We have funded or followed visionary billionaire entrepreneurs in the media space for nearly three decades and never has the outlook been so intriguing. It is clear to us what happens next, but the unintended consequences and ultimate outcome of the impending battle is anybody's guess.
Challengers. We expect each of the dominant US consumer facing internet platforms to spend billions of dollars in 2018 to create premium video content in an effort to take revenue, viewers, and time away from the incumbent TV and film content creators and distributors. Because these companies have built their fortunes by aggregating consumers (FB), information (GOOG), products (AMZN) and apps (AAPL), we label them the Internet Aggregators. Their competitive weapons are significant. They are much larger, have deeper pockets, are held to different valuation standards by Wall Street (implying a lower cost of capital), have global distribution and revenue footprints, are dominant in mobile, and they are willing to subsidize losses for a decade, as YouTube has done. More ominously, they are fast movers with agendas that have little to do with ecosystem health, as evidenced by the value destruction of several historical media ecosystems. We believe that their war will ultimately be against one another, but that the TV and film ecosystems represent a key strategic battleground in that end game.
Champs. From an over-the-air US TV industry generating less than $10B in revenue in 1980, the US TV ecosystem spent the next 35 years together building one of the most successful US consumer products of all time: the linear TV bundle. At its peak reach in 2010, 88% of US households paid a subscription fee to the TV ecosystem for access to 250+ Pay-tv channels. Although mega-bundle Pay-tv subscribers are now declining, revenue has continued to rise, reaching about $170B in 2017. The US TV ecosystem has proven robust because it has hundreds of frenemy corporations negotiating (a core competence) unique longͲ term contracts with each other that forward their own best interest. Whenever any company gets an edge, others follow. Also, it's an ancient ecosystem so specialization is high and successful companies had to out compete every company that came before.
What media stocks should investors own in 2018? We recommend: a) CBS, based on its OTT assets and US election advertising upside in 2018; b) FB, a mobile ad driven juggernaut with powerful ad targeting capabilities built on top of a world-class consumer aggregation platform; and c) ATVI and/or EA, based on growing TAMs, new revenue streams, higher margins and eSports. In midcap, we recommend: a) ROKU, which is an aggregator of OTT channels in the US; and b) WWE, which has successfully made the transition to OTT and owns the wrestling super fan market globally.
Internet Aggregators are coming. Each Internet Aggregator has announced it will spend $3‐6B in 2018 to create premium video content. We believe this will be TV series type content based on: a) Facebook has found that audiences would rather watch multi‐episode video shows than one‐off videos as Facebook series have twice the average viewing time of non‐serialized videos, according to FB; b) Three Mashable series, "Sharp Science," "Bad Days" and "Scamalot," have an average watch time three times longer than non‐serialized videos, according to Mashable; and c) Attn reported that its monthly video series "America Versus" (compares U.S. policies to other countries) averages 30x longer engagement than what Attn gets for its one‐off Facebook videos.
Internet Aggregators (i.e., Apple, Amazon, Facebook, Google) have several competitive advantages in the fight for video economics, each of which we discuss in this report:
- Enormous market caps;
- High valuations (i.e., low cost of capital) and strong free cash flow from their core business;
- Deep pockets and patience with losses; and
- Smartphone dominance—and smartphone viewing is where consumers are going.
Netflix. We do not include Netflix as an Internet Aggregator in this report. Why not? Because the Internet Aggregators organize long‐tail assets, suggesting a power asymmetry with the platform having monopoly power compared to what it aggregates. In contrast, NFLX was built on contracts with the six major US studios, each of which is taking its content away from NFLX to build their own OTT channels that will directly compete with NFLX. Additionally, NFLX must access capital markets to fund its $2‐3B of annual cash losses, suggesting it doesn't have the balance sheet strength to survive in direct combat against the content conglomerates, many of which have investment‐grade balance sheets.
Champs (i.e., incumbent US TV ecosystem companies) have several impressive competitive advantages in the fight for video economics, each of which we discuss in this report:
- Engagement. Enormous time spent daily with linear TV content.
Dual Revenue Stream Business Model. TV generates $170B of revenue, about 40% from advertising and 60% from subscription, at a 20% profit margin. This implies $136B is spent each year on TV and film content plus overhead. We believe it will be nearly impossible for any single revenue stream competitor to unseat a dual revenue stream ecosystem owing to enormous implied losses.
- Cluster Theory suggests that Hollywood and Silicon Valley are global winners in part owing to their geography. Cluster theory jettisons the notion of competitive advantage as a concept relating to a single company and instead redefines competitive advantage based upon the geographic location of an ecosystem of companies, which implies they cannot be moved.
TV Everywhere adds value to the perceived price/value relationship of the mega‐bundle.
- Mega‐Bundle Value. The high monthly price of skinny bundles and individual OTT channels for very limited programing and/or access underscores the value of the 250+ channel mega‐bundle.
- Confusion. Clutter created by a la carte choices confuses consumers, resulting in a fear of making a bad decision. This leads to inertia, which means consumers stick with the mega‐bundle longer.
Ad Growth. US TV advertising is expected to grow, adding about $1B in each of the next 5 years, and reaching nearly $80B by 2020. As ad blockers threaten the ad‐driven internet sites, TV is a sure way for brands to reach audiences with their brand message via full screen sight, sound and motion, and no fraud thanks to independent third‐party measurement by Nielsen or comScore.
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