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Why Comcast's Control of NBC Universal Could Spell Trouble

Comcast's successful control of NBC Universal will partly depend on whether it manages a windfall of news, entertainment, sports and films based on what is good for consumers and the media industry or for its separately owned dominant cable systems.

The perilous divide between content production and distribution has contributed to the failure of bigger media mergers, such as AOL's acquisition of Time Warner. Time Warner is the only other media conglomerate with profitable cable networks that also has owned cable systems -- now trading separately as Time Warner Cable. Still, the NBCU-Comcast deal could ignite a scramble for content by other major distributors. Walt Disney's acquisition of Pixar Animation and Time Warner's acquisition of Turner Broadcast System, demonstrate content mergers can work. There already is speculation about a Time Warner and Viacom film studio tie-up or Lionsgate's buying all or part of MGM Studios.

If Comcast and General Electric keep their promise to make cable, digital and mobile content the core focus of a co-owned NBC Universal, the proposed $37 billion media union could succeed where others have failed.

But Comcast also has its primary cable distribution business to think about. Comcast also may underestimate the difficulty of paying off the new company's $9 billion in debt, buying out GE's 49 percent share, controlling production costs and aggressively funding new digital initiatives. Like other media companies, the new NBCU will wrestle with rising costs against slower growing or declining existing revenues and trickling new digital income.

On a conference call with industry analysts, Comcast COO Steve Burke, who will spearhead the new operations said the profitable cable networks will help to finance new businesses such as interactive advertising, cable channels and programs, pay distribution windows, and online and mobile content extensions. It will be astretch given the companies' nascent digital efforts.

NBCU's $22 billion cable networks and Comcast's $7.2 billion cable networks will generate nearly $3 billion, or 82 percent, of the new company's annual cash flow that will be reinvested in content production and digital build out. Comcast also is contributing $6 billion in cash.

But Comcast executives concede growth rates will likely slow from a meteoric 12 percent average annual increase in affiliate fees (paid by cable, satellite and telephone company providers) and a seven percent average annual rise in advertising revenues. The cable networks can maintain their handsome 50 percent operating margins if they hold down original production and acquisition costs, according to Comcast Chairman and CEO Brian Roberts.

As the country's largest cable operator, Comcast's interests may often be at odds with the new NBCU. A 10 percent rise in program costs is undercutting Comcast's healthy cable cash flow but supporting NBCU and other cable networks.

With the cable networks generating less than half of the new NBCU revenues, the goal will be to create additional revenue streams from online and mobile to fortify income while reducing costs at NBCU's less profitable distressed and cyclical businesses such as broadcasting.

One of Comcast's most daunting challenges will be dealing with the legacy structure, equipment, workforce and other costs associated with NBCU's traditional broadcast network and TV station business. A big chunk of NBCU's $16 billion in annual operating expenses belongs to its broadcast television and film businesses. NBC broadcast network and television stations generate about one-third of NBCU's overall revenues, but less than 10 percent of total earnings, according to analysts and company executives.

Despite management's denial that asset divestitures are planned, Comcast will clearly need to address the declining broadcast business by salvaging the content and selling, eliminating or transitioning the costly outmoded infrastructure. NBCU President and CEO Jeff Zucker said Friday that broadcasting must become more like cable. "The advertising-only supported broadcast model of one revenue stream makes it more difficult. We need to find a model that is more like the cable model. We need to find a second revenue stream and that's what we're all grappling with," Zucker said in an interview in NBCU-owned CNBC.

The broadcast quandary has been framed by watchdog groups and legislators who contend the merger would be anticompetitive and Comcast's unusual public memo on "public interest commitments" issued when the deal was announced Thursday. There will be no easy or fast solution to tapping local news efforts by NBC TV stations and Comcast cable to create a hyper-local online video and mobile business, to integrate and develop Comcast and NBCU sports, news, entertainment and women's/lifestyle programs for all digital media.

That is why Comcast is eager to tap NBC's library of 3,000 TV program and Universal Studio's 4,000-title archive. The plethora of content will fuel Comcast's accelerated experimentation with on-demand, subscription and free business models for cable, online and mobile, the executives said. More immediately, Comcast will ramp up new forms of interactive advertising with more accountable metrics about target consumers. Since all of this will take time, advertising is likely to remain only about 20 percent of the new NBCU's overall revenues.

While Burke has stressed Comcast's intention to provide a "supportive" environment for the complicated creative businesses they know little about, Roberts sees Comcast, the distributor, helping NBCU's content businesses "contend with a new set of realities in the electronic age." The chasm between those two goals could prove treacherous.

Comcast is pushing for film premieres on cable and pay per view at the same time they are released on DVD or even in theaters, where it will square off with the likes of Universal Studios. Comcast and NBCU also could find themselves at odds over how to separately develop their pay and free content strategies during the deal's year-long regulatory review. NBCU's co-owned Hulu is expected to begin selectively charging for content early next year about the time that Comcast and Time Warner launch their TV Everywhere digital program service for cable subscribers. Comcast also owns Fancast, the third largest online video service.

Industry observers already anticipate unavoidable clashes caused by Comcast as gatekeeper of distribution and content. Comcast has got to want this bad.

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