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Time Warner and the War Against Free


In a hangarlike Las Vegas exhibition hall on Jan. 6, Jeffrey L. Bewkes is surrounded by flashing screens, by women in campy space-age outfits, and by aisle after aisle of gadgetry: the great American come-on known as the Consumer Electronics Show. It's been seven years since Bewkes, the chief executive officer of Time Warner (TWX), last attended CES, and he looks a little out of place. A few minutes earlier, Verizon Communications (VZ) CEO Ivan G. Seidenberg brought him onstage as a surprise guest during Seidenberg's keynote, but the tech fanboys in the crowd weren't interested in hearing about Time Warner's vast catalog of movies and TV shows moving onto the Web. They showed more emotion for the demonstration of Google's (GOOG) new "Honeycomb" tablet operating system than they did for Bewkes' video featuring Time Warner stars watching their own TV spots on an array of devices.

Now, moving through a sea of geeks after his presentation, Bewkes resembles a Time Warner character himself—one of those well-dressed, humorless robot agents from The Matrix, surrounded by younger, hipper renegades. He strides through the hall, barely glancing at a wall of 3D video screens, and says why he isn't worried about wowing the techies. "I'm here to explain things to the attendees," he says, "because the attendees tend to not understand the media business." At a trade show that celebrates the wonders of low-cost digital distribution, he's an emissary from the land of paid content. His message is simple and sharp: The devices may be cool, but anything that costs money to produce must be paid for, and any service or channel that doesn't carry its weight is destined to die.

For Bewkes, 58, the solution is a Time Warner initiative called TV Everywhere, which essentially forces customers to keep paying their $75-plus monthly cable bill to access television and movie content on any Web-enabled device they choose. He first floated the idea to Comcast (CMCSA) CEO Brian L. Roberts two years ago, and in late December, Time Warner struck a multiyear deal with the cable operator that will allow subscribers to watch all the content from its basic cable channels—including TNT, TBS, CNN, and Cartoon Network—via Comcast's Xfinity service. Digital access for HBO and Cinemax customers will be available in 70 million homes by the second quarter, he says. Verizon FiOS, AT&T (T), DirecTV (DTV), Dish Network (DISH), and Time Warner Cable (TWC) are also expected to roll out versions of the TV Everywhere concept in coming months. Bewkes wants other media companies to offer the same all-or-nothing Web menu, arguing the only way to win the digital war is to "keep it simple, stupid."

Then again, rival approaches to distribution—from the à la carte menu championed by Apple's (AAPL) iTunes store to the cheap monthly subscription model of Netflix—are pretty simple, too. With the health problems of Apple CEO Steve Jobs compelling him to step down for a third leave of absence, his influence must be measured not just across the computer, phone, and device businesses but across the media distribution business as well. In part it can be measured by the model Bewkes is fighting against: Call it the Apple Trap. Consumers enjoy watching shows for free online or going to the iTunes store and renting them for as little as 99 cents a pop, about 70 cents of which makes it back to the content creator. Since that is far less than what other distributors pay, Bewkes is no fan of it. He won't play the 99 cents rental game for first-run fare, but he is willing to sell episodes, charging a premium for HBO content. "I've talked to Steve Jobs quite a bit," he says. "I tell him if he wants to sell our content, he has to pay a fair price for it."

Bewkes' price doesn't start at a buck. The man who built his career over 23 years at HBO will not make his hit movies or shows available for cut-rate streaming at Amazon (AMZN). Nor will he offer them for instant viewing at Netflix (NFLX), where CEO Reed Hastings recently rolled out a $7.99-a-month deal for unlimited streaming of TV shows and movies. And Bewkes certainly won't let his product be given away on Hulu, which distributes most of its advertising-supported programming for free. Netflix has wooed more than 16 million subscribers, usually paying a fraction of what cable and satellite owners pay TV channels to run content. And while about 70 percent of the ad dollars Hulu takes in gets back to the content owner, those online ads don't draw anywhere near the audience or revenues of TV. That's why Amazon, Netflix, Hulu, and iTunes are potential enemies to Bewkes. He holds the view that companies such as Time Warner can only continue to make high-quality content if they preserve a business model that requires consumers to pay for the whole buffet. Any Web distributor can stream his content, says Bewkes, "if they pay us a billion dollars for a marquee show."

