The last ten years have seen the film and television industry transform beyond recognition. In the latest instalment of our editorial series, Link, experts from our credit and equity teams discuss whether streaming will continue its inexorable reshaping of the media landscape.

Streaming companies are poaching talent from the studios and producing some of the best and most popular shows around

In a little over a decade, Netflix and Amazon Prime have gone from offering online DVD rentals to mass content streaming and producing their own shows, taking control of content as well as its distribution. They are disrupting an order established for decades, whereby producers would own content distributed by cable and satellite companies, each taking a share of the profits.

Not only are streaming companies competing with the distributors, they are poaching talent from the studios and producing some of the best and most popular shows around. This move is reminiscent of what happened twenty years ago in the music industry, when the all-powerful record labels began to be disintermediated.

The music industry has successfully reinvented itself after a long period of soul-searching. But can traditional producers and distributors of video content similarly imagine a new order that will allow them to survive?

To explore this question, the AIQ editorial team brought together Mikhail Zverev (MZ), head of global equities, Nick Clare (NC), equity analyst, Othman Kacimi (OK), credit research analyst and Scott Freundlich (SF), senior credit research analyst at Aviva Investors. They argue that, while viewers are increasingly “cutting the cord” with cable providers, the much shorter shelf-life of video content means the future of television will likely follow a very different path.

How would you rate Amazon’s progress with its streaming offering; do you expect it to become more aggressive?

SF:  Despite the rise of Amazon, we haven’t seen much deterioration in Netflix subscriptions, which shows the growth of the sector as a whole. Amazon has been more strategic, creating limited content that has a higher success rate than Netflix. For a firm that was not historically a media company, it has done a really nice job in terms of selection, and of hiring the right executive teams to run that business.

Amazon will modestly increase its investments, but not necessarily to the degree Netflix has

In terms of its aggressiveness going forward, and alongside Apple TV Plus of the other tertiary streaming names, Amazon will modestly increase its investments, but not necessarily to the degree Netflix has.

NC: They approach it differently too. Amazon has chosen to offer a variety of things and bundle video in with Prime access. It wants the Prime subscriber number to stay where it is in the US where it’s so highly penetrated and continue to increase slightly elsewhere around the world. As we have seen with COVID, Prime usage has only gone up. That seems likely to be some form of a permanent change.1

MZ: Amazon exemplifies two interesting things. One, it is a new entrant into the universe that does not need to make money from video. Under the old order, the main protagonists were companies like Time Warner, HBO, Disney, CBS and Discovery. It was their primary business and the whole ecosystem was very profitable. They were in it to make money.

Amazon Prime

In contrast, Amazon, and more recently Apple, are in that business to strengthen an ecosystem where they make money on something else: retail for Amazon, devices and other services for Apple. While they charge for the service, we suspect it would not be a profitable standalone business, because Netflix only just turned profitable a few quarters ago, and is still not cash generative.2

Interestingly, and perhaps an indication of how aggressive Amazon will be, it has committed to paying $150 million over the next five years for a producer contract with Jonathan Nolan and Lisa Joy. This is tier-one talent in both TV and film. That is a statement of intent.3

Amazon has also committed to paying over $1 billion to serialise Lord of the Rings, just like Disney serialised Star Wars into the Mandalorian television series.4 It shows there are new players willing to commit unprecedented amounts of money and do not need to make money in that business. Certainly, Amazon shareholders are not holding its feet to the fire on whether Amazon earns adequate returns on capital in the media business.

Is Amazon trying to be a media company, or is it using content to retain Prime customers?

NC: Video is not the core offering of the Prime membership. Amazon is able to invest in various ways to keep people interested so they continue paying for Amazon Prime as a whole. Access to the streaming service is just part of that, so I think Amazon’s desire to make content – as opposed to just streaming very well-known shows – speaks to its increasing interest in becoming a media company.

Amazon competes with everybody in everything

The only opposing point to that is Amazon competes with everybody in everything. It can spend a lot of money on everything, so you never really quite know what its true core future focuses are. But this would seem to be one of them given the importance of what is happening with streaming services.

What about Apple? Can it win in this space or is it a distraction from its core business?

NC: I don’t think it is a distraction. It is probably highly unprofitable, but it is a supplemental offering that keeps the ecosystem alive, and the real value of Apple is the ecosystem. Apple will have some hits and some duds, but it is also going to focus on original content and spend rather aggressively in that area. It is something Apple is doing because it needs to.

