We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten. Don’t let yourself be lulled into inaction. – Bill Gates

What is the future of television? This is a question I have asked myself multiple times over the past few years – lately with increased frequency. The answer, I believe, is starting to reveal itself.

Let me begin with a basic premise: viewable content is viewable content, irrespective of the form. It doesn’t matter if you’re watching a broadcast TV show, a YouTube video, or a movie on demand – all of these are just different forms of the exact same thing.

So why then do we have to access them differently? Why do you have to toggle between different TV inputs and navigate different UIs to find something to watch? (First world problems, I realize, but the investment implications here are enormous.)

My answer is this: we are forced to toggle between multiple inputs because we’re in the midst of a transitional period where new competitors are beginning to overtake the incumbent television companies. Multiple inputs are merely a symptom of this transition.

The trend away from traditional television to internet-based content delivery has been enabled by a few key developments (hat tip: Mark Suster):

Massive decrease in costs of capturing and processing video

Significant penetration in broadband, increases in Wi-Fi

Huge advances in compression

Massively distributed advertising market

Consumer behavior which has made internet video a reality

While this trend has been developing for years, I believe we are just now approaching the tipping point where adoption accelerates towards terminal velocity. What gives me confidence in writing this? Three things:

The growth of Apple TV. I don’t know if investors appreciated it at the time, but in January 2007, just 6 months before the release of the first iPhone, Steve Jobs dropped the word “Computer” from Apple Computer (source). That was a seminal event in the history of the Company, signaling a new era and focus. Every investor should’ve taken note – the signals from Apple are subtle. Which brings me to my point: ~4 weeks ago, Apple revamped its online store, placing Apple TV prominently alongside other product lines (source). Why would they do that? Because Apple TV has become much more than “just a hobby” – the numbers prove it: for several years (’07 – ’08 / ’09), Apple sold only a “few hundred thousand” Apple TVs. Now they are selling ten million. Using Apple TV sales as a proxy for the market (which includes Chromecast, Roku, etc), the data is telling us that the trend away from traditional TV (a trend I call “cord shaving”) is accelerating.

The growth of quality content. Television isn’t a one-sided market, which is where a lot of previous cable doomsdayers have gotten it wrong. While it is true that consumers have been frustrated paying for overpriced bundles that include tons of content they don’t watch, this hasn’t been enough for most people to drop cable. What’s required is a compelling alternative – content so good that the decision becomes a “no brainer”. And thanks to the streaming libraries of Hulu, Netflix, Amazon Prime, Aereo, etc, as well as the ability to purchase content from iTunes, Amazon Instant, Google Play, and more, we are finally at the point where the quality and quantity of legally accessible content is broad and deep enough to catalyze the switch.

For the streaming availability of the top 250 IMDB shows (USA), click here.

For the streaming availability of the top 250 IMDB movies (USA), click here.

90% of the top 250 shows can be purchased via iTunes / Amazon (source).

The birth of Popcorn Time. The catalyst for this note wasn’t the recent WSJ article about Apple TV (here); it was the release of Popcorn Time. Popcorn Time is like Napster for video – it creates a new way to access the pirated content that is available through torrent-based piracy sites like The Pirate Bay. Instead of requiring users to download files via a BitTorrent client, the Popcorn Time software begins streaming movies immediately after being clicked. Popcorn Time makes video piracy easy for the first time and delivers it in a beautiful, Netflix-like interface.

This is an incredibly important point because up until now, piracy has been deemed “too hard” for most consumers. This is a key reason why TV execs and investors have believed their businesses were immune from disruption (see page 34 here). But with the birth of Popcorn Time, piracy is no longer “too hard”. Dorothy Pomerantz at Forbes put it best: “I have never watched a pirated movie. That’s partially because I think piracy is wrong but I am also too technologically inept to work my way around the world of torrents. But Popcorn Time is so easy even I can use it. […] The movies all load quickly and stream in what looks like great quality. Although the app can only be used on computers right now, BTIG analyst Richard Greenfield says he had no problem using Airplay to send the stream to his Apple TV. That’s pretty terrifying.”

The birth of Popcorn Time is a watershed moment for online piracy and I believe it marks the beginning of the end of the traditional Hollywood / TV network business model. Note: Popcorn Time has been open-sourced; it’s not owned by a company that is trying to turn it into a business, it’s owned by the internet community. According to Techcrunch, “There isn’t a single entity here that Hollywood’s lawyers can attack. The developers can go underground and distribute their creations under multiple names. They’re not charging for the program or incorporating ads. Popcorn Time is Napster for video without a company that is trying to turn it into a business. It is the epitome of online guerrilla warfare.”

For these three reasons (the growing number of Apple TV units in the market, the increased access to high quality, legal streaming content and the birth of Netflix-like piracy sites), I believe the market has now reached critical mass and is feeding off of itself.

With a US TV ecosystem worth more than $350BN annually, the investment implications here are truly extraordinary; the market disruption will be enormous. My working thesis – one that needs to be tested over time – is that different segments within this market will be disrupted at different times, similar to a cascading waterfall.

