Aereo: Pay TV Ecosystem Disruptor or Minor Industry Irritant?

April 4, 2013

The Second Circuit Court of Appeals affirmation this week in favor of Aereo in its copyright infringement battle with a group of 17 television broadcasters received considerable media, investor and industry attention. The ruling affirms an earlier District Court decision and is a setback for the plaintiffs, which sought an injunction that would have effectively put Aereo out of business. In a press release following the court’s decision, a triumphant Aereo announced plans to expand its service beyond New York to 22 new markets. The legal wrangling is not over, though the rulings would seem to make the plaintiff group of broadcasters an underdog when the case gets to trial.

For those uninformed, Aereo is a start-up company that has assembled tiny, advanced reception devices in Brooklyn for the purpose of receiving free, over-the-air broadcast signals. It then encodes the signals into an IP feed, adds graphics and user interface, DVR capability and streams a package of linear television to laptops, tablets and smartphones of subscribing customers for around $8 per month. Aereo subscribers in the New York area receive live TV when connected to the Internet. Aereo currently delivers the entire suite of over-the-air channels in New York, including WCBS, WNBC, WNYW (Fox), WABC, some smaller network affiliates, PBS, shopping channels, a handful of Spanish-language channels and Bloomberg TV.

Casual observers are forgiven for being puzzled why broadcasters are vehemently opposed to a service that could deliver more viewers to its programming and enhance value for its advertisers. Indeed, Aereo brings a whole new audience category for broadcasters – the out-of-home viewer who may be a train or bus commuter, auto passenger, waiting room patient, etc. Further, broadcast signals have always been transmitted free, over-the-air on public spectrum. Why are broadcasters now opposed to enhanced access to its original transmission method?

The answer is that a legally validated Aereo (or merely its business model) imperils a relatively new and increasingly significant broadcast revenue stream known as retransmission fees. If Aereo can legally retransmit broadcast signals without paying for them, why should cable and satellite providers pay hundreds of millions of dollars per year to the broadcasters for rights to retransmit the same product? Could not cable or satellite companies bypass the current retransmission fee model by developing a similar antenna technology or buying Aereo to receive the over-the-air signals and integrate them into their programming packages?

The legal dispute hinges on whether Aereo’s reception and repackaging of the broadcast signals should be considered unauthorized retransmission or whether its service merely redirects broadcast signals (for commercial intent) that have been received by rooftop antennas for 70 years. Broadcasters argue that copyright infringement occurs when the signal is repurposed for resale; Aereo claims that by leasing a dedicated antenna in Brooklyn to each subscriber the signal is received in a copyright-compliant manner, no different than if the antenna was on the subscriber’s own rooftop. Aereo retransmits broadcast signals on a one-to-one basis – “unique copies…created at its users’ requests…” in the language of the judge, rather than streaming to many subscribers from a single over-the-air receiving device. This is a very important distinction that seems to sidestep the “public performance” threshold that would likely cross the copyright infringement line.

Assuming the legally fortified and Barry Diller-backed Aereo is fully funded for aggressive expansion, as it claims, among the issues for investors to consider are:

Q: Is Aereo a quality product? 

A: Yes, sign-up is quick and easy, video quality is high, channel guide and user interface is intuitive and attractive and the DVR recording feature is a nice bonus.

Q: Is its value proposition compelling at $8 per month? 

A: Certainly it is in comparison to the $76 average video bill charged by cable and satellite. Perhaps it’s not when considering that Aereo’s service can be partially replicated for free by simply receiving the broadcast signals at home but that solution requires a television, antenna, some installation and unobstructed reception. The fact that Aereo serves connected computers, tablets and smartphones anywhere in the given television market area (as validated by IP addresses) adds considerable value.

Q: How many customers might subscribe?

A: Difficult to say. Maybe 5% of households in given market at maturity and perhaps a bit higher in markets like New York with more over-the-air channels, robust wi-fi availability and a higher number of public transportation commuters.

Q: Will it appeal primarily to commuters who might otherwise retain cable or satellite subscriptions at home? Or will it induce cord-cutting by appealing to people who are cost-conscious, satisfied with a broadcast-only lineup and not in need of hundreds of channels? 

A: Probably both but with more customers coming from the latter category. Given the six Spanish-language channels on Aereo in New York, Spanish-speaking households would seem to be solid prospective customers. College students and lower income households may be good targets as well.

Q: Is Aereo friend or foe to cable and satellite providers? 

A: Primarily foe at least until cable and satellite offer authenticated, linear programming to second screens outside the home and become more consumer-friendly with its pricing and bundling. Aereo is an inexpensive service that is likely to siphon off lower-end video customers and accelerate subscriber erosion. It’s conceivable that cable could replicate Aereo’s technology or buy bulk subscriptions from Aereo (for below the price of broadcast retransmission fees) and integrate into its programming bundle but that sounds like a clumsy solution. For cable providers, the value of the broadband pipe and cable authenticated wi-fi is reinforced. Expect cable providers to continue boosting bandwidth throughput and performance to support IP video and for data pricing to rise to offset weakness in the video business. Without a data solution, satellite continues to most at risk here, though a case can be made that satellite’s strength is in smaller markets and more rural areas that aren’t likely to be priorities for Aereo.

Q: With the possibility of being litigated out of business still looming (though no longer likely), will Aereo really commit to millions of dollars to launch service in 22 markets plus the marketing spend for subscriber awareness and acquisition?

A: It sounds like they will, though it’s likely to be a measured roll-out. Aereo may achieve maximum leverage with litigants and prospective partners and acquirers by making grand announcements and proceeding cautiously.

Q: Which 22 additional markets are planned for launch?

A: The list is here --

Q: Will Aereo find a deep-pocketed partner or acquirer and who might that be?

A: Probably but not until the legal challenges to Aereo have been exhausted. A strategic rationale can easily be made for DISH or DirecTV to acquire Aereo, more likely DISH. DISH owns Slingbox, a place-shifting television technology with some similarities to Aereo, it has $10 billion of cash on its balance sheet and Charlie Ergen has been outspoken about rising programming fees. Time Warner Cable could also be a potential suitor given its exposure to cord-cutting in New York and several of the new Aereo markets. Comcast, of course, is not likely to be interested given its NBC ownership.

Q: Why have the stocks of television broadcasters held up so well this week after the Aereo court ruling despite the potential for retransmission fees to be impacted?

A: Most retransmission agreements with cable and satellite providers are in place with built-in fee escalators and the Aereo competitive threat is not yet material. Perhaps also investors think broadcasters could do what Time Warner’s WTBS did in 2007 by converting away from broadcast to a “cable” channel eligible for carriage fees. If broadcasters cease over-the-air broadcast delivery and go to a fiber-based solution, retransmission fees would be preserved, even enhanced, and Aereo would have no business. But that’s not a likely development anytime soon.

Q: Is there an indirect way to invest in these developments?

A: Key trends are advanced television implementations, second screen viewing and the ultimate conversion to pure IP video networking. The software companies that enable video conversion to IP and connected devices as well as those that deliver solutions for real-time, targeted advertising insertion are likely winners. Accordingly, Twinleaf accounts own SeaChange (SEAC), TiVo (TIVO) and Envivio (ENVI).