FanPost

The SEC Network, the Longhorn Network, and the Future

Jim Brown-USA TODAY Sports

In honor of the first disbursement from the SEC Network, I thought it would be fitting to take a moment to acknowledge and praise the Man and the Decision that landed Missouri in the SEC and enabled the SEC Network to become a reality.

Thank you DeLoss Dodds. Thank you for your sad devotion to making the Longhorn Network a reality.

I come to praise the Longhorn Network, not to bash it. Launching the LHN guaranteed Texas A&M would leave the Big 12 and crushed any hopes of a Big 12 Network. Dodds’ further decision to flirt with the Pac-12 (in tandem with the Red Raiders, Oklahoma, and Oklahoma State) and the well-timed comments by David "Wallflower" Boren provided the final knife to the gut which pushed Missouri Chancellor Brady Deaton (not exactly an administrator with a reputation for wild daring) and AD Mike Alden over the edge and into the arms of the SEC. Missouri went from a member of the Forgotten Five to the SEC in a span of months.

I come to praise Dodds’ perseverance. Even when some referred to Texas as a bully during the crazy days of major conference realignment, he endured those slings and arrows, rammed home his priorities, and made sure the rest of the conference members were left to sink or swim as individuals rather than as a conference or a team.

I come to praise his sociopathic devotion to short-term profits over the tedious process of building a strong ecosystem benefitting all the schools within the Big 12, which would have required a modicum of humility and collegiality.

Bless you DeLoss. Bless you Longhorn Network.

The SEC Network

Missouri just received $31 million dollars from the SEC – an amount all SEC members received equally, whether they were Vanderbilt or Alabama. Of those millions, about $7 million came from the SEC Network. Please recall, at its inception, considering the costs involved in establishing a new channel, the SEC Network was not expected to see any real revenue until Year Three. Instead, each school is cashing an $7 million dollar check from the SECN alone. ESPN has knocked this one out of the park in terms of distribution and pricing.

The potential has always been evident. Getting a significant SEC Network revenue check in Year One is phenomenal and the future is bright.

LHN vs. SECN

For the sake of comparison, let’s take a look at the Longhorn Network. One claim that has been thrown around by everyone from Mizzou internet comment jockeys to Fox Sports’ Clay Travis, is that every school in the SEC will make more TV money than Texas because of the SEC Network.

Considering the size of the LHN deal and the need to split revenue among the 14 SEC schools and a share to the Conference, that seems a bit of a stretch. Let’s delve into it.

Taking a look at the contract between Texas and ESPN, I’ve put together a table with the Minimum Annual Guaranteed Royalty (MAGR) owed to Texas by ESPN each contract year over the life of the LHN deal (Section 10.A.i of the contract, pages 16-17). The MAGR is contractually guaranteed to increase by 3% each year. When you hear the LHN deal "guarantees Texas $15 million each year" remember that is an average:

Contract Year

Minimum Annual Guaranteed Royalty

1

$10,980,000

2

$11,309,400

3

$11,648,682

4

$11,998,142

5

$12,358,087

6

$12,728,829

7

$13,110,694

8

$13,504,015

9

$13,909,135

10

$14,326,410

11

$14,756,202

12

$15,198,888

13

$15,654,855

14

$16,124,500

15

$16,608,235

16

$17,106,482

17

$17,619,677

18

$18,148,267

19

$18,692,715

20

$19,253,496


Take a look at that payout schedule. This is guaranteed money, just for signing on the line. Note especially the escalation as the exponential characteristics of the 3% guaranteed yearly increase really begins to kick in towards the end of the deal.

What a thing of beauty if you are a Texas fan. What a dagger to the heart of good citizens like Iowa State. What a fantastic reminder to Missouri of why we left for the SEC.

And the potential upside is just as ridiculous. Per Section 10.A.ii, once a "Threshold Amount" of money has been earned by the LHN, Texas is to receive an "Incremental Royalty" equal to 70% of Network Adjusted Gross Revenues (AGR). Now, the Threshold Amount happens to be $295,000,000 in AGR, but still, in the heady days when they were whipping this contract up, it may have seemed achievable.

Wow. Just wow.

