HBO Now: Could HBOs Over-the-Top Service Hurt Shareholders?

Source: HBO/Time Warner

It's official! Time Warner's HBO is launching its over-the-top streaming service -- HBO Now -- this spring. According to the International Business Times, the service will cost $15 monthly, be available in time for the next season of its wildly popular "Game of Thrones" franchise, and the company is partnering with Apple for inclusion on Apple TV.

In doing so, HBO joins a growing list of networks and companies that are offering streaming content, essentially bypassing pay-TV providers. After Hulu's ground-breaking experiment to stream content from NBCUniversal, Disney-ABC, and 21st Century Fox, Netflix popularized the streaming format as an added feature to its then-core business of DVD by-mail rentals. More recently, CBS and pay-TV operator Dish Networkhave developed streaming services with CBS Anytime and Dish's Sling TV.

For HBO's shareholders this may appear to be a no-brainer. The costs of providing over-the-top delivery are relatively negligible and the content has already been paid for. Even if HBO is able to capture a small fraction of those who don't currently subscribe to a pay-TV but have broadband -- a growing group that is now estimated at 10 million -- it should be additive for shareholders. On the surface it appears HBO can look forward to incremental revenue and profit growth with little risk -- here's why I think that's wrong.

Supply and demand with a powerful buyerAlthough media coverage can be excessively bullish in regards to networks providing over-the-top content, you've probably noticed there hasn't been a mass migration yet. In fact, many networks are faced with a "lose-lose" proposition -- you can't afford to miss out on this growing group of potential subscribers but you also can't afford to anger the de facto buyers of content: pay-TV operators. This third-party billing system, along with a concentrated pay-TV market, gives considerable power to operators during negotiations.

While HBO's situation is slightly different -- the choice for this premium channel rests with end users rather than a pay-TV operator's pre-defined package -- pay-TV operators still have considerable sway by marketing to end users. And it appears that pay-TV providers are dropping the price to compete with this new service.

According to Phillip Swann of TV Predictions, Comcast lowered its monthly rate for HBO from $18.95 to $15; Verizon extended its monthly $9.99 introductory rate from six months to a full year; Time Warner Cable dropped its monthly pricing from $15.95 to $9.99 if you order online

Splits and pricing are open to future negotiationThat aforementioned figures aren't HBO's take, of course, no pay-TV operator is going to offer distribution and billing with no cost. The Wall Street Journal reports that HBO's split is roughly half of the customer's cost. If pay-TV operators are forced to cut prices in order to compete with HBO's stand-alone product, at some point they'd look to pass along those cuts to HBO itself or by less marketing of the channel.

Charter Communications CEO Tom Rutledge has commented on OTT services by stating they make the content "less valuable" to pay-TV operators and mentioned there's "no reason" for a provider to pay for OTT content. You can imagine how tense negotiations will be with HBO and pay-TV operations going forward.

While HBO Now will be great for consumers by virtue of more choice, HBO shareholders could find themselves with lower revenue per subscriber and reduced marketing from pay-TV operators that will continue to handle the vast majority of HBO's subs. The end result for shareholders is not as clear cut as it initially appears.

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Jamal Carnette owns shares of Apple and Verizon Communications. The Motley Fool recommends Apple, Netflix, and Verizon Communications. The Motley Fool owns shares of Apple and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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