SBJ/March 17-23, 2014/In Depth

The RSN conundrum

Launch a net, partner with a distributor or sign a rights deal? Choose carefully

The Arizona Diamondbacks landed what was an eye-popping $250 million rights fee from Fox Sports Net a scant seven years ago. They are likely to come close to tripling the value of that deal when it expires at the end of 2015.

The D-backs’ situation shows how much leverage pro teams have gained through the years, thanks to the emergence of options. They could launch their own regional network. They could partner with a distributor on a new RSN. Or they could sign another straight rights deal with FS Arizona.

“It’s night and day compared to when we last struck a deal,” D-backs President and CEO Derrick Hall said last week after spending an afternoon at spring training with executives from Fox Sports Net. “Not only monetarily with numbers that have increased dramatically, but with the different avenues we can travel, the landscape has truly changed in our favor.”

The Seattle Mariners opted for a majority stake in Root Sports Northwest.
Photo by: Root Sports
Consider the events of the last year alone.

The New York Yankees sold a majority stake in the YES Network. The Seattle Mariners increased their stake in Root Sports Northwest from minority to majority. The Philadelphia Phillies gave up rights fee dollars for a 25 percent stake in CSN Philadelphia. And the Los Angeles Dodgers launched SportsNet LA.

The fact that, in the span of one year, four MLB clubs assessed the media landscape and came to four different conclusions on how to handle their TV rights — and that none of them chose a traditional cash-for-content deal that was the norm for decades — speaks to the evolving complexity of the decision.

Meanwhile, in Houston, the Astros and Rockets watched the regional sports network in which they share a majority stake flop so badly, it landed in bankruptcy court, a reminder of the consequences when teams or their chosen distributors misstep.

It is a given that the vast majority of an MLB, NBA or NHL team’s games will air on an RSN. What remains to be negotiated is who will own how much and whether the team will use an existing RSN or launch a new one that must gain carriage across every cable, telco and satellite provider in the team’s territory.

Roll in the fact that a team’s best chance of launching a viable network is to pair with at least one team in another sport, which may face different territorial restrictions and different league rules on revenue sharing, and you’ve layered on even more complexity.

“There really are no easy answers,” said George Postolos, former president of the Astros and before that the Rockets. Postolos resigned from the MLB club in May, saying he wanted to return to his prior life as a consultant on franchise acquisitions. “This is as important a decision as you’ll make with a team. If you make a mistake or get unlucky on your television strategy, you’re in a position where you’re going to lag the league for eight, 10 or 12 years. That makes it difficult to compete.”

Even if the D-backs renew with FS Arizona, they will do so thanks to leverage created by what has been the hottest market ever for sports rights.

More players = more options

The emergence of RSN options couldn’t have come at a better time for pro sports franchises.

As local over-the-air channels stopped bidding for sports rights, the same RSNs that once afforded leverage to the teams seized it from them. Power swung to Fox Sports Net.

It remained that way until a few teams — notably the Red Sox, Yankees and Mets — proved that they could make hay going it alone or cutting in a distributor.

Today there are even more players at the table creating massive leverage for the teams — driven primarily by baseball, which provides twice the programming tonnage of the NBA or NHL teams.

Consider the four most recent baseball deals and the four different paths the teams chose.

The Yankees and Goldman Sachs, who were trendsetters when they launched the YES Network in 2002, cashed out of the network almost entirely, ceding 80 percent of ownership to 21st Century Fox and landing an $85 million rights fee this season — a fee that will grow 4-7 percent annually over the next 30 years.

The Mariners, who had a minority stake in the Root Sports network owned and operated by DirecTV, chose to take a controlling position in a vast territory that is percolating with NBA and NHL interest, in essence going the opposite way of the Yankees.

The Phillies chose to take equity rather than the straight rights deals they had before, giving up some of the cash they could have collected in exchange for the opportunity to share in profits with CSN Philadelphia.

