BSkyB under pressure – and this is not from Ofcom

David Hellier, deputy editor at City AM, anticipates a tougher future for BSkyB.

As the political world gets itself tangled up in the tortuous debate about who may have compromised themselves most in helping the Murdoch empire over the years, there has been a simultaneous argument going on in the City about the future prospects for BSkyB, the satellite operator at the centre of the Westminster row.

Some see BSkyB, which is reporting third quarter results on May 2, as a massively profitable juggernaut of a group that after years of heavy investment in dishes, then digital and then High Definition technology, is now reaping the benefits of its judicious strategy. Others, however, and this includes the research analysts at Bank of America Merrill Lynch (whose corporate broking team includes BSkyB as one of its clients) foresee long-term reductions in revenue growth as the pay television model comes under pressure from rival sources of content.

The bearish argument about BSkyB’s prospects goes something like this. BSkyB has built up a pay television model that sees it bundling packages of programming so that subscribers who want sports or movies can only do so by signing up to a basic programming package as well. This tends to maintain high margins.

In the past, the wholesaling of sports contents to rivals such as Virgin was also done at high margins. But these have under pressure following intervention from the media regulator Ofcom.

The satellite operation, which has 10 million subscribers, now wants to penetrate some of the 13 million homes that do not have any pay television and will try to do so shortly by launching a new Internet-based service that will allow consumers, for the first time, to pick and mix their channels.

BSkyB argues that since it has already invested in premium programming, such as sports, movies or US drama, it makes sense to leverage that content across as large an audience as possible, which is a no-brainer until some of its existing subscriber base withdraw from their main packages to pick and mix exactly what they want at lower margins.

Ian Whittaker of Liberum Capital says that BSkyB has been underestimated several times before but fears that BSkyB’s overall penetration of the pay television market could stagnate, or even decline, as consumers trade their Sky subscriptions for a hybrid approach of free digital services such as Freeview or YouView combined with subscriptions such as NetFlix or LoveFilm, which reduces the cost to consumers.

The group has also invested heavily in US drama, including taking the hit TV series Mad Men from the BBC. But there is little evidence to suggest this tactic has done much to enlarge the subscriber base. Indeed Whitaker suggests its main impact has been to lower churn.

In this scenario, BSkyB has no choice but to try to attract new subscribers through different pick and mix pricing models. But the risk is great. Lower margins and cannibalisation of the existing customer base are a distinct possibility.

If you believe the bearish model, like Bank of America Merrill Lynch, shares (currently worth 667p) are heading down to 640p. If, like Numis, you prefer to focus on the strong earnings (more than £250m in the third quarter) and favourable resolution of the next round of Premier League rights, you will see the shares rising all the way to 825p, close to the level reached when News Corp looked like buying them all before the hacking scandal erupted.

Take your pick.