I believe the first victims of this trend will be the set-top box makers and their component suppliers. The cable set-top business is characterized by entrenched incumbents that have been slow to innovate and who are in a structurally inferior position to Apple (software / hardware expertise, fantastic supply and distribution channels, consumer mindshare, etc). I draw on the parallel to Blackberry, who had a ~50% market share which collapsed to less than 1% in the years following the first iPhone release. According to a recent WSJ article (source), the next generation Apple TV is a true set-top replacement capable of streaming live TV channels, recording TV a la TiVo, accessing internet programming, streaming on demand shows / movies and serving as the content aggregator to solve the ‘multiple input problem’ I described at the beginning of this note. Consumers will get all of this in a beautiful user interface with their credit card pre-loaded, making consumption frictionless. This is the future of television.

TV networks will be next. In December 2012, Gary Brode of Silver Arrow Capital wrote a great report about the forces working to disrupt TV networks (get it here). His main points are even more relevant today:

[…] the delivery of media content and the way viewers are watching it is changing in many ways.



[…] every single one of these changes is a move to a less profitable model than the current one.

To understand why he’s right you must first understand how TV networks generate revenue, which is in two primary ways: (1) via ads – typically 16 minutes of ads for every hour of content, and (2) via affiliate fees – which are payments cable / satellite companies make to TV networks for content; these fees get passed on to the consumer.

As more consumers move away from cable, ad revenues will be negatively impacted (less eyeballs → less ad revenue) as will revenues from affiliate fees (less cable subscribers → less cable company revenues → less affiliate revenue to TV networks). These forces will work to compound the already difficult situation for TV networks as they will be left with less margin to invest in quality content, causing even more attrition. Taken to its logical conclusion, this negative feedback loop leaves TV networks in a very vulnerable position.

While selling content to Netflix or Hulu might provide a bump in revenue in the short term, it will only help accelerate the shift away from live TV over the medium and long term. And as Brode demonstrates, the Netflix / Hulu revenue model results in significantly lower take than the lucrative ad / affiliate fee model that exists today:

Source: Silver Arrow Investment Management, LLC calculations

Based on the above, it’s in the realm of possibility that networks will see a 50% drop in TV revenues over the coming 10 years similar to what the music industry experienced.

The impact on satellite companies remains uncertain. Satellite companies provide one-way broadcasting to subscribers. Some view the idea of a one way pipe as flawed as it doesn’t allow for interactivity. I’m not certain this is a big deal – the surveys I’ve looked at tell me that consumers don’t really care about interactive TV or internet on the TV – at least not yet (here’s a quick gut check: Do you really care about having your photos beamed to your TV? What about overlaying stats on top of a sporting event? Shopping from your TV? These things sound cool, but these features appear last on a consumer’s wish list):

Source: http://www.ericsson.com/res/docs/2012/consumerlab/tv_video_consumerlab_report.pdf

The question remains: what will satellite providers do when the current pay TV model begins to fall apart? This is the question that gives me pause. Take a step back and consider what Netflix is: it’s a content aggregator and it also creates some of its own proprietary content. It delivers this content in a beautiful interface to millions of consumers at scale. Now consider what a satellite provider is: it’s a content aggregator that also delivers content to millions of consumers at scale. The definitions aren’t too different, are they?

If the transition away from cable and satellite TV accelerates, how would the satellite companies respond? Maybe they could follow Netflix and deliver video over the web – they already have tens of millions of subscriber relationships (plus valuable data on viewing history and relationships with content providers). If they did this, they wouldn’t have to deploy satellite dishes and set-top boxes to homes. The cost savings from this shift in distribution could allow DirecTV and Dish to “double their free cash flow” (source: Citi Research; I would note that this includes an assumption of equivalent pricing, which is a future unknown). Just like Netflix was able to transition from a mail delivery model to an internet model, the satellite providers could transition from satellite to the cloud. Interestingly, DTV has started to integrate satellite broadcasting with internet video. It seems as though they are already positioning themselves for the coming shift.

For more on this, there is a fascinating discussion over at The Brooklyn Investor’s blog (here; scoll down to comments section).

Because there are so many moving pieces, the impact of the TV transition on satellite providers remains uncertain.

Cable companies will outlast. Cable companies have an enduring competitive advantage: they own two-way pipes into > 100MM homes with a geographical monopoly in many markets. Even if the current pay TV model completely disappears (John Malone believes cable unbundling could begin to unravel within five years), cable owners will still need broadband to get TV into the house. Change the pricing structure by charging for volume instead of speed (source) or package broadband with content (source) and the effect of a transition on cable companies may be de minimis. A lot depends on future unknowns, like how net neutrality rules evolve and what consumers are willing to pay in this ‘new world’.

There will be non-obvious winners and losers as we transition away from cable television – companies like GameStop, for example. But I’ll leave the discussion of specific opportunities within this theme for future buyside notes.

Make no mistake: The disruption of television has arrived. Don’t let yourself be lulled into inaction.