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M&A ahead for smaller cable network groups, distributors, says Bain partner

➤ The regulatory environment has not been as open to deals over the past two years as was expected right after the 2016 election.

➤ Deals among smaller network groups are expected as they seek scale to gain more leverage in carriage negotiations or to create their own direct-to-consumer streaming offerings.

➤ Traditional TV advertising remains attractive for ad buyers and brands.

The media and communications sector saw a number of transformational deals in the past two years, including T-Mobile US Inc.'s pending merger with Sprint Corp. and Walt Disney Co.'s purchase of key 21st Century Fox Inc. media assets. But Daniel Hong, a partner in Bain & Co.'s New York office and an expert in the firm's media and entertainment and digital practices, sees some more changes ahead in 2019.

Hong spoke to S&P Global Market Intelligence about his M&A outlook, the regulatory environment and the evolving advertising market. The following is an edited transcript of that conversation.

S&P Global Market Intelligence: How are you thinking about the M&A environment heading into the new year, especially given some of the regulatory opposition we've seen to some recent deals?

SNL Image
Daniel Hong, a partner at
Bain & Co.

Source: Bain & Co.

Daniel Hong: We had thought with a new administration and a new regulatory environment, there would be a lot of things loosening up. And we did see some significant M&A — not only in dollar terms but also in terms of significance for the industry. AT&T Inc. and Time Warner Inc. closing was huge. You hadn't seen something like that since Comcast Corp./NBCUniversal Media LLC. Then this year you had Disney and Fox, which is as big as it gets, and then you had Comcast and Sky PLC. So just those three deals alone make this a banner year in terms of significant M&A in the media sector.

That being said, it wasn't easy. The regulatory environment was not as open as had been expected. You saw deals actually get blocked, such as Sinclair Broadcast Group Inc.'s purchase of Tribune Media Co.

Will the regulatory uncertainty create an overhang in 2019?

I think that may have been a reason you didn't see more M&A in 2018, but I'm not sure regulatory is going to be the big thing that makes people shy away from major deals next year. Where we see more activity next year is with second-tier network groups, like the Viacoms of the world or Discovery Inc. The basic bundle size is coming down and the smaller network groups are under pressure. So what can they do? They can try to survive in the traditional world, and M&A would give them additional leverage in negotiations. But another option might be for them to go direct-to-consumer. To do that, they need to have something to make it worth it. And that again comes back to scale. So scale, I think, is a big enabler of being able to make a move, whatever your strategy is.

Are there other areas in the sector where you expect M&A in 2019?

On the distributor side, there is this whole [smaller] tier of cable providers where scale is key for them. Their content costs are outstripping their core business and so one way to mitigate that is to get bigger to have more leverage. And so those first two legs wouldn't run into regulatory problems just because they are smaller and they are not as transformational.

The third leg is around content, so production studios and libraries. There you have the traditional buyers who are trying to go direct-to-consumer, but you also have the digital natives who are not only building in-house but there's also a question whether they will make an M&A play, whether it's the Netflixes or the Amazons of the world. All of that is to say there are a lot of reasons to believe there should be continued activity in 2019, but probably not the megadeals of the past, both because of the regulatory concerns and because the bigger players are off the table for a while digesting their previous deals.

How do you see video advertising evolving?

From our standpoint, we think the core of traditional TV advertising is still quite solid with good return on investment. It has a real big place in advertisers' budgets. But I think what you are seeing is programmers starting to experiment with saying, "Not only can I provide you with the reach, but I can also provide you with the targeting you are looking for as an add-on or a companion." It's not a substitute. You are not doing a beer or pizza campaign using dynamic ad insertion. You want to hit everybody watching football, but then you also want to double down on the folks you know are really into your brand using something like an addressable TV piece or even a digital piece.

I think where we're going to see new interesting models is in the digital native TV space. And when I say that, I mean the virtual multichannel video programming distributors, things like Hulu LLC's live TV offering. Are they going to be able to experiment to do more with addressable TV ads? Right now, the experimentation is more on video-on-demand. And then, obviously, you never know what Amazon has up its sleeve.

In the past, debates around ratings currencies and privacy concerns have frustrated efforts around advanced advertising. Have we moved past those debates?

No. There are absolutely measurement solutions that the Nielsens of the world will need to enable. The tech is not totally sewn up yet, and you're right about privacy. But I also think there's still a lot of skepticism that if programmers went full bore into this, that the networks could make as much money as they are now. They are still getting price increases on inventory that they have. Frankly, there's not anywhere else to get a few million eyeballs on quality video today. You'd have to stitch together a fairly ragtag group of YouTube LLC channels, and the quality is not there versus commercial breaks on "This is Us" or whatever the hot thing is.