If the situation is so black and white, however, why have Bewkes' rivals been willing to test new distribution models? News Corp. (NWS), Viacom (VIA), and NBC Universal, among others, have experimented with different ways to do business on the Web. Walt Disney (DIS) has been the boldest, perhaps because board member Steve Jobs is its largest shareholder. Disney has the broadest range of offerings on iTunes and last year struck a deal to rent ABC shows for 99 cents each. News Corp.'s Fox network is in a six-month trial to rent hits like Glee at the same price. Both networks are partners with NBC Universal in Hulu, which launched in early 2007 as a way for TV networks to combat the piracy that gutted the music business. "When I took this job four years ago, the words Hulu, Netflix, Google TV, and iTunes were not part of the lexicon," says Jeff Zucker, the departing boss of NBC Universal, now merging with Comcast. "And now, frankly, it's all we think about."

These days on the digital battlefield, it's hard to tell who's a friend and who's a foe. There's the advancing army of Boxee, Roku, Slingbox, and other new services that make it easier to find and stream content. Google and Cisco Systems (CSCO) are getting into the game of connecting the Internet to the home TV; so is Microsoft (MSFT) with its Xbox console. Bewkes views all of them as potential allies in helping people find his shows—but not if they dare to sell their own ads around them. Verizon's Seidenberg argues that Bewkes' obstreperousness makes him an innovator. "If we do this right," he says, "we can work with all the content companies to create a responsible transition to new platforms."

It's understandable that media moguls such as Bewkes don't want to disrupt relationships with TV distributors that have been lucrative for so long. But Boxee CEO Avner Ronen, whose company makes software that lets customers watch Net content on their TVs, predicts the world will move to a model where consumers will pay one price to get a distribution service and another for the content they actually want. Companies such as Time Warner "need to take all their amazing content and be aggressive in engaging with the new technologies. Of course they should be paid. They have to cover the costs to make it." Adds Michael Pachter of Wedbush Securities: "The guys who will ultimately profit the most in the new environment are the ones who own the content."

So far, however, assembling the technologies and players needed to implement TV Everywhere has been a challenge. Rival studios enjoy the extra income and reach that Apple or Netflix distribution can bring. Distributors would love to lower the fees they must pay to carry a range of channels, many of which their customers don't really want. Fox Filmed Entertainment co-Chairman Jim Gianopulos says rolling it out isn't so easy. One concern is how to give a subscriber online access without letting the entire dorm use that account to stream episodes of True Blood onto everyone's laptop. "Any time you try to arrive at a standardized set of rules or content-protection standards across an industry," Gianopulos says, "there's cacophony before there's order."

If the noise bothers Bewkes, he doesn't show it. At CES he's almost buoyant. When a TV reporter describes Netflix as an 800-pound gorilla, he says it's more like a "200-pound chimp." When he runs into DirecTV CEO Mike White, he gives a thumbs-up and declares that "satellite is good!" He notes with satisfaction recent increases in TV viewership and ad rates, along with an explosion of high-quality programs he calls "a new golden age of television." He can also point to his company's results as a sign of survival. Bewkes lost about 1.5 million subscribers at his Cinemax and HBO channels last year but says most were on free promotions. Despite a tough economy, close to 40 million households still pay about $13 extra each month for the premium services. With Time Warner expected to report on Feb. 2 that 2010 earnings grew 3 percent while revenues rose 2.9 percent, to $26.5 billion, Bewkes can claim that his content remains king—at least for now.

