The Big Get Bigger

This article originally appeared in the MIPCOM 2014 issue of World Screen.

The media business is in the midst of a new wave of consolidation as companies vie for valuable IP and channel real estate.

Consolidation fever has swept the media business with a wave of deals since the start of 2014, including several whoppers of industry-shifting scale. Some of the biggest whales in the industry have already been swallowed. Although the biggest proposed move so far—an $80-billion bid by Rupert Murdoch’s 21st Century Fox for Time Warner—was nixed, another one like it might be around the corner.

From a big-picture perspective, the current consolidation has certainly been bound to happen. It was just a matter of time until it did.

“The key driver of the consolidation is the globalization of the final media vertical,” says David Reynolds, an analyst at investment bank Jefferies Group. “Advertising and publishing have gone down this road and now, finally, broadcasting is doing so.” In the wake of the flurry of deals in recent months, he says, “There is a lot more consolidation to come.”

The underlying factors pushing the current rush of activity can be summed up in two words: digital and global. And they are closely related. By “digital,” in this context, we mean the advent of online as a video market in contrast to traditional linear broadcast or pay TV.

Given the market-dominating nature of some of these deals, it can be hard to perceive them as fundamentally defensive in nature, but there is a good argument to be made in favor of seeing them that way.

The challenge of digital is felt by both pay-TV companies facing pressure on their subscription model and by broadcasters seeing continual audience erosion, with its negative impact on advertising.

BALANCING THE SCALE
“Scale is of increasing importance amid the rise of new-media platforms and the likes of Netflix, Amazon and YouTube,” says analyst Adrien de Saint Hilaire of Exane BNP Paribas. “These transforming mergers are about retaining clout, and in order to achieve that, bigger is better. There are different specific drivers in the deals. Sometimes it’s about costs and synergies. Sometimes it’s more about content or finding growth assets to protect the core business.”

The current trend underlines the huge importance of the American market, not only because the biggest deals are being done there, but because being global means having to be present in the U.S.—or, as Saint Hilaire puts it, “sensitive to” the American market.

A media analyst at a London firm, whose company policy is not to speak for attribution, cites two principal factors pushing the latest phase of consolidation in television. “Partly it is relatively cheap to finance acquisitions with debt because interest rates are low. Partly there is a sense that pay-TV operations are moving to a global scale as a function of OTT technology and the emergence of players like Netflix,” he says.

Asked if the need for content is driving most deals, he replies, “I would say it is scale driving them.”

While scale has global implications, the fact is that the biggest deals to date have been mainly situated in the U.S. domestic space.

The first mega-deal, in February, was Comcast’s acquisition of Time Warner Cable in a transaction valued at $45.2 billion. When given the green light by regulators, the move will add New York and Los Angeles, among other major metropolitan areas, to the Comcast portfolio.

“Comcast and Time Warner Cable [merging] is a defensive move,” says Saint Hilaire. “It’s about unlocking synergies and preventing price wars.”

The deal was followed in May by the announcement that AT&T would purchase DIRECTV in an even bigger transaction valued at $48.5 billion (plus almost $20 billion in assumed debt). In the U.S. pay-TV space, the merger will transform AT&T, whose existing U-verse brand has only about 5.7 million subscribers, into a giant with an additional 20 million subscribers from DIRECTV. It also has an international dimension in bringing DIRECTV’s 18 million subscribers in Latin America under the AT&T umbrella.

Randall Stephenson, chairman and CEO of AT&T, claimed before antitrust legislators that “the merger will put downward pricing pressure on cable products—cable bundles, cable video and cable broadband.” As with the Comcast-Time Warner Cable deal, whether the lawmakers believe that rationale for clearing the takeover remains to be seen.

In the shadow of such mega-deals, another big merger in the American TV station market has passed almost unnoticed. In July, Journal Communications and E.W. Scripps agreed to merge their television operations under the E.W. Scripps name, creating the fifth-largest independent TV group, reaching 18 percent of all households with stations in 27 markets, including 15 ABC affiliates.

Why is all the consolidation happening now?

Nick George, a partner in PwC’s U.K. Strategy group specializing in technology, media and telecommunications, explains, “Advertising has improved post-recession. The subscription business proved quite sticky during the downturn. Consumers tended to hold onto their pay-TV subscriptions. These companies traded well and now with the recovery they are looking to grow. We are seeing a post-recession surge led by groups that have come through the downturn and are looking to grow.”

