Aereo Wins Court Battle, Continues Disrupting TV Industry

Reuben is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The Aereo video service, partially backed by IAC/Interactive (NASDAQ: IACI), is surrounded by lawsuits. So far, it's winning. That could materially alter the landscape of broadcast television. IAC is the best way to participate in this potentially disruptive technology.

What is this Aereo of which You Speak?

Aereo is an online video service. It allows customers to receive and record broadcast stations in their home market over the Internet. It is different from Hulu in that it literally streams live television over the Internet, not a delayed or curated version of what appeared yesterday.

That's a big leg up on Hulu and Netflix (NASDAQ: NFLX), which don't provide access to live television, particularly sports and news shows. In fact, this failing is one of the main reasons why customers keep paying for cable. However, with a cost of only around $12 a month, Aereo could cause content distributors real problems.

How?

Aereo rents a little antenna to each customer, which only sends information to one customer at a time. The company argues that this is no different than a person sitting in front of a television set with its own antenna. Thus, Aereo doesn't pay for any of the content its customers are watching, believing this set-up complies with all applicable laws.

Not surprisingly, content owners and distributors are taking the issue to court. IAC, seeing an opportunity to get in on the ground floor of a disruptive technology, made an investment in Aereo. Barry Diller, the company's Chairman, openly backed the company, too. Investors can tag along with an investment in IAC.

IAC is an Internet holding company that owns dating sites, search engines, comedy sites, and video sharing sites, among others. Well-known brands include Match.com, About.com, Ask.com, College Humor, and Vimeo. It earns money through advertising and subscriptions.

After spinning off its travel sites and Ticketmaster, IAC has grown its top-line in each of the last three years. And it started to pay a dividend in 2011. The dividend has already been increased. IAC is well off its all time highs, but with a price to earnings ratio of about 23 is hardly a cheap investment. That said, for growth and income investors, it's a nice way to get Internet exposure and access to Aereo. It yields around 1.8%.

Who Gets Hurt

The list of companies that could get hurt by Aereo is long. Some, however, have more skin in the game than others. For example, Disney (NYSE: DIS), which owns ABC and cable channels, is backing the lawsuits. Disney clearly wants to protect its ABC content from being redistributed without payment, but sports giant ESPN could see demand fall, too, if customers can get local sports and news.

Disney earns nearly 14% of its top-line from ABC, so Aereo isn't an immaterial threat to its business. And, Disney owns a portion of Hulu, which becomes a less interesting service if Aereo takes off. That said, Disney is one of the giants in the content space. As the industry comes to terms with Aereo, so, too, will Disney. Only that won't happen until after the lawsuits are done.

Disney's top-line has grown in nine out of the past ten years, with earnings advancing from about a $1.10 in 2004 to over $3.10 last year. The dividend has also been increased on a regular basis. A price to earnings ratio around 20 is high but reasonable.

Growth focused investors should take a look, but the yield of around 1.2% isn't enough to attract income seekers. That said, if the Aereo lawsuits start to attract more public notice, a share price drop could present a buying opportunity.

Comcast, which owns NBC and cable systems, could also feel the pinch if Aereo successfully defeats the suits brought against it.

Big Aspirations

Netflix, however, has a bigger issue. It wants to be an Internet television station. Aereo is one step better, offering all of the stations in a customer's local viewing area. It's possible that customers could pair Netflix with Aereo to get something of a cable-like service with television, but that could be a mixed blessing—Aereo could severely limit Netflix's ability to push through price hikes.

Customer growth is the driving force for Netflix, but that can only last so long in a quickly saturating market before the company needs to earn more from the customers it has. In fact, it just missed Wall Street expectations on customer acquisitions in the June quarter. Growth prospects have driven the shares from around $50 to around $250 in less than a year. The shares have a trailing PE of over 300. The stock is overpriced now, if Aereo gains traction, concerns about top-line growth at Netflix could eventually take the shares lower.

Disruptive

IAC is publicly and financially backing Aereo and is a good way to buy into the upstart. Hulu, Netflix, Disney, CBS, and Comcast, among others, are closely watching the company's progress. As an investor in any of these companies, you should be watching, too. With regard to Netflix, Aereo's success could be an immediate benefit, but a longer-term negative.

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Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Netflix and Walt Disney. The Motley Fool owns shares of Netflix and Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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