How HBO’s Over-The-Top Streaming Service Can Shape The Network’s Future

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A change in viewing habits and the higher penetration of smartphones and the Internet are forcing some of the media and pay-TV companies to think beyond their traditional offerings and come out with advanced products and services to cater to the rising demand for alternative video platforms and over-the-top services. Video platforms such as Netflix (NASDAQ:NFLX) have already seen a rapid subscriber growth over the past few years. Netflix has over 37 million subscribers compared to 22 million for Comcast (NASDAQ:CMCSA) and 20 million for DirectTV (NASDAQ:DISH). In this changing environment, the challenge for the media industry at large is to make the content accessible in and out of the home. Going over-the-top as a standalone service is a bold decision to make, as it could trim the existing subscriber base on the traditional television. However, some of the networks, including CBS (NYSE:CBS) and Time Warner‘s (NYSE:TWX) HBO, have decided to go over-the-top and offer a streaming service without a pay-TV connection. While its too early to comment on how successful these services will be, it is the beginning of a new trend and a step in the right direction. On that note, we discuss below HBO’s growth and its soon-to-be launched standalone streaming service.

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How Significant Is HBO For Time Warner?

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We estimate that HBO accounts for more than 30% of Time Warner’s value. The network’s programming is distributed in more than 60 countries across the globe. HBO U.S. had 43 million subscribers while the worldwide subscriber base was around 127 million as of December 2013. [1] HBO charges high monthly subscription fees, and therefore has low penetration, compared to regular cable networks. As of December 2013, HBO reached about 41% of the U.S. pay-TV households and charged a fee per subscriber of close to $7 per month, according to our estimates. The subscription revenues have grown from $2.66 billion in 2008 to $3.41 billion in 2013. There are no advertisements on HBO, making it relatively less risky than ad supported cable networks, since ad revenues tend to be volatile during economic downturns. However, HBO is a more discretionary product given the higher fee per subscriber.

We don’t expect any significant growth in HBO penetration due to the rising demand of alternative video platforms, which provide much cheaper option to watch movies and TV series. We estimate the penetration to remain around 41% towards the end of the forecast period. However, we believe that the subscription fee will continue to rise in the coming years and be around $9 per month by the end of our forecast period. This will translate into annual revenues of close to $5 billion by 2020 and an estimated EBITDA margin of 40% will translate into EBITDA of close to $2 billion, representing 17% of the company-wide EBITDA. It must be noted that this is only the U.S. business and HBO generates around 30% of its revenues from international operations.

This growth will be driven by higher contractual rates and HBO’s appeal. Contracts between content companies and pay-TV service providers include prescribed yearly increments for subscription fees. These contracts are long-term, spanning across several years. Moreover, HBO is unparalleled in terms of its movie content and original programming. Given that it charges a very high fee per subscriber, it is able to afford such premium content. Despite increasing subscriber fees, HBO has been able to maintain and grow its subscriber base, indicating sustained demand for this premium channel and its content.

HBO has backed several original drama and comedy series, many of which have won awards and received critical acclaim, including Game of Thrones and True Blood.  In recent years, HBO has largely benefited from the success of Game of Thrones, which has broken all viewership records and stands as the most watched TV series for HBO. The network’s original programming has also helped HBO secure an exceptionally active international fan base. The network generates strong demand due to significant investment in its content. This is the reason why the network has been able to grow its subscriber base to over 40 million despite charging the highest subscription fee in the industry. Continued investment in programming will ensure that the growth in subscription fee continues.

Other than the subscription business in the U.S., HBO also earns money via its subscription business in international markets, licensing content to cable networks and selling its original programming via DVDs, Blu-Rays and digital distributors. In 2013, HBO’s international and content revenues amounted to $1.47 billion, representing 30% of its overall revenues. [1] Growing popularity of HBO in international markets and the growth in digital distribution will continue to drive the network’s international and licensing revenues. We forecast these revenues to grow at an average annual rate of 6%, translating into annual revenues of over $2 billion by 2020. This will take overall HBO’s annual revenues northward of $7 billion towards the end of the forecast period.

HBO Will Soon Launch Its Over-The-Top Streaming Service

HBO will offer a standalone streaming service starting this year, primarily targeting broadband-only homes. There are more than 10 million broadband-only homes and around 80 million homes, which haven’t subscribed to HBO. [2] Rising pay-TV bills are making some customers either drop the service or switch to lower cost packages. In either case, this is not good for media companies, as it will reduce penetration in TV households. It thus becomes important for certain standout networks such as HBO, ESPN or CBS to make their programming available on alternative video platforms. For instance, a broadband-only subscriber likes to watch movies and he can opt for HBO’s streaming service without a pay-TV connection at a less than one-fifth cost. While the company has not given any guidance on pricing for the standalone service, it could be anywhere around $18, according to some speculation. [3]

Given the demand for HBO’s content, a standalone service may look attractive to many customers. If the network does manage to gain an overall streaming subscriber base of 10 million at $18 price tag, it would translate into annual revenues of over $2 billion, which is more than its current income from international operations and content licensing.

Currently, HBO Go offers streaming services for the customers who have subscribed to the network on television. However, the company will remove that barrier and the subscription will be open to all. HBO is not alone foraying into this arena. The future of television lies in streaming where a person can watch his or her favorite programming in and out of the home on any device. Last year, CBS launched its own over-the-top streaming service while Dish has recently come up with a bundled package of 12 networks that can be watched through its Sling TV streaming service without a pay-TV connection and at one fifth the cost of a pay-TV subscription. Moreover, it includes the sports giant ESPN (Read More – Dish To Offer A $20 Per Month Streaming Service With 12 Networks Including ESPN).

We note that going standalone is a bold move and is feasible only for the few networks that have sufficiently strong content. For instance, HBO’s shows are extremely popular across the globe while CBS is the most watched network in the U.S. and ESPN has majority of the popular sports coverage. For smaller networks it may not make much of sense to offer standalone services as it would make difficult for customers to shop for each network separately. Here, something like Dish’s Sling TV or Sony’s Internet TV services, which provide bundled packages, could play an important role in the coming years. [4]

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Notes:
  1. Time Warner’s SEC Filings [] []
  2. Dish Network Unveils Sling, a Streaming Service to Rival Cable (and It Has ESPN), The New York Times, Jan 5, 2015 []
  3. HBO standalone product risks alienating cable, satellite cos, Reuters, Oct 16, 2014 []
  4. Sony unveils Internet TV in challenge to major networks, CNBC, Nov 13, 2014 []