He adds, “Content and digital are the two axes of the trend. Content is attractive for digital. Traditional television viewing remains strong and online adds a new growth dimension.”

With big groups on the hunt for content assets, consolidation is a natural development because there are so many opportunities for acquisitions.

“Content is a $50-billion business and it’s very fragmented,” Saint Hilaire says. “It’s dominated by the American majors, which account for 70 percent to 75 percent of the business in the U.S. The market is growing at 5 percent to 7 percent per annum. There is a very long tail of small production companies.”

DIGITAL MATTERS
In March, The Walt Disney Company agreed to acquire online video company Maker Studios for $500 million and a performance-linked earn-out of up to $450 million. “Short-form online video is growing at an astonishing pace,” Disney’s chairman and CEO, Robert Iger, stated when the deal was announced. With Maker Studios, Disney now has a channel provider with 380 million subscribers and 5.5 billion views per month on YouTube.

It’s interesting to note that Ynon Kreiz, the president of Maker Studios, was involved in an earlier phase of consolidation a few years ago in the sports area, when he led the investment group which bought into Europe’s nascent North American Sports Network and steered it toward a takeover by ESPN.

Just as Disney has moved into enhancing its capacity to deliver specific content for the digital market, so multi-country European broadcaster RTL Group has taken smaller, acquisitive steps to shore up its position in advertising in the digital space.

In July, RTL revealed that it would pay $144 million for a majority stake in U.S.-based digital advertising marketplace SpotXchange. The company automates the process of buying ad slots from online video publishers.

RTL Group co-CEO Guillaume de Posch explained the move as protection against the group being “disintermediated” from the process of selling online video ads. “We fully understand how to sell commercial spots on TV,” de Posch said at the time. “But in online video, the world is much more atomized.”

RTL Group is the first TV broadcaster to buy an ad exchange, following similar acquisitions by Facebook, Google, Twitter and others.

21st Century Fox has long had its eyes on Time Warner’s HBO pay-TV operation and especially the group’s sports rights (mainly visible on the Turner U.S. channels). A merger would have helped Fox, already a sports giant with the FOX Sports brand, challenge ESPN. Cable magnate John Malone told The Wall Street Journal that sports rights were an “important” factor in the attempted takeover but “not the driver.”

TIME TO BUY
The unsuccessful move on Time Warner followed a series of divestments over the last few years by the company that have made it more affordable and attractive to potential buyers. Time Warner chairman and CEO Jeff Bewkes has spun off AOL (whose acquisition of the company in 2000 remains the biggest failure of consolidation in media history), Time Warner Cable, and the Time Inc. publishing division.

With operations in Europe, Asia and Latin America, HBO was also very attractive as an international brand for 21st Century Fox, which already has a massive portfolio of channels on the global market.

The unsuccessful move on Time Warner came four years after Murdoch’s failed attempt to take over BSkyB in the U.K. His group already owns 39 percent of the money-spinning pay-TV operation and the aim was to swallow the rest.

James Murdoch, today 21st Century Fox’s co-COO, said at the time that the aim was to consolidate BSkyB with other Sky businesses in Italy, Germany, India and New Zealand to create the first state-of-the-art, global, 21st-century digital pay-television business, centered in the U.K. “We felt it would be helpful to be bigger in order to compete with other international companies such as Google, Apple and large telecom companies, all of whom are much larger than BSkyB and have been investing in the audiovisual business heavily on a global, rather than a national, basis.”

When the younger Murdoch claimed in the U.K. parliament that BSkyB was not a big player in the grand scheme of global media and communications competition, his argument was widely dismissed as simply self-serving.

But the current consolidating trend reflects a general acceptance within the TV industry of Murdoch’s thesis.

“Amazon, Google, Facebook and the like are already global,” says Jefferies analyst Reynolds. “Broadcasting has some catching up to do.”

FIGHTING BACK
Saint Hilaire adds, “Look at Google: it’s immensely profitable. It still generates most revenues through search, which is not really competitive with TV. But the merger wave is a sort of retaliation. Google is very profitable, and it can invest and leapfrog the existing media giants. Broadcasting is cash-flow generative, but it tends to be local. Google is global and has better margins. You’re not going to destroy your P&L trying to catch up, so you get bigger.”