Content is all he has left. In his three years as CEO of Time Warner, Bewkes has whittled down his company, spinning off Time Warner Cable and AOL (AOL), closing 34 magazines, and folding New Line Cinema into Warner Bros. What remains is about 43 percent smaller in revenues and focused squarely on content in the form of HBO, Warner Bros., the Time Inc. stable of magazines, and Turner Broadcasting's cable channels. Almost three-quarters of Bewkes' operating profits in 2009 came from the cable networks, with subscription fees making up 64 percent of that unit's revenues and ad sales supplying the rest.

Bewkes believes the TV Everywhere model can revive his sluggish magazine business. He wants print subscribers to get the same content on the Web without being forced to pay twice. Time Inc. struck a deal with iTunes to adopt that model for People, but Apple won't allow it for any of its other titles. That creates yet another source of tension with Apple, which prefers to sell separate digital editions on iTunes and take its usual 30 percent cut. (Apple declined comment.) Also troubling, for Time Inc. CEO Jack Griffin, is Apple's control of the process. "You never want to let another party get between you and your customer," he says. "Everyone should be able get what they paid for on whatever device they want."

Hulu, in Bewkes' view, undermines the value of current programs on TV. "Are you testing the proposition that if you give people their favorite shows without commercials, they'll like it? I can tell you: Yes. Yes, they will." (Hulu does in fact show commercials.) NBCU's Zucker, a Hulu founder, says his philosophy was to experiment "but not bet the entire ranch on any one form of digital distribution." And there's always divorce. Viacom chief Philippe Dauman pulled Comedy Central's The Daily Show and The Colbert Report from the site last March. "We said, 'Great service, but the economics aren't quite there yet; come back to us when you have a different model.' "

Bewkes saves his real venom for Netflix. Speculating about its dominance, he told The New York Times, "is a little bit like, is the Albanian army going to take over the world?" Yet it poses the greatest threat to HBO. By letting customers stream unlimited movies or shows for a small fee, it could make the pay channel obsolete. Bewkes says it's feeding off the ignorance of content owners who are risking their core businesses in exchange for modest fees. Hastings declined to comment, but Netflix spokesman Steve Swasey noted that "Netflix adds new money to content owners whereas other ventures do not." He points out that the service carries some Time Warner content, such as the Warner Bros. series Nip/Tuck. Studio chief Barry M. Meyer says he's happy to offload niche shows that can't be sold elsewhere but not his hits.

Bewkes says a growing number of content companies are waking up to the perils of the new low-cost Web channels. "For a year, they had some young digital-rights VP selling this stuff for an extra 10 percent, and people said, 'You should give little Freddy a bonus because he made some extra money,' " he says. "Meanwhile, someone realizes he just sold TNT a series for $2 million an episode that can be shown two times a week, and Freddy sold the same rights for $200,000 to a website that can run it day and night." There go your syndication deals and DVD sales, he says. Turner Broadcasting System CEO Philip Kent, for one, let USA Network outbid him for the right to syndicate the hit Modern Family because he felt it had been overexposed online. To stoke audience appetite, HBO chief Bill Nelson says, "We wait a year or more after airing a show to issue it on DVD."

Netflix stock rose almost 220 percent last year, while Time Warner shares underperformed the market, rising a little more than 10 percent. As Bewkes sees it, a great website and low-paying subscribers don't add up to a healthy business. "We've all seen this movie before," he says. "It was called AOL."

It's a telling quote—as Bewkes intends it to be. After all, he sealed his reputation as a tough executive by standing up to the leaders of AOL after the Web company merged with Time Warner in what became known as the worst corporate marriage in American history. Announced in January 2000, the merger valued AOL Time Warner at $350 billion, the bulk of which came from AOL's market cap. Within two years the deal that had been hailed as an Internet rescue of old media had failed, losing two-thirds of the original valuation. Bewkes was still running HBO when he showed his mettle in a 2002 meeting recounted in Alec Klein's book Stealing Time. Steve Case, the AOL co-founder who was then AOL Time Warner chairman, was extolling the importance of corporate synergies when Bewkes interrupted. "This is bullshit," Bewkes said. "The only division that's not performing is yours."

