The Battle for the Living Room

By Daniel Ferry - June 29, 2012 | Tickers: AMZN, CBS, NFLX, TWX, DIS | 0 Comments

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If Netflix is losing the battle for the living room, then Time Warner (NYSE: TWX) is winning. The company gets bashed often and eagerly by early adopters for failing to adapt to a changing television environment. Time Warner is seen as particularly stodgy compared to innovators entering the space: Netflix (NASDAQ: NFLX), Hulu, and Amazon (NASDAQ: AMZN). I believe, however, that Time Warner recognizes these threats, and has taken steps to continue to dominate home entertainment. 

Much ink has been spilled comparing Time Warner's valuable property HBO with Netflix. They cater to similar demographics, and their failure to work together has frustrated many. Any such comparison misses the mark, however, because Time Warner and Netflix are in very different businesses. Time Warner, through subsidiaries like HBO, Warner Brothers, and New Line Cinema, is primarily a content creator. Netflix, Hulu, and Amazon are primarily content distributors.

Ultimately, consumers want to pay for content, not distribution. As new distributors enter the space, competition will drive down the premiums they command. Content creators will be able to shop around to different distributors to get the best deal. This will benefit all content creators, but Time Warner has some advantages compared to other large studios like Disney (NYSE: DIS) and CBS (NYSE: CBS). First, Time Warner is more of a pure play on video content creation. While Time Warner does have a magazine publishing business accounting for about 10% of revenues, this is small compared to Disney's 40% of revenue coming from parks & resorts and consumer products, or CBS' 40% of revenue from publishing, outdoor advertising, and ad-supported local broadcasting.

Second, Time Warner simply puts out the most—and arguably the best—content. Time Warner has commanded the largest film market share for eight of the last ten years. The company has more series on the broadcast television schedule for 2011 – 2012 than any other studio. In 2011, HBO alone won 104 Emmy nominations, more than double its closest competitor. And its programming is popular: shows like Two and a Half Men and Big Bang Theory are among the most-watched on TV.

Now, those two shows are actually broadcast on CBS. Yet they are produced by Warner Brothers, which speaks to Time Warner's third advantage. Unlike Disney and CBS, which own the ABC and CBS channels respectively, Time Warner has no ties to a major broadcast channel, leaving it free to offer its content to the highest bidder. Even among premium cable channels, HBO's development of original content gives it leverage over competitors like Showtime, also owned by CBS, which license their programs from other studios including Time Warner, and don't have the rights to distribute these programs through other channels like streaming. Other networks aren't just competitors for Time Warner; they're customers.

Detractors observe that Netflix, Hulu, and even Amazon are moving to sidestep Time Warner by developing their own original programming, but this is a distant threat. Netflix and Hulu have each been able to put on one scripted series, and Amazon's initiative to crowd-source ideas for content has so fay yielded four low-budget pilots. Time Warner has spent decades building up their studio capacity. Cinematic series like Boardwalk Empire and Game of Thrones, which are proving a decisive edge for HBO, take millions of dollars in upfront investments before a pilot episode is produced. It would take many years for these upstarts to challenge Time Warner's hold on popular content. While HBO's reliance on traditional cable providers may lead one to believe Time Warner is giving competitors this time, the company isn't sitting still.

While maintaining its partnership with cable providers, Time Warner is building out HBO GO, a service that streams any HBO show to any device, anytime—as long as you're already an HBO and cable subscriber. This has led to claims that Time Warner is forcing people to pirate content by not providing a legal avenue to watch only HBO shows . However, unless pirates would have paid for the standalone content if given the option, Time Warner isn't actually losing potential revenue. Piracy of other media has continued despite the availability of subscription alternatives, so it isn't clear that there's a large potential customer base there.

Furthermore, Time Warner's cable partners not only take care of marketing, billing, and other services for HBO, but also provide a much larger audience. Despite the hubbub raised by those who wish to purchase HBO shows without subscribing to cable, there simply aren't enough of them to make up for the customers HBO could lose by alienating its cable partners. In 2011, 40 million American households subscribed to HBO through cable. A recent Nielsen survey estimates that only 4.5% of Internet-enabled households have broadband and no cable subscription, which would come out to around four million households. However, as the trend toward streaming continues, the development of HBO GO allows Time Warner to quickly change strategies, not only by opening up its streaming service directly to consumers, but by adding more of its original programming to the service's content library.

In the long run, video streaming services are not a threat to Time Warner. Instead, they could be valuable distribution partners for Time Warner's vast content portfolio. Worse for streaming services, if Time Warner decides to turn HBO GO into a standalone product, they will find Time Warner taking their market share, not the other way around. Time Warner has left its options open, and as long as it keeps producing content that people want to see, it will continue to rule the living room.

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