Apple is paying big dollars to get original content

In many ways, Apple wants to be viewed as more than a hardware company, a lifestyle or media type brand, so it makes sense for it to be involved; but again, it is paying big dollars to get original content.5

SF: I agree. Apple has been investing noticeably less than the other players; it is also a newer platform. I would have thought it would be a little more aggressive as it only had a small number of original shows at launch, but it is focusing on original content.

MZ: It is a bit like Disney – every time they open their mouth, they commit to spending a bit more on Disney+ and losses extend further into the future. It’s the same with Apple.

It is a dichotomy between buying back-catalogue content and producing something new, which was the great pivot Netflix made with House of Cards. To me, this is another case in point that a war on talent is heating up.

Apple TV+

A lot of the streaming debate is also about how music transitioned from one product to another, and how it is now growing, profitable and exciting again. Music took a long journey through the valley of death, but who remembers the dark days now the streaming companies are extremely profitable and highly valued?But the crucial difference between video and music is that video’s shelf-life is much shorter. There are few things we watch again and again, but my running music hasn’t changed much in the last 15 years.

NC: Even though it is a small amount for Apple, I think it is very aware of what it is spending. It will keep going up, but it will be the least likely to just throw money at the wall and hope some of it sticks.

What are the cashflow impacts of COVID on the production side?

NC: The ultimate bull case on Netflix is someday, somehow, it will have a major inflection where it becomes wildly profitable, has a giant ecosystem and free cashflow looks great. The delay in production in the last couple of quarters has let people see a pretty big inflection in free cashflow, but I would not look at a single bit of that as savings; it is a delay of spending.7

Free cashflow is probably much further out than what most people are assuming because it is a giant race to win

Whatever the consensus on free cashflow for any of these companies, it is probably much further out than what most people are assuming because it is a giant race to win. To do that, you need to spend on the production side, and that is going to continue as people fight over producers and actors.

OK: I agree with Nick. We saw additional subscriber uptake for these services because people were stuck at home. Free cashflow is getting better because, on the revenue front, they have been less hit than other sectors, and capex plans have just been postponed. Artificially, free cashflow figures have been inflated.

SF: COVID-19 has accelerated the cord cutting [from cable providers] and the move to streaming.8 In response, it has created production cost inflation, because there are more streaming competitors and original television cable networks competing for the same talent, the same series and the same scripts. I am a bit dubious about the long-term cashflow capabilities of streamers, except for the ones that eventually consolidate the space or have enough scale.

NC: Before Pixar or Marvel were acquired, employees were fiercely loyal because they allowed them to be creative and free-thinkers, and they built families around this. You have to wonder if the big names now being signed and given free rein over the creative process are really committed, or if they are just following the money and ready to jump around from platform to platform.

I wouldn’t be overly committed to something that wasn’t a core focus

I wouldn’t be overly committed to something that wasn’t a core focus for a business. You get a huge pay cheque to do your own thing, then you follow the next pay cheque, which could make it increasingly expensive and less likely to drive real return for the companies that sign the cheques.

MZ: John Landgraf, CEO of FX Networks, coined the notion of “peak TV” in 2015, suggesting the industry was producing more scripted video entertainment than people had time to watch. Since then, the industry has kept pushing us to find a bit more time at the expense of sleep and, interestingly, work.9

Producers were pushing the boundaries even before some of the new launches like Disney+, HBO Max and NBC’s Peacock. Then the whole world had three months’ worth of lockdown to binge, and they really scraped the barrel. To refill the mine would take some time and a lot of money.

What has the effect of streaming been on TV providers – cable, pay TV, even public television?

SF: Discovery is talking about creating its own streaming platform.10 This is forcing it to reinvest itself. In terms of financials, it is losing subscribers as part of the pay TV ecosystem at an accelerating clip and offsetting that pretty successfully through price, by charging the distributors such as Comcast and Sky more money. It can also make money through advertising.11 Ultimately, all this is accelerating the reinvention of the cable networks, many of which, in my opinion, will be bought out or slowly die.

MZ: Subscribers of traditional cable TV already felt they were overpaying. They have been given a couple of things they want and a whole bunch of things they never watch for a considerable amount of money.

Cord cutting was accelerating in the run-up to COVID

Cord cutting was accelerating in the run-up to COVID, but one or two years ago the “content owners” increased retransmission fees to the distributors. Cable companies grunted but didn’t quite pass it on to the consumer because the shock would have accelerated the cord cutting.

