Ready for Takeoff

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Last fall, when Cablevision Systems Corp. announced its plan to break up its programming arm, Rainbow Media Holdings Inc., into several parts, it caused more questions than answers. There was logic to separating the national cable networks from the regional sports, news and music interests. But the questions quickly centered on new direct broadcast satellite service Voom, which was also destined to spin off with Rainbow’s three national services.

Most industry watchers agree with Fulcrum Global Partners analyst Richard Greenfield that “Voom has really been a drag” on Cablevision stock, and it’s the main reason for splitting Cablevision from Rainbow. The question now becomes: How viable will the new Rainbow be?

“Rainbow Media should be viewed more as a start-up company rather than a spinoff of an existing profitable entity,” says Larry Gerbrandt, the Los Angeles-based media and entertainment analyst for the financial consulting firm AlixPartners LLC.

To that end the reorganization makes sense for Cablevision to hang onto its interests in established regional channels — the local MetroChannels, News 12 Networks, as well as Rainbow Sports Networks and Fox Sports Net. Also in the Cablevision mix is Fuse, a reincarnation of the MuchMusic service, and the Clearview Cinemas theater chain.

The new spinoff, dubbed Rainbow Media Enterprises, will include two divisions. Rainbow Programming, which contains AMC, WE: Women’s Entertainment and the Independent Film Channel, as well as Rainbow’s on-demand services, Mag Rack and Sportskool. The Rainbow DBS division will contain Voom.

In theory, Rainbow Media will be able to move into new ventures more quickly, whether it’s a new digital network, on-demand programming or an HDTV offering, says Gerbrandt.

“There’s only a finite amount of server space [on the cable systems Rainbow seeks to attract and maintain as clients], and Chuck Dolan knows that,” says Gerbrandt, referring to Cablevision’s founder. “He prefers to move into that space early rather than buy the space later for a premium.” It’s no accident that Dolan — well known for his entrepreneurial drive — is switching chairmanships from Cablevision to Rainbow Media Enterprises. Likewise, Josh Sapan, the current president and CEO of Rainbow Media Holdings, will lead the new company.

AMC, WE and IFC are intended to grow Rainbow in the immediate future. “They’re all good companies” says Greenfield.

The most successful is AMC, which is currently in 86 million households. But in some regards it is also the most challenged. No Rainbow or Cablevision executives would make themselves available for this article, apparently due to the quiet period that precedes most imminent spinoffs.

But observers from outside the company note that in recent years AMC moved from a subscription business model to dual revenue streams. With the addition of ads, AMC has revised its programming strategy to lower the average age of its viewers by scheduling more contemporary movies.

Despite that change, made in 2002, AMC’s prime time ratings were stagnant at a 0.8 between the second quarter 2003 and the same period in 2004, according to Nielsen Media Research. Viewership in the network’s most desirable advertiser category, adults 18-49, has inched up a mere 3% in prime and only 4% in the 25-54 demographic, according to a source outside. “Half of those gains were attributable to adding more households,” says the source. What’s more, the median age of its viewers between second quarter 2001 and 2004 in prime time has hardly changed — 55 years old in 2001 versus 54 today, the source says.

In Gerbrandt’s opinion, AMC’s importance to Rainbow has increased following the sale of Cablevision’s interest in Bravo to NBC in 2002. “In selling off Bravo, Rainbow lost its [chief] advertising vehicle,” he notes.

That isn’t AMC’s only challenge. Last summer’s accounting improprieties led to the dismissal of AMC Networks president Kate McEnroe and 13 other employees. Cablevision says third party investigator Wilmer, Cutler & Pickering has completed its investigation and has found no new accounting problems. As of March, the Securities and Exchange Commission and the Justice Department were still conducting their investigations.

What’s more, Time Warner Cable has taken issue with AMC’s decision to drop classic movies. Time Warner last September threatened to dump the network, but as of January, the MSO has agreed to carry AMC on a month-to-month basis paying lower carriage fees. It is still in litigation.