In July, the Murdoch empire sold its own pay-TV operators in Germany and Italy to BSkyB. The British platform agreed to pay $4.1 billion for Fox’s 100-percent-owned Sky Italia and $4.9 billion for a 57-percent stake in Sky Deutschland (also offering to buy out that company’s minority investors).

BSkyB said it would save £200 million ($330 million) via synergies (mainly cost cuts) within two years of combining the British, German and Italian operations. The benefits will include the accrued tax losses of the German operation.

Ironically, the deal combining the Sky pay-TV operations is actually in line with Murdoch’s stated ambitions of a few years ago, although Fox was a seller rather than the buyer this time. It does, however, benefit from the synergies as the main shareholder in BSkyB.

Also, the move to take over BSkyB was shot down by regulators in the wake of the phone-hacking scandal which engulfed the Murdoch group’s newspapers. There is nothing to suggest such a deal might not happen in the future.

SPORTING CHANCE
At the end of May, Discovery Communications announced the completion of its acquisition of a controlling interest in Eurosport International, taking its stake to 51 percent from 20 percent as part of a larger strategic partnership with TF1 Group. The closing price for Eurosport International was based on an average enterprise valuation of €902 million ($1.2 billion).

The acquisition of Eurosport takes the group to a point where its business outside the U.S. is bigger than its domestic business, according to Jean-Briac (JB) Perrette, the president of Discovery Networks International. With Eurosport’s six pay-TV brands, Discovery Communications now operates more than 210 worldwide TV networks reaching 2.7 billion cumulative subscribers.

Eurosport’s Géraldine Filiol, who has headed both sales and acquisitions and was recently named deputy managing director for international communications, marketing and external relations, tells World Screen that Discovery’s move into the sports market adds a fourth major player to the picture of global competition for premium rights along with ESPN, Fox and, more recently, Al Jazeera.

Discovery is now operating at the intersection between factual programming and sports, and for the first time has a significant presence in the business of live television.

The move into sports is an excellent fit for Discovery because, Perrette says, the American group’s programming brand is all about “telling factual stories,” and sports are full of them. The acquisition is a fine example of consolidation aimed at enhancing a group’s strategic content position.

Also in May, Discovery and Liberty Global formed a joint venture to acquire all3media, the largest independent production group in the U.K., from its founders and the Permira funds for about £550 million ($930 million).

With revenues of £505 million ($820 million) in the latest fiscal year, all3media has a diversified catalogue of more than 8,000 hours of content across many genres, and production capabilities in drama, comedy and factual programming. Steve Morrison, co-founder of all3media, said “the new strategic owners come with a long-term view of the importance of building a leading global content company.”

THE NEXT MEGAMERGER?
At about the same time, 21st Century Fox and Apollo Global Management formed a joint venture with the intention to combine the Shine Group, Endemol and CORE Media Group. The deal follows Apollo’s acquisition of a majority stake in Endemol, producer of Big Brother and many other hit formats. Shine alone has about 30 different companies in a dozen countries. How all the pieces would fit together has not been made clear.

“The scale of the mega-deals involving telcos and cable groups might be bigger in absolute terms, but I would not underplay the content deals,” says PwC’s George. “Leading content producers may be smaller by revenues [but] they are no less significant. This is because of the M&A that has already happened in the production sector, where some things benefit from scale. Bigger groups are well positioned to sell internationally and they are more diverse and resilient. As groups have come together with the consolidation of smaller producers, they have become more important for the biggest players to have.”

These production groups are a far cry from the small cottage businesses that existed 20 years ago and were often dependent on one-off commissions, he says. “They are content platforms with multiple routes to market. They are no longer narrowly dependent and with their greater scale they are well positioned to leverage their intellectual property.”

George adds, “One feature of Europe will remain and that is that there are quite specific market characteristics from country to country. But if you look at the format business, for example, you see there are ways to develop IP and package creativity that can transcend the differences by adapting to them. The larger-scale production groups that exist are the culmination of a lot of innovation and hard work. They are following growth strategies to bring different types of content, including digital content, short form and long form.”

