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Cable Technology Feature Article

March 24, 2014

Apple in Talks with Comcast for STB-based Streaming Service

By Tara Seals, TMCnet Contributor

Apple (News - Alert) is set to shake up its content delivery model with a subscription service for online streaming—and it’s in talks with No. 1 cable MSO Comcast in order to do so.  According to people familiar with the matter, the two are discussing a scenario that would use an Apple set-top box (STB) and provide preferential streaming to Comcast ISP customers.

According to the Wall Street Journal, the talks are merely nascent for now, and many hurdles remain. But the news illustrates that Apple is still mulling its next move in the digital distribution space. It also has been wanting to team with traditional pay-TV providers for years—back in the summer of 2012, reports surfaced that Apple was talking to various operators, including Time Warner (News - Alert) Cable, about creating an Apple-branded set-top box that would also function as a pay-TV tuner for cable TV services. The WSJ reported then that Apple was looking to create an IP-based STB that would be an exclusive for the cablecos and which would be a conduit for direct iTunes purchases, and that it would ask for a 30 percent transactional revenue share for video-on-demand (VOD) sales.

This time around, the streaming aspect of the service is a new wrinkle.

The juggernaut from Cupertino has been consistently rebuffed by the operators despite its efforts. But, with the pay-TV business staying relatively flat in the United States, with cable continuing to hemorrhage subscribers, partnering with over-the-top (OTT) companies to offer differentiated service models is likely looking more and more attractive. Also, there are now analogues to look to, like TiVo’s arrangement with Virgin Media (News - Alert) in the UK and with Com Hem in Germany.

The U.S. pay TV industry recorded its first-ever full-year subscriber decline in 2013, according to SNL Kagan; cable, satellite TV and telecom firms collectively shed 251,000 video subscribers in 2013. As of the end of the year, the number of pay TV subscribers dipped to approximately 100 million. The cable sector is responsible for most of the fall-off: Leichtman Research found that the top nine cable companies lost about 1.74 million video subscribers in 2013 -- compared to a loss of about 1.41 million subscribers in 2012. SNL Kagan meanwhile estimates cable operators lost nearly 2 million video subscribers in 2013 and 388,000 in the fourth quarter to end the year with fewer than 54.4 million basic video subscribers.

Meanwhile, according to Terracotta Capital, Apple is incentivized to grow its content business because pure hardware growth is looking unsustainable in the long term. Terracotta said in a research note that digital distribution of content will drive the Apple’s future profitability, boosting Apple's existing corporate average of 37% profit.

“Apple's (AAPL) content/software/services business is often an overlooked business unit, and for a good reason, given it only accounts for ~8% of Apple's overall revenue,” the investment firm said. “However we believe that the content distribution business will be a bigger component of Apple's revenue growth and profitability as emerging Asian smartphone makers continue to erode Apple's smartphone market share, and that Apple is forced to generate additional dollar per device to drive revenue growth rather than through device volume.”

Apple for now generates profits mostly from the sale of the iPhone and iPad, with mobile devices accounting for 76 percent of total revenue. However, iPhone competes in an increasingly mature and penetrated high-end smartphone segment that is witnessing decelerating growth due to a slower replacement cycle. On top of that, competition is heating up from the emerging Asian players that introduce devices with high-end specifications at cost or at significantly lower price points to erode Apple's previously dominant position in the smartphone market.

“We note that since 4Q11, Apple's market share has been on a downward path (along with Samsung (News - Alert)), while the Chinese players have been gradually expanding their market share,” Terracotta noted. “Apple's hardware specs cannot stack up against the emerging Asian players, even when we use its latest flagship iPhone 5S as a comparable. When the emerging players have already migrated toward higher-resolution display, bigger pixel cameras and faster processors, Apple's iPhone 5S is still lags behind in speed, display and camera.”

And the average selling price (ASP) in North America is expected to decline at 8 percent CAGR from 2011 to 2016, according to iSuppli data. North America ASP is expected to decline only at 0.6 percent, mainly because of less competition and carriers' control over handset distribution.

“In order to offset the inevitable ASP decline and margin erosion due to the competitive smartphone market, Apple should focus on expanding its content distribution business so it could maintain, or expand, its margin profile and profitability,” Terracotta said.

Apple's iTunes remains ascendant in the EST segment. According to Gartner (News - Alert), global app store revenue is projected to reach $35 billion this year, and growing at a four-year CAGR of 30 percent from 2013 to 2017, when the market is expected to reach $76 billion. Out of that, Apple generated $16.7 billion in content revenue in 2013, implying a 63 percent market share.

“We expect content to generate more than 90 percent in gross margin and 70 percent in operating margin after paying content cost,” Terracotta explained. “Note that Qihoo, a Chinese app distributor, and 91Wireless, the app distribution arm of Baidu, both sport close to 90 percent gross margin. Because Apple has considerable greater scale than both Qihoo and Baidu, I estimate that Apple could achieve greater than 90 percent gross margin for its content distribution business.”

Now, it simply remains for Apple to ink a deal with operators in order to kick-start a new chapter.

Edited by Stefania Viscusi

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