Cable Operators

Cleaning Up on Closing DVD Window

1/26/2007 7:00 PM Eastern

Pay-per-view movies sold on demand, now a middling source of revenue for cable operators, could become a much bigger deal as providers and movie studios increasingly implement debut dates that coincide with the release of DVDs.

Sanford Bernstein cable and satellite analyst Craig Moffett's view, in a widely quoted report last week, is that as on-demand release dates for movies move closer to the dates when movies are distributed for sale and home rental, sales and profits for pay movies on cable could increase significantly.

Moffett estimates on-demand movie revenue now stands at about $1 billion annually for all cable operators. That could swell to $4.1 billion per year if the current gap between home-rental and on-demand release dates shrinks, Moffett calculates — or about half the size of the current retail market for home movie rentals.

Profit On Demand
Incremental revenue and profit to cable operators (in millions of dollars) from movies on demand:
Cable Incremental Economics Current Partial Transition to VOD Full Transition to VOD
VOD Film Revenue $1,000 $4,100 $8,200
VOD Film Profits $400 $1,640 $3,280
Cable Incremental Profit -- $1,240 $2,880
Source: Company reports, Sanford Bernstein analysis

TESTS BY BIG TWO

Already, the two largest cable operators — Comcast and Time Warner Cable — have been testing so-called day-and-date releases of on-demand movies. Comcast began its trial in Pittsburgh and Denver on Nov. 28 with selected titles from Warner Bros., Paramount, Lions Gate, NBC Universal and 20th Century Fox.

Time Warner Cable is also testing day-and-date releases in Greensboro, N.C., while also testing a “virtual video store” emphasizing a large library of more than 2,000 titles — about the same number of titles available at a typical Blockbuster retail store and 10 times larger than a typical on-demand movie menu, Moffett said.

The rise in digital-cable penetration over the past few years and the subsequent increase in on-demand service availability also play a role.

Digital boxes were in about half of all cable homes at the end of 2006, according to Moffett. On-demand availability to those digital customers has risen to about 84.1% from a mere 19.4% in 2001.

More customers are using on-demand capabilities as they become more familiar with the technology. Moffett points to big VOD promoter Comcast, which delivered 180 million on-demand video streams in December alone. For the full year, Comcast delivered 1.9 billion VOD streams, up 70% over 2005.

Moffett estimates Comcast had about $480 million in on-demand movie revenue in 2005, which could nearly double to $800 million in 2007 as the release “windows” shrink.

NON-ADULT REVENUE

Most on-demand movie revenue and profit by cable operators comes from sales of adult titles, which wouldn't be affected by a move to day-and-date releases. Still, the impact on overall VOD movie buys is significant.

Comcast's non-adult VOD movie revenue is estimated at about $295 million last year, up from about $226 million in 2005. Moffett thinks that non-adult revenue could nearly double, to $434 million this year.

Comcast and Time Warner Cable, with 24.1 million and 13.5 million subscribers, respectively, would obviously derive the biggest benefit from earlier movie releases. Moffett estimates that within Comcast territory, about $3.2 billion of annual DVD rental revenue is generated — with more than half of those rental payments made by existing Comcast customers.

Studios have resisted day-and-date releases via on-demand because of fears of cutting into lucrative retail DVD sales. But Moffett thinks that's less of a concern now. It's unlikely that day-and-date VOD releases would totally wipe out DVD sales.

And if cable's VOD-movie business carved out half of the $8.2 billion (annual revenue) retail home-video rental business, that would add incremental profits to the studios, as well as to cable.

Cable VOD movie revenue would quadruple, to $4.1 billion, and cash flow would rise to $1.64 billion, an incremental gain of $1.24 billion.

MORE STUDIO PROFIT

The studios get a bigger percentage of VOD movie sales than they do of home-video rentals from retail stores. Studios take 66 cents of every dollar of on-demand movie sales from cable, versus 33 cents for each retail rental dollar. So the studios would enjoy $2.2 billion in incremental profit from a big swing to VOD, according to Moffett.

Earlier release dates for movies on demand also would aid cable's competitive position against direct-broadcast satellite services. While DirecTV and EchoStar Communications have announced plans to emulate VOD via a combination of digital video recorder downloads and digital subscriber line broadband links, the DBS version of VOD still falls short of what cable can provide, Moffett said.

“A movie can take hours to download over [satellite] VOD, and [a high-definition movie] could take more than a day for many DSL subscribers,” Moffett wrote. “That's a far cry from the instant gratification of cable VOD.”

BIG EDGE WITH HD

Cable's biggest advantage could be in selling high-definition movies on demand.

While the studios' struggling over which format to adopt — Blu-Ray or HD-DVD — for home videos could stifle purchase of high-definition home-video players, that dispute is irrelevant to cable's selling HD movies on demand.

HD movies on demand also could benefit cable in that retailers such as Wal-Mart and Circuit City don't expect to see big sales of HD DVD discs because of the high costs of players and the competing formats.

“Retailers, including Wal-Mart, are a key impediment to getting better [earlier[ windows for movies,” Moffett wrote. “Their opposition to earlier HD windows may be less vehement, however, if there are few retail sales at stake.”