He says is it hard to say whether existing big productions groups will get even bigger. “We probably will see the smaller and medium-sized players today trying to get bigger and achieve critical scale as their predecessors have already done.”

Exane BNP Paribas’ Saint Hilaire comments, “Not all of the merger deals aimed at getting bigger will work. Look at Endemol. It has dramatically lost value.”

PROCEED WITH CAUTION
The need for caution applies to broadcasting as well as content-driven consolidation. “Look at broadcasting on a pan-European basis,” Saint Hilaire says. “Any geographical expansion has generated very little synergy. ProSiebenSat.1 buying SBS was based on the idea that it could help reduce the costs of rights, the main costs of broadcasting, which normally account for 60 to 75 percent of costs. It has not worked. They just had a collection of assets rather than an integrated group.” ProSiebenSat.1 sold off its SBS Nordic asset to Discovery last year.

Saint Hilaire adds, “RTL built its pan-European expansion more organically and there is greater integration with some circulation of programming and sharing of best practices. But even so, the synergies are really not that obvious. In the case of BSkyB and Sky in Italy and Germany, they’re talking about synergies of £200 million ($324 million) but in the grand scheme of things that is fairly limited, only about 4 percent of their combined revenues.”

Saint Hilaire sees ITV and ProSiebenSat.1 as the two key consolidators in Europe. “Five years ago they were struggling with low margins and audience issues. New management has done a tremendous job in transforming those groups, turning them into high-margin cash cows which can now invest in new assets. It has been an outstanding transition in both cases. Where these groups are going now is a bit different. ITV has a heritage of programming and legacy assets in content. For ProSiebenSat.1 it is harder. ITV is more into content, while ProSiebenSat.1 is more interested in digital assets. Broadcasting produces good margins and cash flow, but it can’t last forever as it exists. They need to have a balanced business.”

ITV has made an ongoing practice of snapping up independent producers. The biggest deal of late came in May, when the group announced that it would buy 80 percent of American producer Leftfield Entertainment Group for $360 million. The acquisition makes ITV Studios US Group the largest unscripted independent producer in the U.S.

In March, ProSiebenSat.1’s production-and-distribution arm Red Arrow Entertainment acquired a minority stake in Collective Digital Studio (CDS), which oversees YouTube multichannel networks. Last year, ProSiebenSat.1 formed its own multichannel network, Studio71, and the new partnership will aim to exploit synergies between the companies.

“Digital functions globally,” ProSiebenSat.1 executive board member Christian Wegner commented. “Having established a leading multichannel network in the German-speaking region, we are taking the consequent next step with CDS to create a global player in what is a high-growth sector of the entertainment industry.”

Saint Hilaire says deals like this are creating a “significant gap” between the U.K. and Germany and other countries in Europe, which have wrestled with economic crises and have regulatory hurdles.

“Look at the situation with the launch of Netflix in Europe,” he says. “In Germany, the free-to-air broadcasters are going to be ready for Netflix. In France and Spain, they are going to be naked.”

A TASTE OF BRITAIN
The wave of mega-consolidation probably has not run its course yet, and it might spread from the U.S. Liberty Global is currently sniffing around ITV.  The company acquired BSkyB’s 6.4-percent stake in ITV in July for £481 million ($779 million). Another British broadcaster has already been snapped up, with Channel 5’s sale to Viacom.

“The media and communications landscape remains vibrant and a good place to do deals,” PwC’s George says. “We are seeing more investment into the U.K. and Europe. People were focused on emerging markets for growth. Media investors have faced some challenges in the Middle East and even Eastern Europe, and good deals are not easy to come by in Asia. The U.K. offers reasonably good prospects and is a good place to do business.”

Our anonymous U.K. analyst sees more consolidation ahead in Europe, citing Mediaset, Vivendi and ProSiebenSat.1 Media as groups that may be involved in deals. Also possible on the horizon are strategic alliances bet­ween media telco operators.

“You will see more deals, but they are likely to be in adjacent areas, like RTL Group and SpotXchange,” predicts Saint Hilaire. “Online video is a likely area, in infrastructure and technology. This is mostly driven by the U.S. Those companies with sensitivity to the American market will do better. Companies in the U.K. and Germany are better positioned in this respect relative to those in southern Europe, where companies have limited ability to invest abroad and weaker management skills. There will also probably be more consolidation in the content area.”