Research in Action: Streaming media – a case study in tech disruption

Carolyn Bigda: From Janus Henderson Investors, this is Research in Action. A podcast series that gives investors a behind-the-scenes look at the research and analysis used to shape our understanding of markets and inform investment decisions.

Hollywood writer and actor strikes. Record-breaking billion-dollar concert tours. High-stakes cable TV feuds. Today, the media sector is a volatile, changing, and exciting, making for an interesting time to be investing in these companies, says Research Analyst Div Divatia.

Divyaunsh Divatia: You have all those tech companies which are starting to build a content library. They have global distribution. They have tech skills. So, it doesn’t look likely that they will slow down.

Bigda: But is it possible to find investment opportunities in today’s media world – without the drama?

I’m Carolyn Bigda.

Matt Peron: And I’m Matt Peron, Director of Research.

Bigda: That’s today on Research in Action.

Div, welcome to the podcast.

Divatia: Thanks a lot, happy to be here.

Bigda: For anyone who watches TV, it’s probably fair to say that their experience today is vastly different from what it was a decade ago, even a few years ago. In July, streaming services commanded a greater share of viewers than cable TV did for the first time in history in the U.S. There are more programming options than ever, produced and distributed from around the world. But all this content comes at a cost, which judging by the stock performance of some companies, the market is not so sure of.

Div, can you explain how TV streaming got to where it is today, and what the immediate opportunities and challenges are?

Divatia: Sure. So, let me first give a historical perspective here. The first real inflection point in streaming came about one decade ago, back in 2013, when House of Cards and Orange is the New Black were released by Netflix. And straight out of the gate, they were big mega hits across the globe with the audiences. So, until then, nobody thought that Netflix could pivot into original content. And what Netflix did by proving that is that they could be a great studio and make original content, which all the legacy media companies did not think it could do.

And those turn of events set the ball rolling, and Netflix became a big global behemoth, where it tried to make a lot of original successful content and it started growing globally. And then in five or six years from then, market cap grew 20x. Subs [subscriptions] grew five or six times. It turned free-cash-flow positive for the first time in 2020. And it suddenly became one of the large media companies, from an upstart disruptor that it was 10 years ago.

2018/2019 timeframe – five years later – all the media companies woke up and smelled the coffee and saw the writing on the wall. That wow, the linear cable television business, which is the lifeblood of their revenues and profits, is declining or has peaked and streaming is something that they need to show growth to Wall Street.

At that time – boom, 2019/early 2020 – COVID happened. Everybody was stuck at home. Live sports were shut down. There was nothing to do. Everyone started subscribing to streaming subscriptions. And remember, back then, this was a 0%-rate world. So, what mattered to investors was subs and revenues. So, in that land-grab world, every streaming company or every legacy media company started chasing subs by pricing their services as low as possible and by showing growth in terms of revenues and subs.

Fast forward to 2021. What happens? People start leaving their homes. Sub growth starts to slow down; that COVID pull-forward demand is starting to slow down. And back in late 2021, and then early 2022, the sub growth completely hits a stall and then slows down and kind of hits a wall. And then, people start freaking out, inflation starts coming, interest rates start moving up. And what starts to matter to the Street is, start showing me profits and free cash flow.

So, these companies, to react to those things, start increasing prices, introduce advertising tiers, start cutting on content spend and marketing spend –which are the two biggest cost line items for these companies – and try to show profit.

So, all the legacy media companies and the streaming businesses lost $10 billion in 2022. And on the other side, the legacy media companies started losing 7% sub declines on their core cable television business.

So, you had this push and pull of the linear business declining, and you also don’t have a line of sight to making any profits on the streaming business. So, today some of these companies are stuck in the middle, where they’re trying to figure out how do they make profits in streaming without completely taking their linear television business down.

And for some of the services, they are so subscale. So, they’re still in the middle of the journey to get a big scale of subs which is enough for them to make some money in streaming. So today everybody, except Netflix, is not profitable on an EBITDA [earnings before interest, taxes, depreciation and amortization] or free-cash-flow basis, and most of them don’t even have a line of sight or scale to get there.

