As the cable industry waits for a consolidation wave to help it battle higher programming costs, broadcast station groups have taken matters into their own hands, engineering a flurry of deals over the past two years designed to significantly improve their positions at the retransmission- consent negotiating table.
Broadcast station groups such as Sinclair Broadcast Group, Nexstar Broadcasting Group and Tribune have announced acquisitions that have doubled, or nearly doubled, the number of stations they control. They have increased the number of stations they own in individual markets — creating so-called duopolies — as well as the number they operate through shared-services arrangements — creating “virtual” duopolies. Both give them a decided edge in retransmission-consent negotiations.
Individually, some broadcasters have seen retrans fees rise exponentially in the past five years. At Nexstar, for example, retrans fees increased more than four times, to $60.9 million in 2012 from $14.4 million in 2008. At Gray TV, which has 70 stations in the South and Midwest, retrans revenue rose ten-fold in the same timeframe, to $33.8 million in 2012 from $3 million in 2008.
Sinclair, no stranger to the retrans wars, has been the most aggressive, spending nearly $3 billion in the past two years to acquire 107 stations in 42 markets. When the dust clears — its latest deal with Albritton Communications is expected to close by the second quarter of 2014 — Sinclair will control 162 stations in 77 markets across the country. That’s up from 58 stations in 35 markets at the end of 2011.
Nexstar, one of the pioneers in extracting cash for retransmission consent, has also been on a buying spree. Over the past two years it has announced deals for 47 stations totaling $809.5 million.
And the wave isn’t stopping there. In June, Gannett Co. announced it would acquire Dallas-based broadcaster Belo Corp. in a $2.2 billion deal that would create a 43-station “Super Group,” and Tribune said it would buy Local TV’s 19 broadcast stations for $2.7 billion, raising its tally to 43 stations.
Even smaller broadcasters are getting in on the act. Last week, Gray TV announced it would buy four stations in Texas, Wyoming and Nebraska from Yellowstone Broadcasting for $23 million. It was the third station deal Gray has announced this year.
Despite the wave of deals, Noble Financial Group analyst Michael Kupinski said he believes there is still room for more transactions. “I think we are in the seventh inning of the broadcast consolidation game,” Kupinski said, adding that cash-rich station groups like E.W. Scripps have yet to make a big M&A splash and have room to grow.
Even groups like Sinclair, which will inch closer to the Federal Communications Commission cap that limits a single broadcaster to owning stations that reach 39% of U.S. TV households, see room to acquire even more. Although Sinclair will reach 38.7% of U.S. TV households after its deals close, per FCC rules the station group will be at only 24.5%, leaving plenty of run- way for more acquisitions. The FCC only counts half of a UHF station’s audience toward the 39% local-ownership cap (versus all of a VHF station’s audience).
Station group consolidation has not gone unnoticed in Washington. The FCC has sought public comment on the latest flurry of deals and also recently proposed eliminating the UHF discount, though a final vote has not been taken. If the FCC votes to eliminate the discount, Sinclair’s buying days could be over, but other groups would still have plenty of room to get bigger. The commission has also proposed subjecting some sharing arrangements to local-ownership caps, which could put a crimp on the buying sprees.
What is spurring all this investment in stations? While the broadcasters all cite cost synergies, efficiencies and an opportunity to capture a larger portion of local and national advertising revenue — and some could be eyeing a government payout in the spectrum auctions — one of the biggest factors is the potential to gain additional retransmission-consent revenue.
Retransmission-consent revenue for broadcasters has skyrocketed over the past several years, with SNL Kagan estimating it has increased six-fold from $500 million in 2008 to $3 billion by the end of 2013. SNL Kagan predicts retrans revenue will double again by 2018, to $6 billion.
And even that may be a conservative number. With the rise in the number of stations owned by groups like Sinclair and others, SNL Kagan senior analyst Robin Flynn estimated the retrans haul could go even higher.
“This is definitely one of the main driving forces behind the consolidation this year, and the ability to grow the retrans revenue of the acquired stations is definitely something that is impacting the M&A market,” Flynn said.
Flynn added that the case for consolidation isn’t solely in higher retrans fees. Bigger companies also have better cost efficiencies and carry more clout with their network affiliates. On that latter front, Kupinski said, bigger station groups also have the wherewithal to develop their own content.
“I think that over time these station groups are going to have to get bigger and bigger, because I think that they are going to have to start developing their own content,” Kupinski said. He added that as networks continue to receive reverse-compensation fees for all their programming, including more ratings-challenged shows, stations could replace some of that programming with shows that play better in their local markets.
But for cable operators, the growing M&A activity of the stations means only one thing: higher retrans costs.
American Cable Association CEO Matt Polka said small cable operators — the group most acutely affected by the consolidation wave — have seen retrans costs rise exponentially in the past few years. With broadcasters growing in heft and market power as they strike deals that give them control of multiple stations in the same market, those costs are only expected to climb higher.
“We’ll definitely see some impact in the next round of retransmission-consent [deals],” Polka said “If you control more than one must-have stream of programming, you can charge more for it; it’s as simple as that.”
Polka added that virtual duopolies play a major role in a broadcaster’s ability to raise its retrans prices. According to ACA’s own surveys of its constituents — it represents about 900 small and mid-sized cable operators across the country — retrans-pricing demands from a broadcaster that controls more than one station in a market increase by at least 20% and by as much as 160%.
