The COVID-19 Pandemic Has Accelerated The Inevitable Decline Of Linear TV

For more than 20 years, the U.S. linear TV sector has been supported by two solid predictable revenue streams: affiliate fees and advertising revenues. Now, both revenue streams face tremendous secular pressures.

Audience ratings for linear TV are deteriorating at an alarming pace. According to Nielsen, total day audience ratings year to date declined 15% year over year for the four major English-language broadcast networks and 18% for the cable networks, despite the return of original programming and sports, which were missing in 2020 because of the COVID-19 pandemic. Most worrisome, these declines include sports programming (e.g., linear TV ratings for the 2021 Tokyo Summer Olympics declined 40% compared to the 2016 Rio Summer Olympics, though the NFL continues to defy these trends), news, and special events (the ratings for the Academy Awards declined nearly 56% from 2020), which have historically been viewed as highly desirable content that was best viewed upon airing.

We believe these declines are likely to worsen. The parent media companies are increasingly prioritizing placing new original content on their owned direct-to-consumer (DTC) streaming services rather than on their legacy linear TV networks. Over time, these audience declines will weaken the operating and financial performances of linear TV network operators. Ad inventory pricing will eventually decline, which is something that we have been concerned about for years but have yet to see materialize. In addition, declining audiences will affect the networks' carriage negotiations with the pay-TV distributors. We are already seeing more acute evidence of this with the regional sports networks (RSNs) and premium cable networks. We believe the pay-TV distributors will be more successful in limiting per-subscriber price increases, which, when coupled with annual 5%-7% pay-TV subscriber declines, will lead to declining affiliate revenues--the bedrock of the media industry's cash flow.

In our opinion, the only uncertainty is how quickly TV's decline will happen. This commentary will explore that decline and what it could mean for the various linear TV networks. Our goal is to help investors identify which media companies' TV portfolios are most vulnerable to these declines and thus, which media companies are most vulnerable to changes in credit ratings.

The Impact Of Secular Pressures Varies By TV Subsector

The U.S. TV media sector consists of many subsectors with different competitive dynamics (chart 1). This includes the national broadcast TV networks, local TV stations that are affiliated with the national networks, cable networks, RSNs, and premium networks. Cable networks can be further divided into general entertainment, children, lifestyle, news, and sports. We view the decline of linear TV as a credit negative for the entire TV media sector, though the degree varies by subsector, with some subsectors experiencing a quicker deterioration in operating metrics.

Chart 1

Broadcast TV networks

The broadcast networks are the anchor of the TV ecosystem and are, in our opinion, the best positioned of the TV networks because of their over-the-air national reach (reaching 100% of the country, which no other content distribution platform can replicate). Additionally, the broadcast networks have the broadcast rights for key sports leagues, including the NFL, which recently renewed its domestic broadcast TV contracts through the 2033-2034 season). As a result, the broadcast networks are generally included in all legacy and virtual pay-TV video bundles, and they have the least risk of removal from the bundle.

We expect the risks to the broadcast network model to come from both cord cutting and audience ratings declines, which will affect both affiliate fees and advertising, respectively. Of the two revenue streams, advertising revenues are more vulnerable because the broadcast networks may no longer be able to justify charging the highest advertising prices (cost per mille, or CPMs) given smaller audiences. The networks can better justify their high affiliate fees because they will continue to carry premium sports programming for years.

Interestingly, the broadcast networks have hedged their exposure to pay-TV subscriber declines. The networks have largely moved to a fixed per-station reverse-retransmission fee model (fees that the local TV station affiliates pay to the broadcast networks). This transfers the cord-cutting risk to their affiliated local TV station partners, who are still paid by the pay-TV distributers on a per-subscriber basis.

Local TV stations

We believe local TV station affiliates, like their broadcast network partners, are best positioned to withstand the secular pressures on their businesses because the stations are generally the networks' direct connection to viewers (including the owned and operated TV stations). We believe the greatest risks to the local TV station revenue model come from pressures on net affiliate fees as pay-TV subscribers decline. Local TV stations are growing retransmission revenues faster than pay-TV subscribers are declining. We believe the TV station operators will be able to increase retransmission rates for at least the next retransmission contract cycle (typically two to three years). After that, we believe retransmission revenue growth could flatten or potentially turn negative if the annual retransmission rate escalators cannot offset annual pay-TV subscriber declines. How quickly this happens depends largely on how successful the TV station operators are in negotiating large price increases. The greater the price increases, which the pay-TV distributors will automatically pass directly to consumers, the faster customers will cut the cord. Local advertising, which accounts for more than 75% of local TV station advertising revenues, faces less risk than national advertising of losing local advertisers to digital platforms because local advertisers have limited options to reach broad local audiences.