And the Dodgers chose an intriguing option that a team had not been offered before — the chance to launch an RSN that they would own, but Time Warner Cable would operate. The arrangement insulates the team from financial risk with a 25-year, $8.35 billion rights deal and puts TWC on the hook for any shortfalls in distribution.

“You see teams choosing different paths because the decision really is unique to each situation,” said sports media consultant Chris Bevilacqua, who has worked on RSN negotiations with the Rangers, Padres, Reds and others. “It’s unique to the actual ownership structure and their appetite for risk, and the way they approach the market in terms of risk and reward profile. Size of the market. Density of the market. Fan base. All that fits into it.”

Though deals vary, RSNs typically fit into one of three categories:

The seven cases in which one or more teams own or share the majority of the network: CSN Chicago (White Sox, Bulls, Cubs and Blackhawks), CSN Houston (Astros and Rockets), SportsNet LA (Dodgers), Root Sports Northwest (Mariners), SNY (New York Mets), NESN (Boston Red Sox and Bruins) and MASN (Baltimore Orioles and Washington Nationals).

The seven in which one or more teams hold minority stakes in a network owned by FSN, Comcast, TWC or DirecTV. The Yankees, Phillies, San Francisco Giants, San Diego Padres, Los Angeles Angels, Texas Rangers and Boston Celtics have stakes ranging from 10 to 33 percent.

The rest, which are owned entirely by one of those four distributors.

“I don’t think there’s a one-size-fits-all model for these,” said Steve Greenberg, managing director of New York-based investment firm Allen & Co., who last year advised the Mariners on their assumption of a majority stake in an RSN partnership with DirecTV. “Our bent is to do a lot of analysis. But it generally comes back to economics and to risk tolerance. … It’s a critical decision in an area that’s moving very fast. You really don’t want to make a mistake.”

From FSN’s perspective, the riskiest move is for teams today to decide to launch an RSN on their own. The least
Teams must weigh the success of media ventures such as NESN with the risks of taking a financial stake in a network.
Photo by: Getty Images
amount of risk comes from taking a straight rights deal with an established RSN that already has carriage.

“We’ve got 45 different team relationships. Every one of them is a case-by-case basis, based on their needs, their appetite for risk, their need for security,” said Jeff Krolik, president of Fox Sports Regional Networks. “We offer overhead. We offer production efficiencies. We offer value to the consumers. We offer the teams attractive
economic returns and attractive distribution results. We offer consumers one-stop shopping.”

But that hasn’t stopped teams from using the mere threat of going alone. In almost every rights negotiation involving a baseball team over the last 10 years, the conversation has started with the team announcing its intention to start its own RSN. Whether it turns out that way depends on how the talks proceed from there.

The Texas Rangers were emerging from bankruptcy proceedings in 2010 when the MLB-blessed buyers of the club, a group led by Chuck Greenberg and Nolan Ryan, approached FSN to discuss their plans for when the team’s rights expired at the end of 2013.

They told the network that they intended to do their own RSN come 2014, and if Fox wanted to talk about taking equity in that network, they could negotiate that. Knowing that the alternative was that the Rangers might launch a new RSN with Comcast in the nation’s fifth-largest market, Fox agreed.

The deal, as it turned out, didn’t give the team its own network. There was a 90-10 equity split, with the 90 belonging to FSN. Still, the possibility that the club might launch a competitor with Comcast in Dallas gave it leverage in the rights negotiation — so much so, that the Rangers tripled their annual rights fee to about $80 million a year, rising at a 4-7 percent annual clip over 20 years.

“You start with a negotiation over economics,” said Steve Greenberg, who did not work on the Rangers deal but advised on many others, including SNY and CSN Chicago. “There’s an agreement over how much of the value of the market is going to go to the team and how much is going to go to the RSN operator. And then you have the discussion. Do we want to take that payment in dollars, or in equity or in seashells?”

Making it work in Chicago

The Chicago White Sox were way out in front on all of this. In 1982, co-owner Eddie Einhorn had the idea of joining all the Chicago sports teams together to launch a service that would offer a package of their games through an over-the-air service that would send a scrambled signal that could be decoded by a set-top box. It was before cable had gained much penetration in Chicago.

