combination of ratings growth, household distribution growth, increased affiliate fees and advertising growth [higher CPMs]. These revenue drivers are barely offset by an increase in operating expenses,” Ms. Cohen said.
The cable networks are indicative of the prudent and opportunistic way in which Fox and its News Corp. parent manage all of their core businesses.
News Corp. has quietly ramped up its annual free cash flow to about $1.3 billion while pushing operating businesses, such as its cable networks and its broadcast stations, beyond their initial financial targets.
And there still is huge upside left to be realized.
In major markets, especially those have big league baseball teams, Fox sales managers have found that selling two TV stations and a regional cable sports platform can be a potent option for advertisers. On another revenue front, affiliate fees in fiscal 2003 are expected to increase $35 million for Fox News, $50 million for FX and $75 million for Fox Sports, Ms. Cohen estimates.
As owner of more than 21 regional sports networks and with rights to 73 professional sports teams in the United States, Fox is learning to use such leverage as bargaining chips in much the way News Corp.’s BSkyB has done with sports and movies in the United Kingdom.
The Cablevision partnership
Fox could get another boost to its regional sports cable resources later this year when it is in the thick of negotiations with Cablevision Systems to redraft or cash out of their co-partnership. The only way Fox will remain in the partnership is if it gets a commensurate percentage of the revenues generated for its 40 percent stake, sources close to the situation said. Otherwise, it wants 100 percent ownership of the five sports channels and cash or other assets. Cash-strapped, debt-heavy Cablevision could opt to give up the regional sports channels rather than pay Fox an estimated $1 billion in cash to buy them out, payable over three years, sources said.
“The negotiations can turn into a game of chicken, with both sides losing more than they gain,” warns Bear Stearns analyst Ray Katz. Cablevision’s exercising its right to take the properties public would “thwart Fox’s desire to control the properties and monetize its stake.”
Sanford Bernstein analyst Tom Wolzien has other concerns.
“Control of a significant amount of content could be used to leverage the cable operators on price or carriage of additional channels,” Mr. Wolzien said in a report to clients when News Corp. made its first unsuccessful pitch for DirecTV. The shift of Fox’s regional sports programming and other niche cable networks to a U.S. satellite platform could drive down cable subscribers, revenues and earnings.
News Corp.’s potential command of the U.S. satellite market “would threaten both cable programming and cable’s presumed exclusivity in interactive television,” Mr. Wolzien said.
Still, Fox continues to negotiate scores of content-distribution deals fairly and squarely, including a big movie package with On Demand, that would supersede any domestic satellite move made by News Corp. It is talking to the new Comcast about participating in its free video-on-demand trial even though the company believes consumers should pay for such product.
Fox executives said they must protect what is the industry’s most valuable pipeline of syndicated programming, generating $3 billion in annual revenues and $1.5 billion in earnings before interest, taxes, depreciation and amortization from a backlog of syndication deals that extends for five years.
Its sprawling group of television stations, which provides a powerful launch pad for Fox’s first-run and off-network syndicated programs, is rapidly becoming part of the cable defense equation.
Flexing financial muscle
The most bullish analyst estimates call for Fox’s overall television unit to generate just short of $1 billion in cash flow in fiscal 2003, a whopping 75 percent over the previous year’s $535 million in cash flow. Virtually all of that increase is attributable to Fox’s owned TV stations, whose own cash flow is expected to rise more than 32 percent to nearly $1.1 billion, which is partly offset by about $135 million in losses at the Fox TV Network.
For the most part, Fox’s owned TV station group is uniformly improving margins to nearly 48 percent in fiscal 2003. Fox’s duopoly TV station in Los Angeles already has achieved 60 percent margins, even as both stations there maintain separate programming identities.
Even with only three of its nine large-market duopolies fully operational, the nation’s largest TV station group is reaping the benefits of an advertising rebound, reporting pacings up more than 22 percent in October, up 13 percent in November and up 21 percent in December over its 6 percent to 8 percent rises in upfront pricing.
Some of that financial strength has been created by dramatically cutting costs and increasing profit margins as Fox continues to integrate the Chris-Craft Industries TV stations it acquired in 2001. Some stations are still in the throes of renegotiating sticky technical union contracts. Although the company has achieved an average $200 million in annual cost savings, it is spending what it must to remain competitive, according to Lachlan Murdoch, who has immersed himself in the Fox TV stations this past year as part of his ongoing effort to learn the family business.
The appointed heir to the Murdoch media empire, Mr. Murdoch, 31, already has developed a keen eye for decentralized management and local interests that are as important to the company’s U.S. television stations as they are to the News Corp. worldwide newspapers, which he has overseen for about five years. He has played an instrumental role in the turnaround of the New York Post.