Bigda: And let’s just take one step back here and talk about this profitability issue. So, why is it so challenging for the streaming companies to be profitable at this point?

Divatia: I think the bigger issue is that you’re…for some of these companies, you’re priced between, let’s say, $9 to $15. That’s the broader range. That is a lot of content spend you need. Because remember, in the historical linear television business, you didn’t release all your shows at once. You had those shows which were released episodically.

Secondly, in a bundle world, in a linear television world, when you are watching ESPN, you are paying for someone who’s not watching ESPN. So, a non-ESPN viewer is paying for an ESPN viewer, while you are watching, let’s say, TLC or Bravo and someone who’s not watching.

So, in a bundle world, if you’re a linear television business or a media network, your churn is super low because you cannot cancel your cable television because you’re watching something else. And most of these cable television bundles are also bundled with your high-speed Internet or broadband. So, your churn is super low. Whereas in an a la carte, direct-to-consumer world, you can cancel your show or you can cancel your subscription as quickly as the show is over.

So, for some of the services the churn is super high, the pricing is not that high adequately, and then they have to keep making content and spend on marketing and to grow subs [subscriptions], and some of the services are still growing internationally. So, if they want to grow in markets in Europe and Latin America and some parts of Asia, they still have to spend on marketing and content in those markets.

Bigda: So, the consumer affinity with these channels has gotten to be a lot less because of the way that these businesses models have changed, which sounds like it is driven now by new technology, Matt, right?

Peron: Yes, well, Div mentioned the tech companies earlier, and I just want to pick up on that. They’re disrupting as they usually do. So, why have the tech companies had an entrée into this? Why have they been so successful? Do you think they can grow from here?

Divatia: So, let’s step back and say, what do you need to be successful in streaming? You basically need four things, I feel. You need great skills in technology. So, that’s making a great user interface that is not buggy and it is a great experience and has a great recommendation engine. You need a great content library, whether it’s licensed or it’s owned; you have great IP [intellectual property]. Third thing you need is global scale or distribution. Or maybe not global, but a good enough scale or distribution. And the fourth thing you need is, probably, you don’t need a legacy business that you’re cannibalizing.

So, you have all those tech companies, which are starting to build a content library. They have global distribution. They have tech skills. So, it doesn’t look likely that they will slow down.

Secondly, think about this: All the legacy media companies today are leveraged. In a 5% interest rate world, it’ll become incrementally difficult for them to fund a bunch of this content. And on the contrary, these tech companies have hundreds of billions of cash sitting on their balance sheets, so they’re going to make 5% return here.

Secondly, if you’re a tech company and you cannot use that cash to buy any big company – under this regulatory environment, you can’t do big M&A [mergers and acquisitions] – so, the easiest way for them to grow in this business is to buy a bunch of content, spend a lot of cash, which is sitting on their balance sheet, and to actually grow this content business. And these companies take a long-term view. They don’t take a view based on a quarter. So, if they are thinking about next five or 10 years, then this business makes a lot of sense for them to go into. And again, for them, this business is not their core business. So, this business is not going to move the needle for them. But at the end of the day, it helps widen their [competitive] moat and it helps them reach those customers and to give them one more thing to use.

Bigda: At the same time, we still do have the legacy players in the industry. These are the cable operators that for decades made a lot of money selling bundles of TV channels, and then the media companies that collected fees from the operators and advertisers in exchange for content.

But streaming threatens to upend this relationship, this sort of cable bundle that we talked about earlier. Do you think that they go extinct? Or is there a way forward for those two types of companies?

Divatia: It’s tough. I think the biggest change that’s happened in the last five years especially is that these cable companies don’t make any money by selling you video. They make money by selling you high-speed Internet. So, they have little skin in the game now to make money by selling you video.

And in a way, you saw this with the whole spat that happened earlier between Charter and Disney, and maybe that is a future template for how this relationship survives, and they both need each other at this point of time.

