Can Apple save Hollywood? by Philip Elmer-DeWitt @FortuneMagazine February 5, 2009, 3:10 PM EDT E-mail Tweet Facebook Google Plus Linkedin Share icons Congress may have postponed the scheduled Feb. 17 transition to digital broadcast television on Wednesday — ensuring that millions of rabbit-ear TVs won’t go dark for at least another four months — but that doesn’t mean that the way Americans get their video entertainment isn’t in the midst of wrenching change. Take, for example, the story on the front page of Thursday’s New York Times: Digital Pirates Winning Battle With Major Hollywood Studios, in which Brian Stelter and Brad Stone report that bootleg copies of Warner Bros’ “The Dark Knight” were downloaded 7 million times in the space of 6 months — despite an elaborate antipiracy campaign, months in the planning, that included monitoring every physical copy of the film. Or Microsoft’s MSFT report Wednesday that more than 1 million XBox Live gold members (who pay a $50 annual fee) have activated a Netflix NFLX app and used it to watch, in the space of three months, more than 1.5 billion minutes of movies and TV shows downloaded over the Internet. Here you have both sides of the sermon Steve Jobs has been preaching to the studios for years: the “Napster moment” the Times article describes, in which pirates do to the movie and TV studios what they did to the music industry; and the alternative, in which video content is legally streamed or downloaded — for a fee — from the Internet. So where does that leave Apple TV, the set-top box that Jobs unveiled two years ago as Apple’s AAPL path to Hollywood’s salvation? Originally a device for connecting a computer wirelessly to a TV, it was updated last year to allow shows and songs to be purchased or rented directly from the iTunes Store. Although sales of the device tripled last quarter, thanks largely to movie rentals, it is still a minor player in the transition from the old distribution paradigms to the new. “We’re going to continue to invest in it, because we fundamentally believe there is something there for us in the future,” acting CEO Tim Cook told analysts during Apple’s last earnings call, but he still refers to it — as Jobs did — as a “hobby.” (link) The pundits have offered a variety of suggestions for how Apple might solve its — and Hollywood’s — dilemma by revamping Apple TV, including Peter S. Magnusson (who urged Apple to add a tuner, a DVR and a Blue-Ray disc drive), Bernstein Research’s Toni Sacconaghi (who advised the company to turn it into a full-fledged Tru2Way cable box), and Businessweek’s Arik Hesseldahl (who examined a variety of options earlier this week, including buying DVR-pioneer TiVo TIVO ). [UPDATE: Piper Jaffray's Gene Munster issued a report to clients shortly before noon Thursday with his own predictions. See below the fold. ] But the most thoughtful analysis so far may be the one posted Thursday morning at Roughly Drafted Magazine by Daniel Eran Dilger, who looks at what Apple should — and perhaps more important, shouldn’t — do with Apple TV. “Analysts have voiced a lot of terrible ideas that would actually dismantle or saddlebag Apple TV,” he writes, “converting it from a fun hobby into a burdensome money pit failure.” Here, in thumbnail form, are his take on what he calls some of the worst ideas: Add a DVR, perhaps by buying up TiVo. “The only thing worse than jumping into a dead market long after the lights have been turned out is buying out the leading failure in the market in order to do so.” Add an optical disk, perhaps Blu-Ray. “Talk about snatching defeat from the jaws of victory: Apple has been pushing digital downloads as an alternative to the DVD for years now, with pretty decent success.” Add an HDTV screen. “This one takes the cake for ridiculous.” “Apart from those top three ideas for wrapping an albatross and a millstone around the neck of Apple TV,” he continues, “there are a variety of smart things Apple could add to their box to make it far more valuable.” Add iTunes radio features. “Plug Apple TV into your speakers and have streaming radio with graphics.” More alternative content. “…the other big free content source is podcasting.” Add an iTunes Store, and an SDK for interactive content. “Make it easy to download little $5 games and app, and Apple TV will explode with the same software interest as the iPhone.” Additional support for user created content. “How about a custom client for also accessing me.com email, contacts, and calendar on the big screen, navigated by the iPhone’s keyboard?” Consider the controversial. “There are a variety of competitive services that Apple might benefit from partnering with, including ad-supported Hulu and subscriber-supported Netflix.” (link) Dilger fleshes out each of these options in considerable detail and in his usual lively style. The full piece is highly recommended. See also: Tuning into Apple TV 3.0 Apple vs. Netflix: How do they stack up? Apple TV Take 2: What’s the hangup? Below the fold: Gene Munster’s predictions. While Apple downplays the possibility, we expect the company to design a connected television over the next two years (launching in 2011). Separately, and in line with published reports, we expect updates to the Apple TV hardware with TV DVR functionality in the next nine months. We are modeling for Apple to sell 6.6m Apple TVs in CY09, which assumes a continuation of the y/y growth rate of 3x seen in the Dec-08 quarter. If Apple introduces new hardware in CY09 our estimates could be conservative; every 1m units sold adds $0.03 to our CY09 EPS estimate. Source: Piper Jaffray.