This is the first installment of Arctos Sports Operator Notes, a new Arctos Insights series sharing practical guidance for owners and operators across professional sports franchises, leagues, and the broader sports, media, and entertainment ecosystem.
Many have predicted the demise of local sports telecasts for years, including us. Our view has been and remains that the fundamental premise of local television rights is broken in a world of declining cable penetration.
Regional sports networks (RSNs) were a vehicle for arbitrage – driving revenue from the growing fees paid by cable operators while maintaining a slower growth fixed cost base of content. They were a financial trade. This is not well understood. Here’s how it worked. We will anchor the example on Fox Sports, which was the market leader at 40%+ market share for decades, but we could substitute any of the other network groups:
Fox Sports would sign a long-term (7-15-year) rights deal with a team for some significant percentage of their games (+/- 75%). That fee was determined by what kind of affiliate rate could be delivered for distribution and what level of ad sales could be achieved.
Fox Sports RSNs would be bundled with the Fox family of networks (e.g., FOX, Fox News, etc.) that were sold to distributors (think Charter, Comcast, Cox) in 3-5 year affiliate deals.1
Networks strategically timed team rights renewals to align with upcoming affiliate negotiations, maximizing portfolio leverage. An illustrative example: Fox Sports might sign long-term deals with the St. Louis Cardinals, Tampa Bay Lightning, and Orlando Magic just before renegotiating with Charter, the dominant distributor in those markets. This created a blackout risk for Charter—either across all three teams or selectively—pressuring the distributor to cave and / or accede to the Fox Sports’ demands.
Dollars from the bundle would be allocated to the RSNs at generous affiliate rates because these networks would have fixed costs and revenues would drop directly to the bottom line.
RSNs benefited from being (a) typically high quality, must-see TV, including playoff games (in the early days!), and (b) unavoidably bundled with FOX broadcast (and hence the NFL). Cable distributors wanted their ice cream (NFL, MLB playoffs, and Fox News), but the networks forced them to eat their broccoli first (42nd MLB game of the season on a Tuesday afternoon shown exclusively in the San Diego TV territory to 1M homes).
Hence, bundling and generous affiliate fees created a portfolio of large, expensive, and very profitable networks. (By the way, the networks were skilled at not sharing much of their arbitrage winnings with teams. They did this by offering generous-seeming terms but on extremely long tenors. The “big step up + long-term deal” playbook produced a portfolio of content liabilities that structurally grew less quickly than these assets. An incredible financial machine!)
Several things killed the golden goose:
Over time, national rights packages began to take higher quality games, which diluted local packages. The Leagues could afford to do this, because local rights fees were still going up anyway. The local content, while still sports, became less “must-have”.
The decline in the overall universe of cable subscribers (i.e., cord cutting) was one blow, but equally damaging was the drop in penetration and carriage. RSNs that once sat on the basic tier at roughly 80% penetration were pushed onto higher-priced tiers, and distributors lowered their minimum guaranteed penetration rates to closer to 50%. Meanwhile, virtual MVPDs (vMVPDs) (e.g., Sling, YouTube TV) took advantage of access to unburdened broadcast feeds and consistently refused to carry RSNs, further eroding reach.
Once Fox exited, RSNs were left to survive with affiliate rates bloated by years of portfolio-leveraged deals. Most Favored Nation (MFN) clauses preserved those inflated fees—but also handcuffed RSNs from cutting deals with vMVPDs, a growing part of the linear TV market but whose whole pitch to consumers was a cheaper, streamlined bundle. Any concession on price by networks risked detonating significant level of their revenue from their still-lucrative linear base, even as it continued its slow decline.
What’s left of the business is ~35 networks in ~25 markets generating about $5 billion in revenues declining at a hard-to-fathom 10-15% per annum.
When you look at this story, it is hard to come away thinking that RSNs are now an efficient and modern mechanism for delivering local game content. RSN penetration is now down to ~30% of U.S. households. We believe:
Fans want every game in every market. At a certain point, having games locked up in RSNs will become a brand issue for leagues focused on preserving the value of their regular season media.
Fans who cannot access full games will fall back on free media, mostly YouTube and social media. We believe this to be dilutive in several respects: (i) content is intermediated by creators (not unlike ticket brokers); and (ii) monetizes very poorly, which, if persistent, will enculturate fans to expect the regular seasons to be “free”.
While not yet the case today, RSNs will invariably cease to be a compelling rights bid relative to the well-financed and competitive national media market. Our estimate is that – relative to viable “go-it-alone” broadcast + streaming plays – that gap will close in about three years at current run-rates.
What should teams do? Several basic principles as of this writing:
Do not automatically default to “going it alone”. While broadcast does provide better reach on paper, you need: (i) a solid in-house ad sales capabilities (seamlessly integrated with your sponsorship team and ideally led by your CRO/head of sponsorship) to fully monetize that; (ii) a go-to-market strategy to make sure fans know exactly where games will be; (iii) an O&O network (a few million dollar outlay at least) or a partnership; and (iv) a streaming platform provider. You are unlikely to make up the economics today. There are two cases where you should do it anyway: (1) you already have the requisite capabilities, and you want to make the brand investment and finally be rid of RSN uncertainty; (2) you are dropped and hence forced into this option. In either case, Arctos and our advisors know the playbook for how to stand this up and maximize the opportunity, but it will involve work, distraction, and opportunity cost.
Prepare for the future. Our view is that centralization of rights is largely inevitable. But that doesn’t mean all games will be nationalized. National games are shown everywhere in the U.S. Regional games will still matter. The lodestar of sports media, the NFL, has regional games, produced by regionalized production teams under network control. That could be where this goes; but it could also be that teams or leagues will need to handle production, as MLB is doing right now. It could be that all local ad sales are handled by the future network owner (say ESPN or Amazon); but it may be that teams (regionally) or leagues (centrally) will need to sell a portion of local ads themselves.
What is the right model? Sports media is a game with three participants: fans, networks, and properties. The right model is an equilibrium where each segment receives a fair surplus. Fans get reliable, easy-to-find, fairly priced access to everything they want. Networks get must-have content that drives Subscriber Value and Advertiser Value. Leagues and teams receive financial value and brand value. Right now, for local sports, we’re far from that equilibrium.
Here’s a simple framework for the better model:
Fans: Easy access to local and out-of-market games on a (streaming) service or services to which they probably already subscribe (because they are sports fans). Their upcharge is amortized across millions of subs, including non-sports fans.
Networks: Regularly updating stream of must-have live content at rates per telecast that are not exorbitant.
Leagues and teams: Freeing up teams to focus on monetizing brands; improving competitive balance through centralization; brand accretion.
If there is a loser here, it is probably teams’ rights fees from local games. But there are three significant silver linings. First, under conditions of chronically stagnant or declining local TV revenues, valuations have only gone up, even in leagues with meaningful exposure to RSNs (MLB and NHL). Second, despite the turmoil amongst local networks, we’ve seen with the NBA a step-up in national rights can more than compensate for value of lost local rights. Third, local rights could evolve into a 20–40 game promotional package used more for awareness than for revenue. Importantly, it is difficult to measure what a better model for distribution would do for other revenue streams, for competitive balance (and hence national rights values and franchise values), etc.—but whatever the impact, it is hard to imagine that it could be anything but positive.
1 In a world of cable growth, it would make perfect sense for networks to go long on team contracts (with a higher effective growth rate) and short on affiliate contracts (with relatively lower effective growth rate). This was a system was built for growing revenues. That same operating leverage became a liability in a world of declining revenues.
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