Comcast deal for NBC Universal is about content, not broadband

After this morning, there should be no question in anyone's minds whatsoever as to what Comcast's deal with General Electric for control of NBC Universal is about: NBCU is a huge producer of cable TV content, and Comcast would like to be the parent company of that producer. The deal isn't so much about Hulu, or new media, or creating some walled garden around content distribution, as many would have believed and expected.

Comcast CEO Brian Roberts made this fact pretty clear during Comcast's investor earnings call this morning: This is not a technology deal. Comcast, the pipeline company, is already making deals in the technology side, including providing 10% of the operating capital of Clearwire. The pipeline company is going ahead with its plans to produce its own Web-based on-demand distribution network, which Broadcasting & Cable has learned will be called Xfinity. (Comcast must have used the same consultant Sprint used to come up with "Xohm.") And in response to direct questions today as to whether Comcast's indirect acquisition of NBCU's stake in video service Hulu would change Comcast's plans for deploying "TV Everywhere," Comcast COO Stephen Burke responded that he believed NBC's restraint in releasing its own content to Hulu was "smart," and that Comcast would let NBC continue in that regard.

And when pressed as to whether Comcast would press Hulu to create a premium, for-pay service, CEO Roberts emphatically responded, "That's certainly not in the cards."

"Two Comcasts"

The pipeline company will continue to do its own thing. Roberts told investors this morning, "We basically are creating two Comcasts." Here, NBCU becomes essentially Comcast, the content company, whose formal title Comcast's presentation to investors this morning intentionally leaves up in the air, at times calling it just "JV." (One possibility that springs to my mind: CNU, with the logo formed from Comcast's crescent merged with Universal's dual arcs.)
As Comcast's charts to investors this morning illustrated, Comcast's operating cash flow taking the joint venture into account will be 97% driven by cable program distribution and cable channels. Keep in mind that the whole "distribution" slice of the OCF pie (80% by itself) will take into account the multiple platform hops that content goes through, and the Internet is one of those hops. So in that regard, this is an Internet deal.

But the reason Comcast went after NBCU in the first place -- a reason it now freely admits -- is the attractiveness of affiliate fees, those fees that DirecTV and Verizon and Dish Network and Time Warner Cable and their ilk pay to carry programming on their services, as well as to share resources. Even in this down economy, affiliate fees have managed to rise at a rate of 12% annually, thanks in large part to the almost singular efforts of Comcast.

The real reason for the deal

Assuming the joint venture were already in operation, Comcast estimates that its operating cash flow Comcast's fiscal year 2009 -- the amount of its revenue that the company can spend on itself, after expenses -- would have been $2.8 billion. An estimated 82% of that amount would have come from cable channels, largely through affiliate fees.

During this morning's call, COO Burke tried to play down some of these figures, saying that the annual rate of increase in affiliate fees may taper down into the "mid-single digits" over time. "Trees don't grow to the sky," he said. But you could almost hear the smirk in his tone of voice, as though he knew exactly where the jackpot was and believed he had the key to it.

Here is where we realize the extent to which the deal upsets the general belief about the order of precedence in the television industry. Analysts saw this right away and pounced on it: Comcast made a very important point this morning of stressing the contribution of its network of regional sports channels -- something it already owns -- as an element of the deal, as if that were something Comcast was buying. Why would Comcast phrase it as something it was adding to its arsenal if it already owned it?

The answer lies in attribution: By associating Comcast's existing regional sports network with NBC Sports -- the producer of the Olympic Games, the home of Sunday Night Football, and the employer of sports programming legend Dick Ebersol, whose position there appears very, very secure today -- the perceived value of Comcast's RSN rises, just as if that property were acquired. And that's important because regional sports is the tool Comcast has successfully used in recent years in its bargaining with cable and satellite systems for substantiating its ever-higher affiliate fees. Local sports, often at the high school level, is a staple of cable programming. When affiliate deals aren't renewed, Comcast yanks its RSN feeds from subscribing content providers. Customers immediately complain as STBs get turned back in, and before long, the affiliate deals are renewed.

Where regulators will likely strike first

The NBCU deal lends value to Comcast's principal bargaining chip in maintaining high affiliate fees. In a statement this morning, the president of the American Cable Association, Matthew M. Polka, pointed to this issue specifically as a reason why government regulators should nix this deal.

"Without broad government intervention, regulators in Washington, DC will see Comcast-NBCU wield its unprecedented power to drive up artificially the cost of its programming, particularly for its newly acquired local broadcast TV stations and its 'must-have' national and regional cable networks that air live sporting events," stated Polka. "Without restrictions, the new media conglomerate will also leverage its enhanced market power to force other pay-television providers to distribute all of its combined Comcast-NBCU programming on basic tiers, regardless of consumer interest in paying for this content."

And that's another key element: Comcast already owns the Style Channel, the Versus sports network, and the E! entertainment network, which not every pay-TV system in the country feels it needs to cover in its "basic" service. NBCU, meanwhile, operates two of the country's hottest cable properties, Bravo and USA. Comcast certainly could -- and probably will -- offer the entire slate to pay-TV systems in an all-or-nothing deal for basic tier subscribers. If you want Bravo, it may tell them, you gotta have Style.

The new order of media

As was made evident today, the NBCU deal was not about The Tonight Show or Law & Order or even NBC Nightly News. It was about Top Chef.

If federal regulators do raise objections to or concerns about this deal (as is likely to happen), they will be about affiliate fees. They will not be about broadband service rates, which are an entirely different part of Comcast's business. Comcast is not restructuring here. And as Comcast's executives made clear, its intention is for all of the free cash flow generated from the new NBCU, or whatever it's called, to be reinvested in NBCU's existing businesses. So revenue from cable will be redirected to cable and cable content, not to offset possible future revenue declines from broadband service.
Thus the theory that Comcast could appease regulators by saying revenue from cable, television, and film could help keep broadband utility rates low, goes out the window.

In fact, the two elements whose names form the company Comcast will control, NBC and Universal, are frankly incidental players in all of this. The NBC broadcast network will contribute 11% of revenue to Comcast following the joint venture's creation, Comcast estimates, and 0% of that revenue will contribute to cash flow because NBC is a money-losing business. Comcast expects to garner more cash flow from Universal Studios' theme parks than from NBC. Universal, meanwhile, will provide about 2% of Comcast's OCF.

This is not a merger deal like AOL Time Warner or CBS + Viacom, but a change in control. And while those mergers failed spectacularly, this buyout may yet succeed. Still, deals of this nature often result in spinoffs of properties discovered to be of lesser importance. And it's altogether possible that, come 2012 or so, the two most expendable components of this deal, sold perhaps to some interested investment banking consortium outside of US borders, will be the NBC Television Network and Universal Studios.