That Bewkes would turn out to be so tough was not a given. The second of three boys, he grew up in a family of achievers that moved around commuter towns in New Jersey and Illinois before settling in the moneyed seaside community of Darien, Conn. His grandfather had been president of St. Lawrence University, a private liberal arts college in upstate New York, and his father was a top executive at conglomerate Norton Simon before becoming chairman and CEO of American Bakeries. The family's wealth was understated, a friend says, and the dinner table was a place for good manners and intellectual debate. The Bewkes boys were steered toward pursuits such as skiing and windsurfing, according to James Angell, an artist who roomed with Bewkes at Yale University. Team sports were shunned. "His family considered the level of intelligence inversely proportional to the number of people on the field," says Angell. While "you wouldn't call them touchy-feely," he adds, "they were quite funny."

Bewkes' path to success was well mapped. He spent his high school years at Deerfield Academy, a prep school founded in 1797, then moved on to Yale, studying a little bit of this and that—"pursuing my interests without regard to a careerist pigeonhole," as he told the dean who insisted he declare a major. (He picked philosophy because that's where he had the most credits. Later he earned a Stanford MBA.) Christopher Isham, a fellow Yalie who's now the Washington bureau chief for CBS News, describes their group of friends as having "a certain strain of irreverence."

It's a strain he still displays today. Bewkes will happily riff on the finer points of paint color and stonework in ancient Rome for several minutes before settling back in his chair and adding, "We're very busy here at Time Warner." David Chase, who created The Sopranos, recalls one Bewkes speech in which he talked about trying to learn Yiddish at the age of eight so he could break into show business. PepsiCo (PEP) CEO Indra K. Nooyi, who serves with Bewkes on the Yale board, says he often has the other board members "rolling in laughter" at meetings. "He doesn't operate from a place of fear," says Chase. As head of HBO, he says, Bewkes gave the go-ahead for The Sopranos even though its pilot didn't test well. He showed the same confidence in questioning the wisdom of AOL Time Warner when the dot-com people were still in charge and few inside the company would risk their careers by speaking up. "Jeff was clearly echoing the sentiments of everybody on the Time Warner side," says Richard D. Parsons, who was then the CEO. "He was never intimidated by the AOLers."

When Bewkes took over from Parsons in early 2008, he immediately began to break apart the company. First he spun off its 84 percent-controlled cable operation, which gave Time Warner $9.25 billion of extra cash when the deal closed a year later. While the cable business wasn't broken—its stock has outperformed its former parent—Bewkes didn't want a $17.2 billion-a-year distribution business with high capital costs. Glenn A. Britt, a long-time colleague of Bewkes' who's now CEO of Time Warner Cable, says the executive team agreed the businesses were better off apart. "I was always more into cable and technology," he says, "whereas Jeff was more into content." As for the confusion created by now having two companies with the same name, Britt points out that "we were the only part of Time Warner that used the name to do business." Since taking in the cash payout from Time Warner Cable, Bewkes has spent roughly $1.6 billion on dividends and $2.7 billion on stock buybacks—a conservative play, for sure. The company had $4 billion in cash on hand in September, its most recent filing.

Next, Bewkes turned his attention to the dysfunctional AOL. Its core business—selling dial-up Internet access to 26.7 million subscribers at its height—had gone the way of the buggy whip. In March 2008, Bewkes made his biggest strategic gaffe, spending $850 million to buy a social network site called Bebo. A year later he brought in Google ad executive Tim Armstrong to run AOL, and Armstrong eventually sold Bebo at a fraction of its original cost. ("You can call that one a failure," Bewkes says.) Armstrong had plans to turn AOL into a content company, but Bewkes cut it loose in December 2009, giving Time Warner investors one AOL share for every 11 TWX shares they owned in a deal that valued the denuded Web player at $2.5 billion.

