[Satellite News 06-30-09] BSkyB CEO Jeremy Darroch reacted furiously to the news that a consultation from U.K. telecoms regulator Ofcom revealed that the agency might take action to offer Sky’s premium content at better wholesale prices to Sky’s competitors in an attempt to even out the market.
    Ofcom “defies belief that it expects Sky to lower its wholesale prices to compensate for the higher costs of less efficient platforms,” Darroch said in a June 26 statement.
According to the consultation, Ofcom said it was concerned about the distributions of sports and movie channels on other platforms and that customers face “a restricted choice of channels and platforms in the short term. In the longer term, new platforms based on innovative distribution technologies may be prevented from developing without access to this content.”
    In defense of his BSkyB’s wholesale pricing policy, Darroch blasted competitors BT and Virgin Media. “Forcing Sky to sell its channels for less than their true value is a subsidy for companies that have shown no appetite for investment in programs. BT and Virgin Media do not deserve to be handed a reward at Sky’s expense for their repeated failure to invest,” he said.
    Darroch accused Ofcom of proposing an unprecedented level of interference in commercial markets. “Good regulation does not involve micromanagement,” he said. “Nor does it mean tinkering to reshape an industry so that it matches a preconceived ideal or a spreadsheet in a regulator’s office. We reject Ofcom’s assumption that it knows better than us how to create value for our business.”
    If Ofcom acts on its consultation, BSkyB could be forced to charge 20 percent less than it is now for its premium channels on a wholesale business making competing platforms even stronger, according to Nick Bertolotti, a media equity analyst at Credit Suisse.
    “An immediate effect of lower prices would be a hit to wholesale revenues from Virgin Media, which flow directly to the bottom line. More importantly, longer term, we believe the benefit of more wholesale revenue accruing to Sky will be more than outweighed by the negative effect of the loss of their more profitable retail subscribers to competitors which would now have unfettered access, at a lower price, to Sky’s premium content — including HD (high definition),” he said.
    However, not all analysts believe the impact on BSkyB would be that much. In a June 28 research note, UBS media equity analyst Daniel Kerven said the threat to Sky direct-to-home service will be limited, “given pay [digital terrestrial TV’s] inferior offering, Virgin’s limited coverage and Sky’s ability to offer wider choice, HD and better triple-play pricing,” said Kerven.
    Patrick Wellington, a media equity analyst at Morgan Stanley, believes Ofcom is adopting a tougher approach towards Sky with this latest consultation. “Ofcom asserts that it believes Sky feels an incentive to restrict supply of core premium channels to other retailers, which arises from its own vertical integration between retail and wholesale activities. Ofcom claims that Sky’s pricing to Virgin is dictated by Sky’s view as to the highest price it can charge without coming into conflict with the [U.K.] Office of Fair Trading’s 2002 margin squeeze test rather than on a commercially backed calculation,” said Wellington.
    Under Ofcom’s suggested price strategy, “The average suggested price discount to the existing rate is around 20 percent. Ofcom believes that its regulated prices will still allow Sky a reasonable return based on its investment at the wholesale channel level based on an estimate of 10.3 percent for Sky’s cost of capital. Ofcom’s aim is to allow a larger competitor (for example reaching 3 million subscribers after 10 years) to compete with Sky’s retail prices,” said Wellington.
    In terms of when any changes to pricing may occur, Bertolotti said his firm expects the publication of Ofcom’s final document in the fourth quart of 2009 or first quarter of 2010. “Assuming Sky appeals to the Competition Appeal Tribunal, as we believe likely, there will be a lengthy appeal process. Some analysts are arguing Sky can suspend the implementation of its wholesale must-offer obligation until after the appeal process. However, our conversation with an industry legal/regulatory expert suggests Sky may not be able to argue for a stay during the appeal process and that the obligations should be implemented during the appeal and as early as the first half of 2010,” said Bertolotti.