Now, distributors like Charter have decided to ‘tear the plaster off’ and pass on the price increases.12 What happens when their subscribers cancel their cable is the cable companies lose the margin, which is $10 to $20. They offset that by removing the bundle discount from the broadband package and by encouraging customers to upgrade, say from 50Mb/sec to 100Mb/sec. That more than compensates for the lost margin on the distribution of video. But the video producers have no recourse.

NC: Like many Americans, I like to have cable access to watch sports, but if I want to watch a show, I can easily find something. The diversity of selection is good, and if I wanted that type of diversity on streaming, I would end up spending more money purchasing all these streaming products and still have no access to sports.

ESPN

Just to give an example, on August 6, the USPGA was the first major championship in golf history that wasn’t free on TV. It was only on ESPN+, which you have to pay for. People went crazy on Twitter.13

There is a competing dynamic that to get this broad swath of entertainment you need to have a lot of different services as well as broadband. I think people are quickly going to start noticing they are paying more money than they used to just to get cable. It is difficult to know how it will play out, but it is an interesting dynamic.

OK: As before, there is enough money to go around for media consumption. The shift is it’s all about content, and about this perception I am free to watch whenever I want, over the platform I want. But you are right, it is going to go back to the days of people spending $45-60 a month on entertainment, in addition to sports.

MZ: But the more excessive margins might disappear. If you look at the music industry, it transitioned from one thing to another. I’m not sure what the average spend on music is today versus the age of CDs; Spotify costs $9.99 a month14 and you might have one or two others. When these transitions happen, some value accrues to the consumer through reduced cost and increased convenience or variety.

OK: Everybody was saying Spotify would become the Netflix of music, but the difference is musical content has a much longer shelf-life than video. Going forward, the real source of value for Spotify is partnering with the record labels and those that own the historical content.

A lot of the historical content libraries are valuable, and for Spotify to do what the record labels have been doing for a century would be tricky. Where it can monetise its investments and business model is by leveraging its technologies and understanding the listening habits of users to guide the record labels on what artists or songs are going to become the next successes.

Spotify can differentiate is by leveraging its technology and helping record labels reduce their spend on this

The highest spend for a record label is what they call ‘artist and repertoire’ – the R&D of the music industry. All the trial and error of trying to find an artist, recording sessions, costs a lot of money. Where Spotify can differentiate is by leveraging its technology and helping record labels reduce their spend on this.

NC: I agree music has definitely become cheaper for the consumer. It is $14.99 a month for Apple music for the whole family and anybody can access it at any time, whereas for video, each service might offer a good deal, but it all adds up.15

I also think it is slightly different because I don’t really see a point where all of a sudden, the video price would just come down to $14.99 a month with access to everything. That is not going to happen, so it is slightly different for the consumer.

The streaming market is fiercely competitive and, at some point, consolidation seems inevitable. Is it too early to get a sense of who the winners and losers will be?

MZ: We can see the competitive tension on the price paid for content and talent, and still some relatively low prices for services, but there is an interesting “double anchoring” phenomenon going on.

Once upon a time, investors rationalised paying high multiples for Netflix before it became profitable by looking at the huge legacy profit pool that had become technologically obsolete, and concluding it was just a matter of time before it transitioned to the new world, i.e. Netflix.16

Then other people came on board, Disney being a prime example, earmarking ever more content for streaming.

That makes two key contenders for that profit pool, with an anchoring relation of one off another, who may well be the winners at the end, at least in terms of sales share; Netflix because it is already there, Disney because its content is so hard to compete with.

Will investors value other streaming providers the same as Netflix and Disney?

The question is: will investors value other streaming providers the same way – HBO Max, NBC and the rest? At some point, the profitability of that ecosystem will not be the same as that of pay TV was for decades, optimised for all involved. I just don’t think that deflation of the profit pool is fully priced in.

NC: I agree with Mikhail: you have Netflix, and then you have Disney. Disney has franchises, like Marvel, Star Wars, Pixar or Disney, with some of the strongest fan bases. Once the fans join the platform, they are going to stay.

Disney clearly has the play, and Netflix is the 600-pound gorilla, so it has the play. For everybody else, including Amazon and Apple, if the offering is not bundled in, it is going to be hard. It will be expensive to catch up to those two businesses; they can dominate without really competing against each other because they have very different target audiences.