The Cubs dropped out, but the other four teams — the White Sox, the Bulls, the Blackhawks and the North American Soccer League’s Sting — agreed. The service launched at a rate of $19.95 a month. All it had was games, so it went dark when there wasn’t one on.

“We lost a bundle of money,” said White Sox and Bulls Chairman Jerry Reinsdorf. “Einhorn was ahead of his time.”

They sold the service to Cablevision, which locked the teams’ rights up for 15 years. Their games would air on cable, which took longer to break through in Chicago than it did in much of the country, but eventually did so.

“If we could have waited a couple of years we could have done the same thing,” Reinsdorf said. “But we didn’t have the money to wait. [Cablevision Chairman Charles] Dolan was tough and he knew we had nowhere else to go. So he locked us up for 15 years and he made a lot of money.”

Reinsdorf tells this story to explain how he got to where he is today, with the ownership groups of the White Sox and Bulls holding 40 percent equity in CSN Chicago and the Cubs and Blackhawks owning 20 percent each. It has worked out well for the teams and for Comcast, Reinsdorf says, a point that is echoed by others who have worked with teams on RSNs.

“Chicago is probably the perfect model,” said Greenberg, who worked on the deal and advised the teams to bring in Comcast after seeing the YES Network struggle to get carriage through its first season. “You had all four teams in the market taking their rights at the exact same time, partnering with the largest distributor in the marketplace, which assured 50 percent coverage on day one but really assured you would get the rest because of Comcast’s influence in the market. And it worked beautifully. Every distributor signed up.”

Comcast manages CSN Chicago as a minority partner, as it does in Houston. There is a board that includes representatives from Comcast and the teams, as in Houston.

But the structure differs in an important way. The Houston network requires unanimous approval from the three parties on matters such as whether to lower a rate to strike a carriage deal when distribution is lagging — as it has been in Houston from the start.

CSN Chicago can set a price without unanimous consent, Reinsdorf said. All it needs is a majority. It hasn’t come to that for the Chicago teams, since their carriage discussions have gone relatively smoothly, largely because of the power of having four teams in the market.

“I don’t know how much stomach I would have had [to launch the RSN] if I didn’t have all the teams lined up,” Reinsdorf said. “We were prepared to go it alone and we ended up letting Comcast buy in. They were the main distributor, and we felt we had every team. I don’t know if I’d have had the courage to do what they did in Houston because carriage was a real issue there, and as it turns out they haven’t gotten it.”

Of course, Houston is not Chicago.

The four teams in the CSN Chicago deal share similar territorial footprints. While some MLB clubs have vast expanses that they may explore, the White Sox and Cubs are confined by the Cardinals to the south, the Brewers to the north, the Tigers to the east and the Twins and Royals to the west. That puts them in about the same-size boat as the Bulls and Blackhawks, who are restricted by the NBA and NHL’s more narrow views of team territories.

The Astros have the entire state of Texas; not only Houston, but also San Antonio, Austin, El Paso and every tumbleweed in between. They even could go up against the Rangers in Dallas-Fort Worth if that were a fight they chose to pick.

When CSN Houston pitches to a carrier in its immediate market, it can offer the two teams that are most relevant to local fans. But when it goes out to those more distant territories that might be important to the Astros, it brings only the Astros.

Consider how that offering might look in San Antonio, the third-largest TV market in Texas, with about 900,000 homes. Not only is that a city where the Spurs dominate, but the major cable provider is Time Warner, not Comcast. It’s also headquarters to AT&T, which launched its U-verse service there in 2006. Oh, and the Rockets are blacked out there.

Offering his opinion only as an interested outsider, Greenberg said the network could have overcome those hurdles if it had built them into its expectations of the rates they could get.

“I’m reminded of people who took out big mortgages because they thought housing prices only went up forever,” Greenberg said. “Well, they did, until they didn’t. There has been a dramatic market shift, led by the Dish Network, in terms of whether they were going to carry sports and at what price. And now what we’re seeing in the market is DirecTV playing harder ball on carriage.