That sale is essentially what activist shareholder Carl Icahn was pushing Parsons to do in 2005. "I wish it had happened earlier," says Icahn, who also suggested spinning off Time Inc. "Jeff has done a real good job." Fund manager David Giroux, who holds 10.4 million Time Warner shares though the T. Rowe Price Capital Appreciation Fund (PRWCX), is more impressed with what Bewkes is doing now. Giroux describes him as "the first person to realize that giving away your content for free is not a good business model." Bewkes' preference for buybacks (and the richest dividend in the media business) over acquisition pleases Giroux, too. That said, Bewkes confirms that he's looking into buying assets from Dogan Yayin Holding, Turkey's largest media group, if the price and political climate are right.

Taken together, the company calculates that return to shareholders from the three former parts of the empire rose about 13 percent during Bewkes' first three years on the job. Returns from Time Warner alone were up only 1.9 percent, according to Bloomberg data. That places Time Warner between the performance of Disney (up 21 percent) over the same period and rivals such as CBS and News Corp. (down 21 percent and 26 percent, respectively). Lead director Frank J. Caufield says he's pleased. "The entire board thinks Jeff has done an extraordinary job," says Caufield. "He has a consistent vision, and he's aggressively pursuing it."

Because Bewkes is known as a practical, shareholder-focused manager, some describe him as cautious and conservative—a "numbers guy" and even a "sensible technocrat," in the words of a New York magazine profile. (Bewkes calls the label "better than some of the alternatives.") Don Logan, a former Time Inc. chief who shared operational duties with Bewkes when Parsons made both group chairmen in 2002, praises him as an analytical boss who "doesn't put a lot of layers between himself and the people in the field." When he took over the top jobs at HBO and later Time Warner, Bewkes didn't replace himself as COO.

That Bewkes is rarely described as a visionary is a relief to Turner's Phil Kent, who had enough of the vision thing and left CNN shortly after the merger, then returned in 2003 when the AOL side of the company was on the wane. "The business has evolved to a place where you need really smart, clear-thinking leaders who put shareholders first."

Given the flux in the media business right now, matched against the sizzle and speed of Silicon Valley, some might wonder whether a leader who stands for stable evolution may be more hindrance than help. After listening to Bewkes speak at the UBS Global Media and Communications Conference in New York last month, one media executive, who asked not to be named because of close ties to the company, admitted to feeling a little empty. What Bewkes said sounded sensible, the executive says, but he didn't offer any compelling reasons to buy the stock.

Bewkes likes to remind people that Time Warner's businesses are typically top in class, though nobody is about to brag about CNN's recent prime-time performance. There's the leading pay channel, the powerhouse production studio, the cable channels, and the magazine unit with still-profitable titles from Sports Illustrated to Time to People. Skeptics point out that he could have trotted out the same list of leading properties two decades ago. What's new at this company?

What's new, Bewkes says, is defending what's old. In a world where Time Warner content is everywhere, the company is still getting paid for it. If he succeeds in keeping that world alive, Bewkes will be justly hailed, if not for his vision, then for his intransigence. Back at the electronics show in Las Vegas, Bewkes is ever vigilant. At the Samsung booth, he spots Britt, chief of the spun-off Time Warner Cable, and motions to a reporter. "Come here," Bewkes says. "We liberated this guy." As Britt shows off some new Samsung technology that gives subscribers a snappy interface and no need for a set-top box, Bewkes has just one question: Will anyone be able to shrink that screen and sell ads around Time Warner's content? An exasperated Britt shakes his head.

Bewkes has to go, but he wants to show that he cares about the football fields of new tablets, smartphones, and other gadgets on which his content increasingly appears. So he turns to a colleague at the Samsung booth, Warner Bros. chief Barry Meyer, and says, "Barry, don't leave without seeing all the other stuff." Meyer nods in mock deference, promising to inspect no fewer than 13 other devices, all with different-sized screens.

Until Bewkes is comfortable that each of those screens will more than cover his costs, he might be right to hold the line on digital distribution. It isn't brash, but it may be effective. "In times of crisis, Americans tend to default to action," says analyst Laura Martin of Needham. "Maybe Jeff, in taking no action until it makes sense, is being more innovative than you'd think."

Brady_190
Brady is a senior editor for Bloomberg Businessweek in New York.

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