Diamondbacks Billion Dollar TV Deal and the Bubble that Refuses to Pop

Despite television deals with ESPN, FOX, and TBS that will net Major League Baseball an average of $1.5 billion per year over the next years, franchises derive most of their revenue locally. Ticket sales, advertising, naming rights, local radio broadcasting rights, and local television rights constitute the majority of each team’s revenue. In recent years, new local television deals have generated incredible revenues with one-third of all teams now having signed deals worth at least one billion dollars. The deals have raised a question: When will this television rights bubble burst and send these skyrocketing guarantees back to earth? The Arizona Diamondbacks new television deal, believed to be in excess of one billion dollars, partly answers the question: Not yet.

Skepticism regarding the continual rise of local television contracts is justified. There have been indications recently that all is not well for the regional sports networks. The Los Angeles Dodgers generated news when they signed a contract worth more than $8 billion two years ago. Unfortunately for the Dodgers, that contract is still generating news as Time Warner Cable has been unable to successfully negotiate with the rest of the television providers in the Los Angeles area, leaving 70% of LA homes without the ability to watch Dodgers games on television. The San Diego Padres have had trouble getting their product in local homes before reaching a deal prior to the start of last season, and Houston’s deal has been a disaster as they try to charge high subscriber prices to watch a team they had no plans to make successful for several seasons.

Baseball television ratings have remained high, winning in prime time in many markets and keeping advertisers happy. High ratings are a good indication of interest in the game, but they mask what is no longer a well-kept secret: Ratings and advertising money mean very little for the regional sports networks and the massive contracts they have handed out to teams. Regional sports networks make their money off of subscriber rates, and in order to pay the guarantees they are making to teams, they have to get their network on the basic cable tier. The networks charge $2-$5 per subscriber, get on the basic cable tier, and for every one million subscribers, they have around $50 million in annual revenue before they sell a single advertisement.

There are two potential problems with this model. The first one is evident in Los Angeles and Houston, when carriers balk at the subscription cost. If the network cannot get on the basic cable tier charging high per-subscriber rates, it stands to lose a vast majority of its revenue. The problems seen in Los Angeles and Houston could be a precursor to problems in other areas. However, they could also be the result of near-perfect storms resulting from trying to add a fourth regional sports network to an already full lineup in Los Angeles, and trying to sell a terrible on-field product that leaves very little consumer backlash in Houston.

The second problem is more troublesome for the local television contracts. Regional sports networks are highly dependent on the current cable model. Cable companies currently package a wide range of channels into their standard cable offerings. Don’t like news channels or Disney or the History Channel? Too bad, you are paying for them. Don’t like sports? You are paying a big portion of your cable bill for them, whether you want to or not. Bundling channels in this fashion is the standard model for cable, but it has been subject to some erosion of late. HBO’s announcement that it would offer a non-cable-based offering for its network has given rise to speculation that others, perhaps ESPN would follow suit. A smaller bundle with ESPN was announced, but the network makes a lot of money off bundling the entire ESPN family of networks together along with other Disney-owned networks like ABC Family and the Disney Channel. Many of those per subscriber fees would go away if the networks decided to change their model of distribution. In addition, unlike regional sports networks, ESPN makes significant revenue off of advertisements and losing subscribers by going to some form of an a la carte model means fewer eyes on the flagship network and a loss of advertisements.

The biggest bet regional sports networks make when they sign teams to ten-figure deals is that the current bundling model in cable will survive. Without that model, networks would not be able to guarantee the money they have been offering. Should that model disappear, Major League Baseball is in a good position to weather the storm. MLBAM is at the forefront of streaming technology. As a result, MLB would be in a better position than most to monetize a move to a la carte programming, but losses could still be significant.

Details are not yet know about the Diamondbacks television deal, but indications are it exceeds one billion dollars and could triple the current rights deal which pays an average of $31 million per year. This comes a year after the Philadelphia Phillies signed a contract for $2.5 billion that will pay an average of roughly $100 million annually and includes a 25% stake in the network. Despite claims that WGN was losing money last season airing Cubs games, the team decided to opt out of its contract and split its 70 game package between WGN, who decided to keep paying to broadcast the Cubs, and the local ABC affiliate. This move sets up the possibility of creating a franchise-owned network when those deals as well as their major deal with Comcast run out in 2019.

An expanding television bubble is likely a bad sign for consumers. Cable networks are betting that bundling is not going to disappear as quickly as we might believe. Accompanying the cable deals are the local blackouts that have caused considerable consternation as cable companies demand exclusive distribution. Reasonable proposals will be met with powerful opposition. Consumer desires to pick and choose precisely which channels to watch could be outweighed by the desires of cable networks and distributors that use bundling to keep costs high and limit access to programming.

The Dodgers deal set a bar unlikely to be matched anytime soon, but teams are still getting good deals from networks, even in mid-size markets like Phoenix. The bubble will be tested in coming years as smaller markets like the Tampa Bay Rays, Cincinnati Reds, Kansas City Royals, Pittsburgh Pirates and St. Louis Cardinals see their current deals expire. Good local television ratings show an interest in the game, and help make a strong case that the networks airing games should be on the standard cable tier. Changes to the cable model or waning consumer interest to fight for cable channels as bills continue to soar could pose problems in the future, but for now, the bubble continues to expand.