HBO Could Earn More Than $100 Million From Subscribers Who Currently Pay It Nothing

As many as 10% of HBO's 30 million subscribers are "non-revenue generating." A new report from Barclays Capital says converting half of those subscribers to paying ones would generate between $72 million and $144 million in cash.

HBO didn't earn one cent off the majority of the 2 million subscribers the pay-TV network added in the U.S. last year, according to a new report out Thursday from investment bank Barclays Capital.

But don't panic — the apparent negative is actually a positive, as the network can move to change its contracts with pay-TV distributors such as Comcast or DirecTV to generate income from these "non-revenue generating subscribers," as Barclays calls them, in the future. In fact, doing so is one pillar of the strategic plan Time Warner CEO Jeff Bewkes laid out for investors as a rationale for rejecting an unsolicited $80 billion takeover offer from Rupert Murdoch's 21st Century Fox last month.

In a lengthy analysis of HBO's potential strategic options laid out in the report, Barclays analyst Kannan Venkateshwar estimates that roughly 5%-10% of HBO's subscribers, or between 1.5 million and 3 million, don't currently generate revenue for the network. Converting half of them, or between 750,000 and 1.5 million, to paying subscribers, of which $8 for each would flow to HBO, would equate to between $72 million and $144 million of pure earning before interest, tax, and other considerations for the network.

You see, HBO's current contracts with distributors emphasize subscriber growth through marketing incentives, allowing them to keep the fees to themselves rather than split them with the network after subscribers exceed a pre-determined range. It's a nuance of cable contracts that most casual observers overlook or fail to understand.

For example, and this is purely hypothetical, let's say HBO's contract with Comcast calls for a preset subscriber goal of one million. In that scenario, HBO would get paid for every new subscriber up to one million, but all the money from anyone who signs up for the network after that amount would go directly to Comcast. That contract framework encourages distributors to basically market the crap out of HBO. The more people subscribe to the network, the better chance the distributor has of exceeding its goals and keeping the additional money for itself.

From HBO's perspective, structuring contracts that way provides a safeguard in carriage negotiations. Unlike basic cable networks, which have increasingly been blacked out over fee increases in new carriage negotiations, distributors can't do that to HBO since it is a premium network that consumers have to consciously sign up for to receive. But what distributors can do — and have done — is go dark on marketing, basically shutting down any promotional campaigns for HBO.

Obviously, HBO would rather have distributors market and promote its network than not. And all it needs to do is raise the preset subscriber levels with distributors in new contract deals to turn those "non-revenue generating" subscribers into massive revenue generating ones — something Venkateshwar said "should be relatively easy fix over the coming years."