“At the time the deal was done, I would’ve said [CSN Houston] was a lay-down hand. I thought it was Chicago revisited. But the market has shifted. I don’t think it’s people not wanting to carry that network. It’s the market pushing back and saying I don’t want to pay that price.”

It’s easier for distributors to push back and not pay that price in a market like Houston, where the Astros have been miserable on the field, losing more than 100 games for three consecutive seasons, and the Rockets missed the playoffs for three consecutive years in the run-up to the launch. Teams that aren’t playing well struggle to get their fans riled up enough to generate pressure on carriers.

In other markets, distribution executives have learned the hard way that live sports — especially live local sports — is critical to retaining customers and keeping them from cutting the cord.

“One of the things that I’m cognizant of as a distributor is that in an increasingly and fiercely competitive environment, live sports remains one of the important stalwarts of keeping the cable offering strong,” said Melinda Witmer, executive vice president and chief video and content officer for Time Warner Cable. “But there’s definitely a tension there. The cost of sports rights has gone up for years and years and years. That’s been an ongoing theme for a long time. I don’t know if that’s going to stop any time soon.”

That uncertainty is a main reason why Witmer signed deals to launch three RSNs in the Los Angeles market over the past year and a half — two with the Lakers and one with the Dodgers. Witmer points to the long-term nature of the deals as providing cost certainty — she knows what Time Warner Cable will be paying for the Dodgers and Lakers for the next two decades.

That’s not the case when she’s subletting the rights from Fox, Comcast or DirecTV, whose carriage deals typically come up for renewal every five years, and often yield big increases and public carriage battles.

The Padres signed a 20-year deal with Fox that included a 20 percent stake in Fox Sports San Diego.
Photo by: Fox Sports San Diego
Those price increases are a reason efforts to grow CSN Houston have failed so far. In a way, the Houston teams are a victim of their own success — not as a product that would mandate distribution, but in their ability to attract what in hindsight appear to be outsized rights commitments.

Postolos was president of the Rockets before the creation of CSN Houston and of the Astros after its creation.
Though he led distribution talks for the Astros when the channel was launching, he was not involved in the deal that led to its creation. But he has been in the market long enough to appreciate the leverage the teams were able to create by hitting the market together when they did.

“You had AT&T with its presence in San Antonio looking at content deals,” Postolos said. “You knew DirecTV was going to be looking at the content deal. And you knew Comcast was going to be a player and Fox was going to be a player. And then there’s always the opportunity for the teams to do something independent. They had that range of options.”

The Astros and Rockets ran an auction for its rights fees among all those parties. Comcast won, agreeing to pay the teams $157 million for a 22.4 percent interest in the new channel. It agreed that the Astros and Rockets would receive annual rights fees starting at $55.5 million and $44.4 million, respectively. It signed on to manage the network for an annual fee starting at $5 million. And it provided a $100 million line of credit to fund the startup.

To make that math work, CSN Houston would need broad distribution at carriage rates that, in hindsight, were higher than the market would bear. When it didn’t happen, the network blew through its cash, the line of credit and a $24 million cash call. When the partners couldn’t agree on what to do next, the network landed in bankruptcy.

“If you think there’s a bubble, and either Fox or Comcast are willing to give you a big rights fee and guarantee it, you might be better off to take it,” Reinsdorf said. “It all depends on how you view the going forward part and what your leverage is.

“How long can it keep going the way it’s gone? Nobody knows. Look at what’s happened to [Houston].”

Finding common ground

In 2007, five years before their rights deal with FSN Bay Area was due to expire, San Francisco Giants ownership saw the rate at which RSN carriage fees were escalating, and the way MLB rights appeared primed to race forward, and began to explore starting their own channel.

“We could have tried to do the thing ourselves,” said Giants President and CEO Larry Baer, who has played a role in making the franchise one of the more entrepreneurial in all of sports. “We have private equity players in our ownership group, so it was within our means.”