Now, as much as we all love revenue, let’s turn our attention to the costs, such as we know them. Bevo will say "Who cares about ESPN’s costs? Where is our check? We are Texas!" That is a valid, and very Texas, way of looking at things (as in, a short-sighted and sociopathic emphasis solely on the income stream coming their way with no regard to the consequences of their actions on those around them or acknowledgement of their external environment), but let’s look anyway.

From my reading of the contract (and please comment below if you see something I don’t) – that MAGR payout looks rock solid. There seems to be no way to withhold it or reduce it other than if ESPN had chosen to locate the Studio on campus (per Section 10.A.iii), and ESPN chose not to do so.

Now, let’s turn our attention to Section 4, FACILITIES/STAFF and pull some details from it:

  • First, accommodations for a studio are required. They wound up selecting an office park in Austin for the scenic locale, funded and equipped at an estimated cost of $13,000,000 (the "Initial Capital Commitment").

  • The target number for staff is 75 people. Think salary, benefits, training, settlement costs for that unfortunate incident between the Marketing Manager (it’s always the Marketing Manager) and that hot little intern from Southlake, etc.

Next, let’s jump to Section 8, ESPN OBLIGATIONS, where they discuss the Annual Operating Budget:

  • Estimated Production Costs Year 1 were $15,000,000, increasing annually at 3%

  • Estimated Overhead Costs Year 1 came to $11,000,000, increasing annually at 4%

Now, as the contract states, these are just estimates and the contract won’t be considered in breach if the true amount varies from that, but they are the numbers we have, so, excuse me while I whip out another chart of what this looks like over twenty years:

Contract Year

Estimated Production Costs

Estimated Overhead Cots

Estimated Annual Budget

1

$15,000,000

$11,000,000

$26,000,000

2

$15,450,000

$11,440,000

$26,890,000

3

$15,913,500

$11,897,600

$27,811,100

4

$16,390,905

$12,373,504

$28,764,409

5

$16,882,632

$12,868,444

$29,751,076

6

$17,389,111

$13,383,182

$30,772,293

7

$17,910,784

$13,918,509

$31,829,294

8

$18,448,108

$14,475,250

$32,923,358

9

$19,001,551

$15,054,260

$34,055,811

10

$19,571,598

$15,656,430

$35,228,028

11

$20,158,746

$16,282,687

$36,441,433

12

$20,763,508

$16,933,995

$37,697,503

13

$21,386,413

$17,611,354

$38,997,768

14

$22,028,006

$18,315,809

$40,343,814

15

$22,688,846

$19,048,441

$41,737,287

16

$23,369,511

$19,810,379

$43,179,890

17

$24,070,597

$20,602,794

$44,673,390

18

$24,792,714

$21,426,905

$46,219,620

19

$25,536,496

$22,283,982

$47,820,478

20

$26,302,591

$23,175,341

$49,477,932


Now, Bevo be all like "those are ESPN costs, not UT costs, so hook ‘em and gimme my check, I’m hitting Sixth Street tonight," and that is a valid, and very Texas way of looking at things.

What else is ESPN on the hook for? Well, insurance for one. Turning to Section 13, INSURANCE, ESPN must provide broadcasters’ liability insurance, workers comp, bodily injury by disease (what the hell goes on at those office Christmas parties?!?), auto insurance, and other coverage. Just to make it easy on ourselves, let’s assume this is a negligible cost as the ESPN borg either self-insures, or the coverage for this 75-person staff is in the noise as far as the Mother Ship in Bristol is concerned.

Digging further we come to Annex C where we find ESPN got the pleasure of paying IMG a one-time "Consulting Fee" of $5,000,000 as part of this agreement.

Okay, let’s recap the expense picture for ESPN. We have Texas getting a guaranteed payout that started at just under $11 million and which escalates remorselessly at 3% each year. ESPN spent around $13 million to set up shop in Austin. IMG got a cool $5 Million for helping set this ludicrous deal up. The estimated cost to run the LHN kicked off at $26,000,000 in Year One and climbs from there.

And just how much, pray tell, is the LHN generating in terms of revenue?

