If Twenty-First Century Fox Can't Have HBO Should It Buy Starz?

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Twenty-First Century Fox's  $80 billion offer to purchase Time Warner  was believed by many to be driven by CEO Rupert Murdoch's desire to own HBO in order to use the pay channel to compete with Netflix 

Murdoch pulled that offer off the table in a handwritten note to Time Warner CEO Jeff Bewkes, The New York Times reported in August, but that does not mean the billionaire has any less interest in taking on the leading digital streaming service. It seems highly unlikely though that those efforts will be helped by a purchase of Time Warner or an offer to just buy HBO. 

The statement released by FOX after Murdoch pulled the offer for Time Warner makes it seem the deal will not be revisited:

We viewed a combination with Time Warner as a unique opportunity to bring together two great companies, each with celebrated content and brands. Our proposal had significant strategic merit and compelling financial rationale and our approach had always been friendly. However, Time Warner management and its Board refused to engage with us to explore an offer which was highly compelling.

With Time Warner and HBO effectively off the board, that means that if Murdoch wants to take on Netflix he either has to start from scratch, which, even supported by FOX's deep content library, would be a daunting task, or acquire a lesser subscription channel. Since CBS  owns Showtime, HBO's closest rival, and would be unlikely to sell for the same reasons as Time Warner, that leaves Starz  as the next man up.

Starz is certainly well behind HBO in subscribers, original programming, and brand awareness, but it's a similar business model which has had some success and its CEO has said that it's up for sale if the right buyer comes along.

Why did FOX want HBO?
Netflix has changed television so radically that the current cable television model is likely to break apart. This, coupled with new technology and changing regulatory tides could lead to cable companies being forced to offer a la carte pricing and customers being able to buy pay TV in a purely digital format without wired subscriptions. That could ultimately cut into revenues for the FOX network as well as the company's family of cable channels.

With cable in its current form being a declining model, building a direct subscription service like Netflix's becomes more appealing. Streaming services cut out the cable company middleman and HBO, were it to stop requiring a cable subscription in order access its Netflix-like HBO Go service, would likely see a number of its customers drop cable and subscribe to HBO directly. Time Warner does not regularly report HBO subscriber totals, but Bewkes told Variety in February that HBO has 130 million subscribers worldwide -- more than double the 50 million Netflix has.  

Is Starz a reasonable substitute?
HBO had $1.4 billion in revenue in the second quarter and that number would likely increase on a per-subscriber basis if it could transfer some of its subscriber base to a direct model which cuts out the cable companies.  

Starz stands well behind, reporting  $328.2 million in revenue for its second quarter. The company does not report subscriber totals.  

Revenue, however, does not tell the whole story for FOX and the biggest detriment to buying Starz -- which has publicly been seeking a buyer -- comes from how little exclusive programming it owns. Though HBO has licensed some older shows to Amazon , it has hot programs including Game of Thrones and the final season of The Newsroom to lure in subscribers as well as a huge archive of original content not covered in the Amazon deal. Starz has had a few minor successes with original programming, including Spartacus, but its current slate features little-known shows and its brand lacks the credibility of HBO.

These are drawbacks, but when you factor in the FOX library and the power that Murdoch's company would have to market Starz, the deal seems like it could make sense. FOX would give Starz more leverage with cable companies in the current, dying pay TV world, and would be able to, in time, build up its original and archival offerings in a pure digital product.

Shows like Starz's Black Sails are minor hits at best. Source: Starz 

Should FOX buy Starz?
The biggest argument against buying Starz may be that FOX is already a partner in Hulu, which has rebroadcast rights to a number of FOX properties. Owning and bolstering Starz while remaining committed to Hulu, which offers some shows free and deeper archives on its Hulu Plus subscription service, would be a challenge.

Still, the FOX library is deep and includes a movie studio, cable channels including FX and FXX, as well as the fledgling FS1 and FS2 sports channels. If FOX can figure out a way to balance its commitments to Hulu with an effort to improve Starz, then the channel could provide a solid base to take on Netflix.

Starz needs more hit original programs and FOX could help with that. It also needs more promotion and FOX can certainly offer that. Starz may be well behind HBO, Netflix, and Showtime, but as they say in real estate, it 'has good bones" and could give FOX the foundation it needs.   

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The article If Twenty-First Century Fox Can't Have HBO Should It Buy Starz? originally appeared on Fool.com.

Daniel Kline has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and Netflix. The Motley Fool owns shares of Amazon.com and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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