We will closely monitor the tug of war between the local TV stations and broadcast networks over retransmission/reverse retransmission fees. This relationship may become more contentious as the broadcast networks pay considerably more for sports broadcast rights and their parent companies increasingly prioritize premium programming onto their streaming services over their broadcast networks, reducing the amount of appealing content on TV.

Additionally, while local TV stations negotiate retransmission deals directly with legacy pay-TV distributors, they do not negotiate retransmission contracts directly with the virtual pay-TV distributors. These contracts are negotiated by the national broadcast networks, and the local TV stations can opt in. While the economics between virtual and legacy pay-TV subscribers is relatively comparable for local TV stations, this could change if the networks sign deals with virtual pay-TV distributors that lower the share of revenue given to the local TV stations. As the base of pay-TV subscribers becomes increasingly virtual, this risk grows.

Domestic cable TV

The domestic cable TV networks, broadly, are highly vulnerable to the health of the pay-TV video bundle because these networks lack over-the-air distribution and thus lack an alternate way to reach consumers. The degree of vulnerability differs by type of cable network and specifically if that network is fully distributed (carried in the basic pay-TV video bundle) or carried in a second- or third-tier pay-TV video bundle. Fully distributed networks are likely to experience lower subscriber losses because they are more likely to be carried in both skinny bundles and virtual bundles.

General entertainment networks

These networks include Turner's TNT and TBS, NBCU's USA Network, AMC Networks, ViacomCBS's Paramount Network, and Disney's Freeform. These networks charge the highest affiliate fees among the non-sports/news-focused cable networks, yet they face steep audience declines because of limited original programming. In addition, a lot of the licensed syndicated programming on these networks (movies, situational comedies, etc.) can also be found on streaming services. We believe the parent media companies recognize this issue and have tried to support these networks with sports programming (TNT and TBS carry the NBA, MLB, and the NCAA men's basketball tournament; USA has WWE wrestling and will inherit additional sports programming after NBC closes NBC Sports Network later this year). Given the limited sports programming compared to networks that carry all sports, such as ESPN, this programming strategy may slow the decline for these networks, but it is unlikely to prevent their longer-term demise.

Lifestyle

At first glance, lifestyle programming appears to be more vulnerable to cord cutting than other cable network genres because of the abundance of similar programming on streaming services. However, we believe lifestyle networks are less vulnerable to being dropped from or retiered within pay-TV bundles because they charge relatively low affiliate fees and still generate steady audience ratings. Lifestyle networks typically have sizable content libraries that don't become stale as easily as other content genres, and while the content isn't generally considered must see (i.e., not strong enough to draw in new pay-TV subscribers), it can still keep viewers engaged.

News and sports

We have historically viewed news and sports as the glue holding the pay-TV bundle together, because the content is often exclusive to TV and is overwhelmingly watched live. While still the most attractive content on TV, the draw of news and sports is weakening as both genres are increasingly available online. Notably, both CBS and NBC simulcast their NFL broadcasts on their streaming services, and Disney will simulcast some regular season NHL games on ABC or ESPN and its ESPN+ streaming service.

Not surprisingly, many media companies have over the past year announced plans to start offering live news and sports on their streaming services. In August, Fox announced plans to launch "Sports on Tubi," an ad-supported service that will include live and on-demand sports content, including professional football, baseball, soccer, and collegiate sports. News content is similarly moving increasingly online, with Turner's CNN planning to launch CNN+ in early 2022 with daily live content and Fox offering its Fox Nation streaming service to its Fox News superfans.

Children

Cable networks focused on children's programming face increasing obsolescence and cannibalization from streaming services. These streaming services see children's programming as the key to subscriber growth and minimizing churn. Children don't depend as much on new original content because they will repeatedly watch library content. Given the success of Disney+, Disney shut down 30 networks in fiscal 2020, including Disney Channel, Disney Junior, and Disney XD in select overseas markets. The company also announced plans to close an additional 100 networks in fiscal 2021 as it shifts more content to its streaming platform.

