British Sky Broadcasting (BSY) has done a great job of aggregating some of the best content available and then marketing its services. More than a decade ago, the firm began to enter exclusive deals to carry major sporting events in the United Kingdom. In addition, it acquires rights to many first-run movies and U.S.-produced series, which are becoming increasingly popular in the U.K. While it resells the majority of its purchased content to other television carriers, it also produces its own shows to distinguish its product. This capability was enhanced by the completion of a new production facility in 2011. The new building has several studios, including one that is large enough to hold an audience and produce live shows, such as game or talk shows with a live audience. As a result, BSkyB has outperformed its competitors by consistently expanding its television subscriber base. In addition, it is selling additional services, such as high-definition television, DVRs, second set-top boxes, and video on demand. All of these services increase average revenue per user and increase profitability.
The firm also offers broadband and phone service. These businesses have grown rapidly and are now similar in size to Virgin Media and Talk Talk, though they are still smaller than those of BT Group (BT.A), the incumbent telephone operator. In fact, BSkyB and BT have been gaining the majority of the net new broadband subscribers in the U.K. for the past several quarters. While the firm doesn't have the scale in broadband and telephony that it has in pay TV services, the profitability in these operations is improving faster than we anticipated. The competition in these segments is much more intense than in television, so BSkyB will never have the scale and moat in broadband and telephony that it does in television, but the incremental business is improving the firm's margins and free cash flow for now.
BSkyB is the U.K.'s largest pay TV operator, with 10.4 million subscribers versus only 3.8 million cable customers. This larger base and early investments in content have allowed the firm to control the best content available for television viewing in the U.K., including sports, movies, and television series. Better content has driven increased viewership, and this has produced additional funds to acquire even more content, leading to a virtuous circle that we think provides the firm with a solid narrow moat.
The biggest risk facing BSkyB is whether it can sustain its hold on the best television content in the U.K. Although it historically has done an impressive job in this respect, we are concerned that increased competition, particularly from BT, makes it unlikely the firm will be able to continue to dominate content in the same manner it has in the past.