Well, I don’t know. We’ll go with an estimate from Clay Travis at Fox Sports as our best guess at the moment (SNL Kagan answers his emails, not mine, and if you can cite a better source for the revenue, please let me know in the comments). Mr. Travis finds:

According to SNL Kagan, the Longhorn Network now has 6.5 million in-state subscribers paying an average rate of .29 a month. Based on SNL's numbers, that means in 2015 the Longhorn Network will bring in $22.6 million in revenue from those 6.5 million subscribers in Texas. ESPN doesn't comment on particular revenue numbers for channels, but ESPN says the LHN actually has 20 million subscribers. That's a big difference in subscriber numbers, but when you parse the difference between those subscriber numbers, the revenue isn't much different. That's because, according to SNL Kagan, all of the national subscribers outside the state of Texas -- that's roughly 13.5 million subscribers -- are paying $0.02 a month, or $0.24 a year, for the Longhorn Network. Those 13.5 million subscribers would add just $3.2 million more a year in revenue, meaning after four years the Longhorn Network is still just doing $25.8 million a year in revenue.

Now, let’s be generous and say that with advertising sales the LHN will generate $30 million this coming year.

The upcoming Year Five of the agreement sees Texas getting $12,358,087 in Guaranteed Royalty money from ESPN. The Year Five budget estimate is $29,751,076. And we are ignoring insurance costs.

ESPN is spending $42 million to generate $30 million.

For those of you in the private sector, meditate on this for just a moment. Think about the time you had to go into the COO’s office and explain a revenue slippage or listen to your sales manager scream at you for missing your target numbers. Ask yourself what goes through the mind of the LHN CEO when the smart phone pops off with a Bristol area code.

Seriously, ESPN is spending $42 million to generate $30 million.

Bevo be all like "So what! Where’s my check? We rule! Our bad years are better than Missouri’s good years!" (You knew I had to work that in at some point, didn’t you?), and that is a valid, and very Texas way of looking at things.

Those of us not drunk on the burnt orange Kool-Aid might be asking questions like "At what point does ESPN begin to have second thoughts about this deal?"

Reasonable people might even ask, quietly, just what does the contract say as regards termination? Well, I’m glad you asked. Let’s jump to Section 14, Events of Termination and take each subsection point by point:

  1. The agreement can be terminated if one party goes broke or dissolves. If either ESPN or UT dissolves, I doubt it will matter as I’ll be hunkered down in my repurposed Y2K bunker, hiding from the Four Horsemen of the Apocalypse.
  2. This section is redacted. Not much was redacted in this contract (kudos to UT on the transparency, though I assume that was driven by wanting to brag more than their dedication to openness) and it makes me wonder. If you know, clue me in.
  3. If Texas can’t provide the inventory of games required in Annex A, then the agreement can be voided.
  4. If the law changes to make this contract impracticable, the contract can be voided
  5. If the agreement is terminated, certain responsibilities, such as indemnification and other legal odds and ends remain in force.
  6. IMG’s agreement can expire and ESPN would pick up the ad sales piece.
  7. Had to do with the studio location and is not relevant now.

Overall, this looks like a very tight contract. Who knows what 14.B. says, but unless it allows for termination due to poor financial performance, this looks like ESPN would have the Devil’s own time of extricating itself from this thing. Whoever negotiated this deal for UT should get her or his own case study in the Harvard Business Review, a statue out in front of Darrel K. Royal Stadium, and no cover charges at the Yellow Rose for life.

And what Ivy League crack baby at ESPN green-lighted this thing? I’ve seen some wild-eyed start-ups pitch some seriously deluded market penetration figures before, but holy Truman, who the hell thought they could make money off a single-school channel with a cost structure like that? And I sure as hell would never have signed something like this without a clean way out. Amazing.

As for the SEC Network, we don’t have the contract to review, but from our limited knowledge, again, well-summarized by Fox Sports’ Clay Travis, and based on initial subscriber estimates, each SEC school can expect to receive $19 million in revenue from the SEC Network by Year Three. Considering how well Year One went, that no longer appears to be the ludicrous assumption I had regarded it when I first read Travis’ article last year.

The LHN will pay out $19 Million to Texas in Year 20 of their agreement (along with an estimated operating budget of just under $50 Million).