RSNs

The RSNs (largely owned by Sinclair Broadcast Group Inc.) broadcast local sports, primarily MLB baseball, NBA basketball, and NHL hockey. We believe the RSNs will likely experience higher subscriber losses than the industry average. The RSNs charge high affiliate fees (table 1), and many are available through second- and third-tier packages within the bundle, making them more vulnerable to consumers downgrading to smaller (skinny) pay-TV bundles that are unlikely to include the RSNs. In addition, the RSNs are not universally carried by the virtual pay-TV distributors, thus missing out on the only pay-TV platforms that are growing. For example, both Sling TV and Philo do not carry RSNs, and both YouTube TV and Hulu Live stopped carrying Sinclair's RSNs in 2020.

Sinclair has announced plans to launch a streaming service for its RSNs in the first half of 2022. While the streaming service could attract new subscribers from outside the pay-TV ecosystem, we believe it will likely cannibalize some of the company's existing RSN subscriber base.

Table 1

Premium networks

The premium cable networks (HBO, Showtime, Starz, and Epix) charge a separate subscription fee above the price for the basic pay-TV video bundle. These premium networks are particularly vulnerable to substitution risk as their parent media companies prioritize their streaming services over their premium networks. These companies view DTC services as critical to their long-term success and will increasingly prioritize new programming on their streaming services at the expense of their premium networks, further diminishing the importance of these networks to the pay-TV ecosystem.

Spanish-language

Like its English-language peers, we believe the Spanish-language broadcast networks are better positioned than their cable network peers because of their over-the-air reach and key sports rights, such as Liga MX, the Mexican football league. Despite this, we expect subscriber declines for the Spanish-language broadcast and cable networks will exceed the industry average because they are not universally carried by the virtual pay-TV distributors. In September, Univision Communications Inc. announced it reached an agreement with YouTube TV to fully distribute its services. That said, while the Spanish-language networks face the same secular pressures as their English-language peers, we believe the pressures are less immediate because only 10% of the global Spanish-speaking population uses a streaming service (compared with 70% for the English-language market), according to Grupo Televisa S.A.B.

The Effect On Ratings Is Company-Specific But Broadly Negative

We believe the decline of the U.S. linear TV sector is inevitable, but the pace of that decline will vary based on the TV genre. Still, even if the TV network mix is more favorable (i.e., broadcast networks and sports- and news-oriented cable networks), overall exposure to the U.S. TV ecosystem is a credit negative given the oversized earnings that the media companies have come to depend on from this sector. The effect on credit ratings is company-specific and depends on exposure to the various TV subsectors and diversification with other businesses. For example, our issuer credit ratings on Comcast Corp. and Walt Disney are less affected by the decline of their domestic TV operations because 1.) both companies have other large businesses that provide earnings diversity (such as Comcast's cable business and Disney's theme parks), 2.) they own broadcast networks (Comcast operates NBC, and Disney operates ABC), which we believe have a longer runway, and 3.) they own DTC streaming services, which somewhat offset traditional pay-TV declines.

On the other hand, we consider Sinclair and AMC Networks to be more vulnerable to these sector declines. Sinclair's Diamond Sports business unit is the largest domestic RSN operator, and AMC only operates five domestic linear general entertainment cable networks. In January, we lowered our assessment of Sinclair's business profile because of the RSNs' underperformance (see our research update, "Diamond Sports Holdings LLC Rating De-Linked From Parent, Lowered To 'CCC+'; Outlook Negative," published Jan. 27, 2021). Last year, we revised our assessment of AMC's business profile because of its exposure to the secular declines in the U.S. linear TV ecosystem (see our research update, "AMC Networks Inc.'s 'BB' Rating Affirmed; Business Assessment Revised On Market Positioning; Outlook Stable", published Aug. 31, 2020). Our ratings on other media companies are vulnerable to the decline of linear TV, and thus, investors should view the actions that we took on both companies last year as the first of many to come.

As we have pointed out in past commentaries, we anticipate that our view of these businesses will weaken in advance of a weakening in credit metrics. In most cases, companies will be able to maintain credit measures even as their underlying TV businesses weaken. Thus, we could potentially revisit our business risk assessments or tighten rating thresholds as the U.S. pay-TV universe declines well before we lower credit ratings.

Chart 2

Relevant Research

• U.S. Media And Entertainment Industry Check-In, Sept. 1, 2021
• How The Decline In The U.S. Television Ecosystem Could Squeeze Credit Ratings, April 22, 2021
• Gauging The Business Risks Of Local U.S. TV Broadcasters, April 15, 2021
• Diamond Sports Holdings LLC Rating De-Linked From Parent, Lowered To 'CCC+'; Outlook Negative, Jan. 27, 2021
• AMC Networks Inc.'s 'BB' Rating Affirmed; Business Assessment Revised On Market Positioning; Outlook Stable, Aug. 31, 2020