Regardless, AMC’s recent financial performance is on the upswing. Its revenues increased 26% last year, and are projected to jump this year at least 20%, or $301.5 million, according to Kagan World Media. Some 28% of AMC’s revenue comes from advertising, and it has one of the shortest commercial pods in the industry at 10 minutes per hour, says a source.

AMC appears to be just a signature-show away from mainstream. And the same could be said for IFC and WE.

WE, which targets women aged 25-49, currently reaches 56 million viewers. The channel has revved-up its programming offerings with series and specials, but it still trails its two main competitors. For example, in the 25-54 adults category, WE ranked 45th among Nielsen measured channels in total day viewership (with 50,000 average viewers), Oxygen was No. 39 and Lifetime was No. 4 during the second quarter 2004.

According to Kagan, WE’s revenues should top $121 million this year, and cash flow should reach $28.8 million.

Meanwhile, with a television network, film distribution unit, production unit and video-on-demand service, IFC is working hard not just to grow its audience but to become a major force within the independent film community. The network now has over 33 million subscribers, and this year’s revenues for IFC are estimated at $76.9 million, with cash flow of $24.7 million, according to Kagan.

IFC also co-distributed Michael Moore’s Fahrenheit 9/11, one of its most noteworthy successes this year. Though it recently shuttered its Rant magazine, IFC is extending its brand with the purchase of a theater in New York’s Greenwich Village that will showcase indie films, and provide a resource center for filmmakers.

VOOM CONTROVERSY

No part of Rainbow Media is more controversial than its DBS division. The HDTV-focused Voom debuted last October, and the early results are disappointing with only 8,000 subscribers and $1 million in revenues. According to Cablevision’s first-quarter earnings statement for 2004, its losses were pegged at $54.8 million from the year-earlier period.

“The biggest challenge [for Rainbow] will be how to finance Voom,” says Greenfield. No one disputes that, but Gerbrandt notes that Chuck Dolan has “had many more success than failure. And if there’s one thing he knows, it’s upscale consumers — which is the exact target for Voom.”

Regardless, Rainbow DBS executives have moved on several fronts to improve Voom’s appeal. One of the most pressing concerns for consumers was the initial cost of the channel. At $749 for the equipment, installation and six-months of basic HD programming, the upfront charge was too steep to stimulate a lot of buyer interest. This spring Voom introduced a lease option for its equipment. Now consumers can either lease the receiver for $9.95 per month or purchase the unit for $499.

Voom has also improved its distribution. Originally, Sears, Roebuck & Co. held the exclusive retail-distribution rights. Now that is expanding to include Crutchfield Corp. and BrandsMart USA.

The monthly subscription cost remains the same: $39.90 for basic and $79.90 for premium service. But Voom has added new channels, boosting the number of HD channels to 35, up from 21. The service also has increased the amount of standard-definition fare and music channels for a total offering of over 120 channels. Still missing from Voom’s lineup are three of cable’s top 10 channels: Lifetime, USA and Fox News.

Voom also is increased its satellite capacity and footprint. This spring, Rainbow DBS leased 16 transponders from satellite provider SES Americom Inc. This month, the company successfully bid $6.4 million for two additional DBS slots at a Federal Communications Commission auction.

Although this latest purchase was “a remarkable bargain” according to Merrill Lynch & Co. media analyst Jessica Reif Cohen, Voom still has a long way to go to reach solvency and satisfy its critics.

Gerbrandt points out that Voom is targeting the fastest-growing segment in the business: homes with HDTV sets. “There’s a minimum of [HD] content out there,” he notes. The Yankee Group estimates that demand for HD sets is likely to double in the next two years, and prices for the sets will continue to decline from the current average cost of $1,295.

As Rainbow Media counts down to its impending spin off, tweaking its various properties to their best advantage, it’s clear that investing in Rainbow won’t be for everyone. But it should attract investors looking for the entrepreneurial drive that has characterized Chuck Dolan’s business style over the decades. Janet Stilson contributed to this report.

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