HBO Wants a Bigger Piece of Your Cable Bill

Left to right: HBO President of Programming Casey Bloys, actress Julia Louis-Dreyfus holding two Emmys, and HBO CEO Richard Plepler.Image source: Time Warner.

HBO's popularity is soaring. Between the recent success of its original programming and the launch of its over-the-top service, HBO Now, the Time Warner (NYSE: TWX) subsidiary added about 2.7 million domestic subscribers last year for HBO and Cinemax.

HBO's contracts with pay-TV distributors provide incentives for them to sign up lots of new customers, reducing the price paid per subscriber to HBO. HBO is reportedly working to renegotiate those deals to drive subscription revenue growth for several years. It expects the new deals to produce more revenue growth than its stand-alone over-the-top service.

New subscribers, but not much new revenue

HBO launched HBO Now in April of last year. By the end of the year, it had 800,000 subscribers. In March 2016, the company updated the number to nearly 1 million subscribers. HBO Now subscriptions mostly go directly to HBO, although it sees only an estimated 70% (possibly more) of subscription revenue from customers signing up through an app store. Still, that's significantly higher revenue share than HBO is used to with pay-TV distributors. HBO managed to increase domestic subscriber revenue $195 million last year, "driven mainly by higher contractual rates," according to the company.

Management, however, feels there's a lot of room to improve. During the company's fourth-quarter earnings call in February, CFO Howard Averill said, "We continue to see very strong growth in our subscriber base; the subscriber mix remained a constraint on revenue growth." HBO CEO Richard Plepler later added, "Our opportunity is now, as we have said, to go capture the revenue that reflects that sub growth."

Going forward, management expects HBO subscription revenue to grow in the high single digits. It will have to make negotiations with several newly consolidated distributors, including Charter (NASDAQ: CHTR) and AT&T (NYSE: T). The companies each of them bought out -- Time Warner Cable and DirecTV -- were historic undersellers of HBO. That could give the distributors more leverage against HBO to keep the revenue share favoring the distributors.

Will HBO Now help or hurt negotiations?

On the flip side of the conversation, HBO holds HBO Now as a piece it can play against distributors. If the cable companies don't want to pay HBO what it's asking, it will go ahead and sell the service directly to consumers, cutting out the cable companies entirely.

CBS (NYSE: CBS) is using a similar strategy to raise its retransmission fees and increase sales of Showtime. The OTT alternatives for CBS and Showtime allow the media company to remain firm in its asking price. That's evident by the number of holdouts we've seen from the company over the past couple of years compared with other broadcasters. For example, CBS is the only major broadcaster that's not featured on Sling TV.

CBS is often touted as a leader (by both itself and others) in retransmission rates. Its goal is to reach $2.5 billion in revenue from distributors by 2020.

It's not as if CBS All Access is immensely popular. It only has 1 million subscribers -- about the same as HBO Now. HBO can use its over-the-top service in much the same way as CBS despite its relatively small subscriber base. Considering the value of HBO to distributors, it's more likely HBO will get what it wants than the other way around.

What this all means for investors

HBO's subscription revenue accounted for about 17% of Time Warner's total revenue last year. The company's consolidated revenue growth has been in the low single digits for the past few years. With expectations of increasing subscription revenue in the high single digits for the next few years, HBO's subscription revenue will grow to become an even bigger piece of Time Warner's business while potentially modestly accelerating revenue growth of its parent company.

A secret billion-dollar stock opportunity The world's biggest tech company forgot to show you something, but a few Wall Street analysts and the Fool didn't miss a beat: There's a small company that's powering their brand-new gadgets and the coming revolution in technology. And we think its stock price has nearly unlimited room to run for early in-the-know investors! To be one of them, just click here.

Adam Levy has no position in any stocks mentioned. The Motley Fool recommends Time Warner. 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.