2Q16: Core TV Network Growth Decelerates -- Drexel Hamilton

Normalized ad revenue growth accelerated for cable networks in 2Q16 and moderated for broadcast networks as ratings weakness mounted. While ad growth looks to be improving, the results are skewed by outlying performance at AMCX and are still trending below our programing cost inflation benchmark - the growth rate we often refer to that is needed to maintain stability in the TV ecosystem. Furthermore, the strong upfront may not be indicative of a sustainable improvement as results are partly tied to a one-time rebalancing of ad spend away from scatter and digital allocation. Broadband-only homes grew 16% YOY.

Ad Revenue – Broadcast advertising grew 3% while cable network growth accelerated from 6% in 1Q16 to 8% in 2Q16. However, growth was skewed by AMCX, which posted 29% growth due to the timing of originals that offset the low 1% growth it reported last quarter. Cable growth would have decelerated to 5% excluding AMCX. FOXA, SNI, and TWX beat the 5%-7% programing cost inflation benchmark with 11%, 8%, and 9% growth, respectively. VIAB was the only company to report a decline (-4%). Growth decelerated for most of the broadcast networks – with the exception of FOXA.

Affiliate Fees – Companies saw a 4% increase in fees but the loss of SVOD revenue at VIAB skewed the average, which jumps to 6% excluding VIAB. The industry continues to face secular headwinds as evidenced by the ubiquitous reported loss of subs in 2Q16. The latest SNL data shows that broadband only homes grew 16% YOY to 14.4 million in 2Q16 (+390,000 additions). This trend will likely persist if revenue growth continues to lag programing cost inflation as networks' only recourse is to raise rates, which perpetuates a vicious cycle.

Retrans – CBS and NBC reported a 44% and 64% increase in retransmission fees, respectively. While ABC does not disclose the growth, FOX commented that retrans fees should continue to grow double-digits. We believe these fees put substantial pressure on the traditional TV ecosystem and are one of the reasons CMCSA's MSO business reported a 9% increase in programing cost. However, the fees continue to represent a stable and rapidly growing source of revenue for broadcast networks that supports our thesis that investors should position to gain broadcast exposure. The FCC recently declined to revisit retrans rules that could have threatened broadcasters' ability to negotiate fees.

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