Premium Networks Take a Hit

Like a deadbeat confronted by one of Tony Soprano's enforcers, pay cable networks are getting badly beaten up and are bleeding subscribers.

The worst numbers are being posted by the smaller pay networks, with Showtime and Starz! losing 9% of their cable and DBS subscribers last year. Even the venerated HBO saw its overall growth nearly halt in 2003 as it started losing subscribers.

Sanford Bernstein & Co. media analyst Tom Wolzien gazed at pay-channel prime time audience levels for December and was startled to find declines of 14%-28%. "All you have to do," he said, "is look at their ratings to see the premium business has problems."

One source of their woes is Comcast. All pay networks got crunched when the cable giant acquired AT&T's systems and ended their deep discounts on premium services.

Another culprit is EchoStar. Its Dish TV provider has been pushing HBO and limiting sales efforts on Showtime and Starz!.

But the pay services face far more fundamental problems. Cable operators are focused on pushing lucrative high-speed Internet or phone services, not Cinemax. And as digital cable and video-on-demand dramatically expand viewers' options and increase their bills $10-$15 a month, pay networks become less essential.

Maybe the woes won't last. Larry Gerbrandt, Kagan COO and senior analyst, said his fourth-quarter analysis isn't complete but initial numbers indicate that the downturn may have stopped. "This dislocation seems to be short lived. The fourth quarter actually was a positive one for HBO."

For all networks' investment in high-buzz programming like HBO's Sex and the City and Showtime's lesbian knock-off The L-Word, their business remains hugely dependent on the sales engine of their retailers, the MSOs and DBS services. HBO's customer churn runs 5.5% monthly; other pay networks churn at 6%-7% per month. Much of that is "move churn": customers relocating and reconnecting through other cable systems. But that still means pay networks have to replace 40%-60% of their customers every year just to stay even.

Mark Greenberg, Showtime's executive vice president of corporate strategy, expects 2004 to be stronger, partly because operators are integrating pay networks into some of their key new products, video-on-demand and high-definition services. "They've been distracted somewhat by selling cable modems. It's certainly a distraction from the pay-TV business."

Kagan World Media data show that Showtime's subscriber counts lost 1.2 million units during the first nine months of 2003. That's a 9.1% drop to 12 million subscribers. A big chunk of that came from DBS (off 18%), in large part because of a preview promotion that ended at the end of 2002. But even adjusting for that, Showtime's counts would have dropped 5%.

Starz! lost 1.2 million units, a 9.1% decline to 12 million, damaged by a dispute with Comcast. After buying AT&T Broadband in November 2002, Comcast scrapped an expensive sweetheart deal that Tele-Communications Inc. had signed years before with Starz! parent Liberty Media (both Liberty and TCI conveniently controlled by John Malone).

The old deal encouraged AT&T to give Starz! away to anyone taking HBO. But Comcast's new, more conventional deal spurred system managers to repackage and raise Starz! prices, costing several hundred thousand subscribers.

HBO actually squeaked out a gain, up 0.8% to 27.2 million subscribers. On cable systems (20 million of its subscribers), HBO dropped 1.9%, largely because of Comcast. Many old AT&T systems had hugely discounted to drive penetration of digital packages, to the point where many systems were selling even HBO at a loss. Comcast found subscribers with enhanced basic, digital cable and HBO paying less than the enhanced-basic price. That stopped.

Also, industry executives say that, while all three networks were cutting new affiliation deals with Comcast, the MSO turned down the volume on marketing for several months.

But HBO pumped up its DBS business 11%, mostly through a special deal with EchoStar's Dish Network. For most of the year, EchoStar offered new subscribers its Top 100 basic networks plus a few HBO channels for $49 monthly. Other pay networks weren't promoted heavily.

Networks have found other ways to make money than charging cable operators $4-$5 per subscriber each month. Despite slack sub growth, HBO boosted sales about 10% to $3.2 billion last year. That growth is coming from other products: theatrical movies, DVD sales, syndication (both of series and the big outside success it owns a piece of, Everybody Loves Raymond). Already 20% of HBO's revenues comes from other sources than subscriber fees.

Slow Pay
Premium channels lose subscribers. HBO, despite critical acclaim, is flat.
Dec '02* Sep '03* Chng.
*Subs (millions) Source: Kagan World Media
The Movie Channel10.710.7-9.2%