So yes, if the SEC Network continues its trend, each school, from Vanderbilt to Mississippi State to Missouri, will get more by pooling their Tier 3 Rights than Texas will from going it solo. I would not have guessed that prior to running the numbers.

And what’s even sweeter – the creation of the LHN may have actually made the SEC Network viable. By pushing Texas A&M (roughly 4.6 million cable households) and Missouri (roughly 1 million cable households) into the arms of the SEC, the SEC footprint went from 11 million cable households to over 16 million cable households (and if you have valid subscriber numbers for DISH and DirectTV, let me know, but I expect they show a similar ratio). This added the massive TV markets of Texas and the not-inconsiderable markets of Kansas City and St. Louis to the SEC footprint.

As an aside, the LHN would not have been the only tipping point for this. If Texas had not been wedded to the concept of the Longhorn Network, then UT, along with OU, OSU, and Texas Tech would almost certainly have jumped to the Pac-12, creating the Pac-16, and driving TAMU and MU to the SEC anyway.

Helping Out Texas

Wrapping up the comparison, it may not be totally fair, especially at this point, to say the SEC Network has worked out better than the Longhorn Network, because the LHN started significant payouts from Day One, while it appears the SEC Network committed to paying startup costs off first. Possibly a lesson-learned from someone sober reading the LHN contract over at Bristol. That argument will become weaker over time if we really do see annual payouts from the SECN north of $15 million per school.

We also need to see what the subscriber numbers look like next year. ESPN leveraged the roll-out of the SEC Network to force a lot of folks to take on the LHN. For instance, I get SECN via DISH. The DISH plan requires you to also have the LHN. Now, the spread in revenue will still be lopsided in favor of the SECN, clocking in at $1.30 - $1.40/month per footprint subscriber for SECN vs. $0.29/month for Texas subscribers to the LHN and $0.25/month for the SECN out of footprint vs. $0.02/month for the LHN out of Texas, but if the various providers are lumping the LHN in with the SECN, then ESPN might eventually see the Longhorn Network get close to breaking even.

Staying close to break-even will be a problem, though, with their fixed costs (the MAGR) and their Annual Budget costs set to rise like clockwork every year. I don’t see how the LHN can get the kind of carriage-fee increases it would need to keep up with that cost structure and am not sure they can sell the kind of advertising they’ll need to actually make a profit. Assuming they will see a bump in subscriber numbers based on riding the coat tails of the SEC Network, viewers are what matters in advertising and unless something changes, the LHN will be the Google+ of the network world - widely available and even widely subscribed to, but a quiet desert, utilized by a tiny minority of viewers.

Going broke from the bottom up is excruciating and I couldn’t wish it upon a better victim.

What’s even more amusing is that we live in a funny old world where the LHN’s only potential path to financial viability is by piggy-backing with the SEC Network. I guess Texas A&M can do their little brother a solid in this case. ESPN is certainly pulling out all the stops to make the LHN work, but there is only so much you can do with a single-school channel when trying to pimp it out nationally as the content is self-limiting.

Looking at this from a strictly Gordon Gekko point of view, UT’s Tier 3 income is still going to be massive, assuming ESPN does not have the ability to terminate the contract early and cut off the cash spigot. The SEC Network Tier 3 net revenue is already massive and the per-school payout will probably eclipse the LHN payout to Texas at some point in the next 3-5 years.

Was all this worth gutting the Big 12? Bevo don’t care, and, as Missouri has landed in the SEC, neither do I at this point.

The Years to Come

And so, with the first conference year of the SECN behind us, we begin the big experiment. Brand power vs. Content. Is the Big 12 model, where teams each go out and "eat what they kill" in the Tier 3 markets more lucrative for the various independent contractors who make up that conference, or is the SEC model (and B1G Network Model, and Pac-12 Network Model), where teams pool their Tier 3 rights on a dedicated platform, going to end up sending more cash to the member schools?

We shall see, but for those of us in Rock M Nation, we no longer have to worry about what Texas will do or decide, we no longer have to flinch every time realignment is mentioned, and we no longer are part of the "Forgotten Five." We are back-to-back SEC East Champs in football, full partners in the baddest athletic conference around, and founding members of the most successful cable channel ever launched.

Fight Tiger.

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