And the way forward I think is maybe the cable companies start to create a new bundle, and the bundle being you start to scale up, and you start to bundle up a bunch of the streaming services into your linear cable bundle. And that helps, in terms of the streaming services, it helps their churn to go down.

And then secondly, the streamers can make money by advertising. So, once they get scale, they get engagement, they can make money on ads.

And then on the second side, this might also extend the life of that whole ecosystem. Today, you have 7% sub declines. Maybe this takes the sub declines slightly lower, and then you can extend the life of this product by a few years or 10 years or something like that, which is incremental.

So, maybe I feel that it is the right way forward, where some of these cable companies start creating a new bundle. And as a consumer, people are also fatigued by having 10 different subscriptions. They can literally go to one company and pay same amount of money or pay one bill and get five or 10 different services, which makes sense, eventually, from a consumer point of view, as well.

Bigda: So, maybe we go from a world where we have cable TV as its own entity, then streaming services as its own entity – to a world where they merge into a single unit. Is that the idea?

Divatia: I think the bigger question is maybe it works for someone, a streamer which is not scaled enough. So, some of those services which are large and have enough mass, don’t see a value to be part of that bundle, because they’re not going to gain any subs, or they’re not going to reduce churn. But for a lot of others, it makes incremental sense for them to get scale, and to be part of the bundle, and to reduce churn, and to actually reach [across] that aisle and get some profits in the next 12 months or 24 months before things get really bad and it’s not possible to scale this business.

Bigda: So, let’s turn to sports, because they have been a big piece of the TV business model for a long time. For some people, the sole reason they sign up for cable is to access sports programming. But that’s changing now, too, as coverage increasingly gets split up and distributed across multiple platforms. You talked about it a little bit earlier, but what do you think the sports landscape looks like in the future?

Divatia: That’s a great question. Actually, sports is the only glue that keeps this whole thing together right now. ESPN is the glue, and then there are the whole other channels that makes people have cable television. So, we had around 100 million paid TV households or cable TV households at the peak. Today, we have something less than 75 million. And various analysts estimate that the floor could be around 50-million range.

Now, the problem for sports leagues is that they have not been able to connect to younger viewers because a bunch of the younger fans are not on linear or paid TV distribution because they use streaming and most of the sports games are not available on streaming. For example, the average age of an NFL fan is 43 years, but the average NFL viewer on television is 54. So, it shows you that whole disconnect, where the NFL is not able to reach younger fans. So, these leagues have to increasingly move to streaming or adopt streaming to reach those younger fans.

But the leagues are also not dumb enough to completely rip the cord one day and to go all in into streaming one day and snap in. They will gradually dial the knob and move slowly into streaming because they also don’t want to take out the value of those TV rights one day.

So, I think, increasingly, we’ll have this dual model of broadcasting plus streaming. So, the leagues will use broadcasting for a bunch of these games for reach. But then you will have some games or some of those rights will be carved into something like streaming.

So, you look at what the NFL has done: If you want to watch a game on Sunday, you go to CBS or NBC or something like that. If you want to watch a game on a Thursday, you go to Amazon Prime. So, they are increasingly trying to slice and dice it in a way where you can have some streaming, but you can also have some broadcasting. And I think that’s going to be the template at least for this decade, and then we’ll see how those things happen.

But the longer-term issue is, again, only the tech companies can outbid those legacy media companies because of the scale and the balance sheet that they have. And again, those competitors don’t have to make money in video. So, when you’re not making money in video, if you’re making money by shopping or by search, you don’t have to make standalone money by selling those TV rights.

So, it’s getting increasingly difficult for some of these media companies to sustain their business model by paying more and more for sports rights because the only way they can make money is by selling a video bundle.

Now, you will see a lot of fragmentation into sports and various games will be on different apps, and I think that’s where the consumer pain-point will reach at a critical at some point in future, where you will have to go to  10 different apps for which game, and you won’t know which game is on what app or what service. So, I think longer term there is a value for someone to come and aggregate all this into one thing. So, I think that’s the future. But again, we don’t know if that happens in the next five years or 10 years, but that’s what it looks like increasingly if the fragmentation continues.

