Multichannel operators put their own spin on sports rights costs

By Adam Swanson and Derek Baine

There has been quite a bit of chatter in the media recently about the dramatic increase in sports rights fees, which is eating into multichannel operators' margins. Many executives have spoken out about their inability to pass these fees on to consumers, as well as the continued decline in the profitability of video services.

We will see if operators indeed prove unable to pass fees through. According to news reports, in September,DIRECTV started quietly adding a surcharge of $3/sub/month for new customers who live in an area with more than one regional sports network, or RSN, such as Los Angeles and New York. The surcharge does not apply to the basic package, but that's not the package of choice for high-end DIRECTV subs.

The contracts with the RSNs probably require placement on the basic package and the inability to place the networks on a sports tier, but this strategy stays within those rules while grabbing additional revenue to offset spiraling costs for RSN carriage.

The surcharge hits four DIRECTV packages, including Choice and Choice Plus. About 20% of markets across the country have more than one RSN, according to DIRECTV.

The timing is not coincidental. September is when DIRECTV was battling with new RSN Time Warner Cable SportsNet/Deportes, which in February signed a 20-year deal with the Los Angeles Lakers for a whopping $3 billion after Time Warner Cable Inc. refused to absorb a large rate hike for News Corp.'s FOX Sports West. Time Warner Cable opted instead to bid against FSN for the Lakers rights and launch its own channel.

Time Warner Cable CFO Irene Esteves said at the Bank of America Merrill Lynch Media, Communications and Entertainment Conference in September: "As we've always said, our only reason for being in this business is to ensure long-term access at reasonable rates for important sports programming. We prefer not to be in this business, and if we had been charged more reasonable rates for important sports programming, we probably wouldn't be in this position. But now that we are, we're going to make it a successful business." She noted that programming costs have risen 32% over the past four years, four times the rate of inflation. "I don't think our consumers are seeing a value that is up 32%," she said.

A FOX Sports executive disputed Time Warner Cable's portrayal of the situation, saying that there was no offer on the table for a renewal of FOX Sports West when Time Warner Cable made its bid for Lakers rights, and thus there is no direct link between an increase in the RSN license fee and the cable operator's bid for Lakers rights. The fact that Time Warner Cable is asking an in-market rate of $3.95 per sub for TWC SportsNet certainly does not make it look any less aggressive on charging for RSNs than FOX Sports has been.

Time Warner Cable is not done with its sports rights-buying binge, according to recent reports. It's reportedly aggressively bidding against FOX Sports for the rights to the Los Angeles Dodgers. If successful, these games would also go on Time Warner Cable SportsNet.

The closing of the window to Fox's exclusive negotiation period with the Dodgers clears the air for the team to seek other TV partners, although Fox is still believed to be a serious bidder and might offer the Dodgers an equity stake in Fox Prime Ticket, rebranding it as Dodgers Network.

Long-time Fox executives must be lamenting the fact that they sold the Dodgers to Frank McCourt in 2003 for just $430 million. Fox picked up the team in 1998 for $311 million, but it was valued at $2.15 billion in April when purchased by Guggenheim Partners and Magic Johnson.

However, Fox and Time Warner Cable are not the only options open to the Dodgers. Comcast Corp. has also flexed its muscles recently in the sports rights space and could be in the market, and it is also possible that the Dodgers may decide to partner with another investor and launch their own RSN.

The stakes have never been higher. Fox recently purchased a 49% share of YES Network (Yankees Entertainment & Sports Network; see valuation below) and has said it intends to use some of the content from that network on its soon-to-launch national sports network, Fox One.

Those privy to the deals have noted that a few factors may sway the deal in one direction or another. It has been noted that the Dodgers would like to cash in on the recent equity-sharing craze that has struck baseball and RSNs (such as Fox's deal with the San Diego Padres and Comcast's deal with the Houston Astros). If TWC's deal with the Lakers is any indication, the Dodgers will not receive equity if they partner with TWC. (The distributor pays the Lakers cash via rights fees.)

Another option also available to the Dodgers if the deals with TWC, Fox or any other interested party not pan out, would be to launch their own branded network, similar to the New York Yankees' YES Network. If the team were to launch its own network, however, everything would need to be up and running within the next year (when Fox's deal with the team expires).

Back in 2002, when the YES Network was launching, baseball labor unrest abounded because the players felt that at an average $2.6 million per player, they were underpaid. This phenomenon continues today, with leagues facing possible strikes, resulting in numerous player raises, which in turn cause teams to charge more for rights fees in an attempt to stay profitable.

The fees were deemed so high that Cablevision Systems Corp. filed an antitrust lawsuit against YES Network in April 2002 for refusing to allow it to distribute the service on its basic tier. It was not surprising that there was bad blood here. Cablevision affiliate Madison Square Garden Network had sued the Yankees over whether MSGN was fairly offered a right of first refusal.

In 2000, when MSGN's 12-year contract with YankeeNets for the Yankees games at $486 million was expiring, YankeeNets turned the tables, offering a one-year deal to International Management Group, or IMG, effectively eliminating Cablevision's leverage. MSGN decided to match the $57.4 million one-year contract with IMG. MSG executives said at the time that the IMG offer was a sham, with the rights being resold to YES Network, while IMG insisted it had no side deals with YankeeNets. Litigation ensued.

That suit was settled in April 2001, but the other issue with Cablevision Systems went on for some time. YES Network was not on basic on Cablevision until March 31, 2003, after New York Mayor Michael Bloomberg stepped in and brokered a one-year deal between the two parties. The two finally came to a long-term carriage deal in March 2003 when Cablevision agreed to pay $2.12/sub/month and put it in a package with MSGN and FOX Sports New York (now MSG Plus) for $4.95/month, or any of the three channels could be purchased a la carte for $1.95 each. YES was also added to premium packages such as Cablevision's iO Silver and iO Gold packages at no charge. (These packages cost $65 and $85 per month, respectively, at the time.)

YES did have successful launch in 2002, turning a profit in its second year and growing its license fee per sub from $1.18 to almost $3 a decade later. (See YES Network Economics.) With a total of 5.5 million TV households available in the Los Angeles area (see video subscriber data for the L.A. DMA), the Dodgers won't be able to reach as many customers as YES Network, which has the potential to reach 7.4 million TV households in the New York area. (See video subscriber data for the New York DMA.)

One thing is clear: Buyers of sports rights don't foresee any slowdown in the rapid escalation in rights fees we have been observing. Prior to the deal with the Lakers, contracts tended to vary from three to 12 years. The Los Angeles Angels' deal with FOX Sports West set the bar much higher (17 years), as did the Lakers' deal with Time Warner Cable SportsNet (20 years). Recent deals between the Astros and Comcast SportsNet, the Padres and FOX Sports San Diego, and the Texas Rangers and FOX Sports Southwest have all been 20-year deals, and the one between News Corp. and YES Network was even higher, at 30 years.

News Corp. announced Nov. 20 that it was buying a 49% equity stake in YES Network from Yankee Global Enterprises, Goldman Sachs, Providence Equity and other investors. The price was said to be at a $3 billion valuation, with News Corp. having the option to buy an additional 31% in three years at a valuation of $3.8 billion. On top of that, News Corp. is reportedly paying about $420 million directly to the Yankees to lock in a favorable long-term contract. We have included this as part of the purchase price because rights fees would have been higher without it, depressing cash flow.

One shocking aspect of the deal, however, was that YES Network also signed a media rights agreement that goes all the way through 2042, a 30-year deal. It seems as if 20- to 30-year deals will now become the norm.