SF: In terms of the economics of streaming, the value will probably be lower ten years from now than across the pay TV ecosystem today. That is just because more value should accrue to the consumer.

It will be interesting to see what happens to sports and local news. They drive the legacy pay TV ecosystem today in the US.

NFL

We are starting to hear the NFL work with Amazon to show certain games.17 I don’t think one aggregator can have it all, but it will be interesting if, over time, Netflix has Monday Night Football, Amazon has Thursday Night Football, and Comcast has the Premier League… Could we go that way? We could, but it is going to take a long time. There is still a melting ice-cube effect where pay TV remains because of local news and sports.

NC: It would be such a risk for those brands to do that to their fans too. For the NFL, which is probably one of the most profitable corporations that exist, to tell a large part of their fans they have to acquire these three streaming services to watch what they want, a careful balance is required. That is why it is going to be a while.

Video game/e-sports live streaming has reportedly risen sharply during the COVID-19 lockdown. Could we see more integration between TV, film and video game streaming in the future?

NC: For serious gaming, there cannot be any kind of delay, so it will probably be some time before hardcore gamers play Call of Duty combat mode on their phones from the cloud. But as soon as the technology is there, the convenience factor is significant and will expand the addressable market for these companies.

Game creators can start to reconsider the amount they have to pay the console providers

For the creators of games, like Activision or Take Two, it is also very positive because they can start to reconsider the amount they have to pay the console providers, which is usually around a 30 per cent cut. That will definitely go down when games can be distributed directly through Amazon or Google. It will be good for consumers and video game producers.18

Will these games one day be streamed on the big platforms like Netflix for people to watch?

NC: Amazon is already doing it; it would make sense for Netflix to follow suit. It is all part of media, and gaming has a large, captive audience as it is, although on the tech side, it may not be a natural thing to do for Netflix. Amazon and YouTube/ Google have really established themselves as the places to watch other people play video games. But it is a huge market, and it is only going to get bigger as you can play these games online and stream them.19

References

  1. Parkev Tatevosian, ‘Will Amazon Prime reach 200 million members by the end of 2020?’, The Motley Fool, July 18, 2020
  2. ‘2020 quarterly earnings: Second quarter earnings’, Netflix Investors
  3. Joe Otterson, ‘Jonathan Nolan, Lisa Joy exit Warner Bros. TV for massive overall deal at Amazon’, Variety, April 5, 2019
  4. LaToya Ferguson, ‘’The Lord of the Rings’: Everything you need to know about Amazon’s big money adaptation’, IndieWire, July 6, 2020
  5. Mike Reyes, ‘Apple TV Plus is investing $6 billion on original content, here's how it's being spent’, Cinema Blend, September 2, 2019
  6. Matt Binder, ‘Three major music labels make $19 million a day from streaming while artists count their pocket change’, Mashable UK, February 25, 2019
  7. ‘2020 quarterly earnings: Second quarter earnings’, Netflix Investors
  8. ‘Research: Covid accelerates shift from linear TV to OTT’, Advanced Television, August 19, 2020
  9. Brandon Katz, ‘The numbers say peak TV will drown us in even deeper content in 2020’, Observer, January 9, 2020
  10. ‘Discovery, Chip and Joanna Gaines announce multi-platform media joint venture’, Discovery, April 10, 2019
  11. ‘Discovery, Inc. reports second-quarter 2020 results’, Discovery, August 5, 2020
  12. Jon Brodkin, ‘Charter’s hidden “Broadcast TV” fee now adds $197 a year to cable bills’, Ars Technica, July 7, 2020
  13. Alex Myers, ‘PGA Championship 2020: Golf fans were NOT happy to learn early coverage was on ESPN+’, Golfworld, August 6, 2020
  14. ‘Premium’, Spotify, as of September 23, 2020
  15. Leah Yamshon, ‘Apple Music FAQ: The ins and outs of Apple's streaming music service’, Macworld, July 29, 2020
  16. Graham Elton and Harris Morris, 'Media money will flow to content managers', Financial Times, August 31, 2006
  17. Alex Sherman, Jabari Young, ‘Amazon to exclusively stream an NFL game next season in new deal’, CNBC, April 29, 2020
  18. Tom Marks, ‘Report: Steam’s 30% cut is actually the industry standard’, IGN, January 14, 2020
  19. ‘Live game streaming market - global market share, trends, analysis and forecasts, 2020 – 2030’, insightSLICE, June 2020

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