Peron: So, another big segment of the media business is music, and they were through a lot of this before. It wasn’t too long ago that the music labels were under assault by the streamers, as well. So, can you update us on what’s going on there?

Divatia: As you know, the music business, again to give historical perspective, got completely gutted when Steve Jobs introduced the iPod. And then you had Spotify, which came with a $9.99 plan, unlimited streaming. So, both those things just took those businesses completely out of the shackles.

And then what happened is the industry returned first … the first time it showed any growth was in 2015, after its peak in 1999. And then it just surpassed its peak in 2021. So, it took them 22 years to surpass its peak that it had in ’99, and this is on an inflation-unadjusted basis. Think about all the value destruction that’s happened in the music business in the last 25 years.

Now, fast forward today, music business looks very robust and healthy. You’re around 500 million-plus streaming subscription users. There’s a path to a billion-plus. Music discovery and listening has gotten much easier and convenient. You got AirPods now. You got home speakers. You got Shazam. You got TikTok. So, it’s become much easier for someone to access music, find music. So, that’s helping in terms of music penetration and engagement is on the rise.

And then you also have older listeners who grew up in a world where, if they had to listen to The Beatles and The Rolling Stones, they had to go back in the day and buy an album. Now, those consumers are starting to realize in the last few years that they can consume anything that they grew up with for $9.99 at their fingertips.

So, the music business is one of the only businesses after sports in the whole media ecosystem which has some pricing power. And so, for the first time you saw music apps take a price increase. The price went up from $9.99 to $10.99. And that’s helping the record labels. So, overall, it looks like from a labels and music perspective, you are in the sweet spot of increasing engagement, penetration, and pricing.

And then from the artist perspective, 90% of their income comes from touring, and streaming is more of a medium for them to get their music out, break out a new song, and to engage with their fans. But the real meat of the money lies in concerts, which is where they make most of their money and the lifelong fans, is when they’re on the road.

Bigda: Speaking of concerts, I think it’s fair to say that if there’s any part of the music business that’s having a renaissance, it is the concert business. Artists like Taylor Swift, Beyoncé – both women by the way – broke multiple records this year on their respective tours.

Do you think the concert bonanza is a one-off? Is this a case of revenge concert-going after the pandemic? Or can the momentum be sustained?

Divatia: And now there’s Olivia Rodrigo. So, we’ve got not two women, but three women. She’s breaking the system as well, I heard. So, the concert business, similar, shut down during COVID. And then when it reopened, there was a lot of pent-up demand. The economy was super strong. And so, you have this effect where some of this demand is basically a pent-up demand that came from the COVID lockdowns.

However, structurally, also, a few things have changed in the business. Younger people are valuing live experiences much more. Think about it: This generation was born and raised with an iPhone. The only time they connected with their friends was online. The live concert is one of the only ways they can go with their friends and connect offline.

Secondly, there’s a little bit of social behavior with social media where people can post if they go to a concert, which people like to feel good about themselves when they’re posting something. So, there’s a little bit of those social elements.

The other structural change that has happened is that music has globalized, right, because of social media and streaming. If you are a Taylor Swift or a Drake, you drop a song today, it goes across the world. Back in the day, you had to put out an album, which goes to a label, which goes to a record store, which goes to some parts of the world after a few months. So, this business has completely changed in the last 10 or 15 years.

Secondly, there are a lot of new artists that are breaking out. There are a few Latin artists, which no one had heard of a few years ago, and now they are one of the hottest artists in the world. New types of music is breaking out. Again, thanks to streaming, you can listen to whatever you want. And K-pop is big. African music is getting bigger. Latin music is really mainstream.

And then, vice versa, the U.S. artists historically were touring mostly parts of U.S. and some parts of Western Europe and maybe Japan or some other countries. Today, because of artists being global and being megastars, they can literally go to parts of the world which no one thought about five years ago.

So, you have a bit of pull-forward, but you also have a lot of structural change in the business, as well as new types of music, as well as a lot of artists breaking out and consumers valuing experiences much more.