The Giants identified three priorities. They wanted an upfront payment, rights fees that were commensurate with the market, and a “considerable slug” of equity that would give them upside if carriage fees and ad rates increased, allowing them to keep pace as other clubs signed new deals.

As Baer got deeper into conversations with Comcast executives, he realized that their vision lined up with the ownership group’s. Comcast thought the same.

“We look to see if there could be an alignment of interests and other strategic factors that might play into it that would make it appealing,” said Jon Litner, president of CSN at the time and now president of NBC Sports Group, which operates 12 RSNs across the country. “We like the business where we can create an alignment of interests and create a model that creates what we hope is a strong value proposition.”

“We felt that it was pretty hard to forecast where rights were going,” Baer said. “And this wasn’t going to be a short-term deal. A hedge against not calculating the rights properly would be to have a decent amount of equity. We felt a decent amount of equity was about a third. That was appropriate exposure to increasing markets. That’s what we did.”

With the rival Dodgers launching their own RSN, Baer frequently is asked whether he regrets not doing the same. He says he doesn’t.

“If we did it all ourselves there would have been a carriage battle, because that’s what happens,” Baer said. “Would the games eventually have gotten on the air? Yes. Would it have been painful? Probably. Would it have been worth it? Maybe if you’re just looking at the one deal. But I’m looking at the overall franchise, not just one silo. One revenue area of television. That’s important, yes. But I’m telling you, we have 246 consecutive sellouts and are pushing annual double-digit revenue growth — and having your games not be available on television while you negotiate carriage deals does not help you on those fronts.”

When Bevilacqua met with the Padres for the first time, he gave Jeff Moorad, the former player agent who was in the process of buying the team, the same advice that Moorad had given many of his players.

“You’re sitting on a gold mine here,” Bevilacqua said. “We’ve just got to get to free agency.”

Bevilacqua had studied the San Diego TV market and the Padres’ place in it and found a situation that set up ideally for the club.

For 15 years, the Padres’ rights deal was with Cox, which together with TWC maintained an unheard of penetration of 87 percent in the team’s footprint, about 20 percent higher than the national norm for cable. Bevilacqua expected that Cox would defend that market share fiercely, and knew that the satellite providers and telcos would chase it aggressively.

He penciled out what making San Diego look like other TV markets would mean, calculating the lifetime customer value of each subscriber at the industry standard of $5,000 a household.

“Twenty-percent customer transfer from cable to satellite and telco is worth $1.5 billion, and your product is going to make that happen,” Bevilacqua told Moorad. “All we need to do is get out to the market.”

Cox bowed out, but Fox and the telcos rushed to the table.

The Padres ended up with Fox, signing a 20-year deal worth as much as $1.2 billion, which came with a 20 percent stake in an RSN that Fox would launch, distribute and manage. It was less about market size than market dynamics.

Not only did the Padres cash in on their rights, they hooked up with the behemoth they needed to negotiate distribution with Cox, which, by the way, was none to happy about losing the rights.

“If you launch with someone other than Cox in San Diego, you do have that risk that Cox stiff-arms you entirely or you don’t get the rate out of them that you hope to,” Greenberg said. “On the other hand, if you partner with Fox, you have the knowledge that in Fox you have a terrific operator and a King Kong in the programming world who has a lot of leverage and enough of a stake in your network to be willing to use it to ultimately get carriage, which is what has played out in San Diego.

“We’re believers in having the strongest possible strategic partner that you can find in any one of these deals.”
When Fox offered to put up 80 percent of the equity, Bevilacqua suggested the Padres jump at it.

“If you could get somebody to deal with all the issues [facing networks as the landscape evolves] over the next 20 years and you could get the right price, you’d do that deal in a heartbeat,” Bevilacqua said. “Who would you rather have negotiating the carriage agreement? News Corp.? Or the San Diego Padres independent? You’d rather have News Corp. doing that. Your [investment] is on safer ground.

“Look, it’s not my money. But I say let the big guys handle all that stuff and you just take your cut.”



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