Polka estimated that about 50 markets across the country are duopoly markets, and the number grows with each passing deal.
FCC regulations prohibit one company from owning more than one television station in a particular market. But in the past, station groups skirted those regulations by setting up separate entities — called “sidecar” companies — that would own the additional stations, or by setting up local marketing arrangements or shared-services agreements with other station owners that would give them control over managing and negotiating deals for those additional stations.
Gannet plans to use that strategy as part of its $2.2 billion acquisition of Belo. As part of that deal, Gannet will have two stations in several top 100 TV markets, like Phoenix, St. Louis and Tucson, Ariz., but will stay within FCC rules by having a separate entity own the second station in each market. The ACA — which along with Time Warner Cable and DirecTV has formed the American Television Alliance (ATVA) and petitioned the FCC to block the deal — said these sidecar companies are created only to circumvent the law.
“That, to us, is illegal because it violates current FCC media-ownership rules and it violates federal antitrust rules that prohibit collusive behavior,” Polka said. “They are being absolutely bold in thinking that these mergers are legal.”
For their part, broadcasters have stressed that what they are doing is strictly within the letter of the law and has passed FCC and Department of Justice scrutiny on every front. What’s more, despite some arguments that consolidation adversely impacts news coverage in local markets, Sinclair CEO David Smith said in a statement that consolidation has led to increased staffing and investment in the acquired stations.
“Not only have we created jobs, but we have added 81 hours of local news per week, allowing us to deliver an increasing number of meaningful local news stories to our viewers,” Smith said in a statement. “We have made significant investments to upgrade stations to high-definition newscasts so that our consumers can have a high-quality news experience.”
Broadcasters have made no bones about virtual duopolies being an important factor in selecting deals.
In releasing Nexstar’s third-quarter results Nov. 5, company chairman and CEO Perry Sook boasted that after its deals are complete, it will control multiple stations in 33 of its 51 markets, “consistent with our M&A criteria that emphasizes the development of duopolies.”
A day later, Nexstar announced a deal to purchase seven stations in four markets from Grant Co. for $87.5 million, boosting its number of duopoly markets to 36.
Mediacom Communications group vice president of legal and public affairs Tom Larsen added that much of the retransmission-consent impact from broadcast consolidation hasn’t been felt yet because deals haven’t come due. When they do, it can be expected that prices will rise accordingly.
“It all means higher prices for consumers,” Larsen said.
In some areas, it is already happening.
Nexstar, for example, increased retransmission-consent revenue by 69% in the third quarter and noted that it has about 27 retrans deals that expire before the end of the year. On a conference call with analysts to discuss third-quarter results, Sook said negotiations for those deals are ongoing and, aside from the initial pushback regarding price, are moving forward.
“We believe that content always wins in these discussions,” Sook said on the call, adding that Nexstar provides 1,300 hours per week of local content and another 100 hours per week of local lifestyle programming. “I believe that the local content holders and the national content holders ultimately have the upper hand on the distribution partners,” Sook said.
So what is an operator to do? ATVA member ACA is pushing the FCC to declare virtual duopolies and coordinated retrans negotiations out of bounds. New FCC chair Tom Wheeler has promised Congress to look into the retrans blackout issue, and thanks to ATVA efforts an FCC docket on retrans reforms is open. But Wheeler’s priority is incentive auctions and broadband deployment, and congressional Republicans have pushed back on the virtual-duopoy front, so near-term action beyond the UHF discount vote is unlikely.
Most operators, especially the small ones, may have to buck up and swallow the increases. The aftermath of Time Warner Cable’s recent month-long blackout of CBS — which resulted in the MSO losing more than 300,000 subscribers in the third quarter — has given broadcasters a solid advantage, at least in the near term. In the long term, distributors are hoping that regulatory reform will help. Although there seems to be some light at the end of that tunnel — Polka pointed to FCC and DOJ requests for additional information on several proposed mergers — few are holding their breath for any near-term change.
Some Congressional leaders have also made proposals for reform. Rep. Anna Eshoo (D-Calif.) introduced legislation that would allow the FCC to grant interim carriage during a retrans impasse, and Sen. John Mc- Cain (R-Ariz.) has proposed a la carte legislation. Most believe, however, that any substantial changes on the regulatory front are at least a year away.
“We have to just keep going back to Washington,” Larsen said. “It’s a long, slow crawl to get policy change.”
And then there is the case of simple inertia swinging the pendulum back in favor of distribution. With retrans fees in the range of $1 to $1.50 per subscriber, per month, and expected to rise past $2 in the next few years, broadcasters may simply price themselves out of the market.
“Retransmission revenues are definitely going to go higher,” Kupinski said, “but I worry about expectations from an investor standpoint primarily because I don’t think they expect any types of backlash related to that. There is always some risk in pushing retrans to the Nth degree. Those risks are pretty well known from the cable side, the consumer side and maybe even the network side.”
Flynn agreed. “Obviously something has to give at some point,” she said. “It’s not like they can just keep getting more and more fees from small operators without them having to raise rates to the extent where they’re losing a lot of subs.”
John Eggerton also contributed to this story.
Broadcast station groups are on a consolidation spree, driving up retransmission-consent revenue as they tip the balance of power in their own favor.