The question now is, what happens if the economy slows down? Are we going to revert back to the normal? Are people going to take a pause for some time because they did a lot of concert binge in the last two years? Or are we going to still see a lot of people go to new concerts? The artist supply still looks robust for next year. So, we shall see from a demand perspective what happens.

Bigda: Matt, when you think about this industry, it sounds like there are a lot of crosscurrents between long-term trends and more near-term, cyclical maybe opportunities. And so, I guess, when you’re talking with the team, how are you guys thinking about this?

Peron: Our DNA, if you will, is long-term trends. [We] really try and focus on the secular growers, the innovators. And in media, as you see, that focus, that long-term focus is really key because you can get lost in the noise of the cyclical, as you say. So, we really try and focus on, okay, what is this going to look like five and 10 years out? And find those drivers.

Bigda: Going back to the music example, that was a 20-plus-year time horizon to see the shakeout from streaming services, find a point where the industry could grow again. Do you think that for media and TV, they’re going to need a similar timeline to sort themselves out?

Peron: So, we always take a long-term view, and we start with the group dynamics that are going on and work from there. And so, in the music business, for a long time, it was under pressure. It was very hard to invest in a space that was under such secular pressure for 20 years, as you mentioned. So, I’ll leave it to Div as to the comparison today. It’s probably a little bit different, but it does have some historical precedent here.

Bigda: Div, what do you think?

Divatia: I think that’s spot on. Look at linear television today, or legacy media companies. And if you look at, based on stock prices, the longer-term investors focused on business models are avoiding these names because they don’t see long-term value in this business. They feel that the business model is impaired. They don’t see the pricing power. And they feel that it will take a lot of things to happen before the business is rightsized and they can start growing.

And then the other question is, in music, you didn’t have Apple or Amazon buying labels. They only created those end-state platforms where you can consume music. They were not creating labels or buying those content. They were mostly only trying to distribute the music that the labels owned and had the rights to.

In this business, you have the tech companies which are also creating content. So, it’s going to be different here, and we’ll see how that happens. But as of now, it seems like the Street is saying that the linear television business has a lot of room to go down, and they don’t want to associate with those names at this point.

And a bunch of these companies are also leveraged. So, at a 5%-rate world, it doesn’t make a lot of sense for a lot of these longer-term investors to be associated when you can anyways own a lot of other businesses and other ways to win and capture some of that upside in a longer-term way.

Bigda: So, let’s end the conversation with what you think the next big shakeup in the world of content, streaming TV might be, in your view. Is it that Rupert Murdoch’s retirement creates a seismic shift? Taylor Swift takes her tour and her fans to the moon. Is it something even crazier?

Divatia: Good question, wow. Many possibilities here. What will AI [artificial intelligence] bring us? That’s one of the things that could be a thing that people are still not thinking in the content-creation world. But it’s clearly that we are seeing a lot of disruption happen in the broader tech space, and even within this space, and this disruption has staying power.

Every time there’s a big change in Hollywood, there is a strike. So, you saw a strike and it was because there was streaming. Last time there was a strike, there was another technological change. So, what AI does to content creation could be very disruptive. Where suddenly, if you can create content with much lower cost, and suddenly that opens the gates for anyone to become…not anyone, but a lot of people to become a media company and to create the next Game of Thrones or the next Star Wars with a much different skillset by using a lot of AI, that’s a thing to keep an eye for.

So, some of those technologies are moving incredibly fast and might reach an inflection point, and that’s something that we have to keep monitoring in terms of what happens to the broader change in the media world in the next 10 years.

Bigda: So, I guess we’ll just have to stay tuned. Div, thanks very much for joining us today. It’s been a great discussion.

Next time, we will check in with members of the Financial Sector Team to get their view on the property and casualty insurance industry, which is grappling with a significant leap in net underwriting losses as a result of extreme weather events, inflation, and more. We hope you’ll join.

Until then, I’m Carolyn Bigda.

Peron: I’m Matt Peron.

Bigda: You’ve been listening to Research in Action.