As a seasoned financial analyst with over two decades of experience in the ever-evolving world of media and entertainment, I find the current landscape both intriguing and challenging. The strategic moves suggested for Warner Bros. Discovery (WBD) demonstrate a clear shift in the industry’s approach to survival and growth.
analyst Tim Nollen from Macquarie examines five major companies: Walt Disney, Comcast/NBCUniversal, Warner Bros. Discovery, Paramount Global, and Fox Corp. In his analysis of the Hollywood quarterly earnings season published on August 11, he pointed out that ad revenue did not increase compared to the first quarter and cord-cutting became more prevalent. He emphasized that only Disney and Comcast are projected for long-term earnings growth due to their direct-to-consumer offerings.
If you’re already wincing at the thought, brace yourself for his pessimistic outlook: “This market sector is challenging to navigate. We advise against investing in any of the five stocks under our review.” In fact, Nollen has given a “sell” recommendation for Paramount and neutral ratings for the rest.
One reason for his lack of enthusiasm could be the shift towards cord-cutting, a trend that has caused significant financial losses for cable network divisions that once served as major revenue streams for Hollywood companies.
It was observed by Nollen that the number of pay TV subscribers decreased by 10.9% compared to the previous year among cable, satellite, and telecom companies that are publicly traded. When taking virtual distributors into account as well, this decline amounts to approximately 8.5%. As a result, the income from linear TV affiliate contracts at major broadcasting networks deteriorated by 3.9% annually.
CFRA Research analyst Kenneth Leon also pointed out significant hurdles facing the entertainment industry in his August 15th report. He underscored that there’s been a significant move of TV network advertising towards social media firms and video streaming platforms, rather than traditional linear networks.
In late July, analysts Robert Fishman and Michael Nathanson from MoffettNathanson lowered their long-term predictions for traditional video across their coverage of entertainment stock universe. On a positive note, they recommend buying Disney, Fox, and Comcast (as suggested by Craig Moffett), while giving a neutral rating to Paramount, Warner Bros. Discovery, and Netflix. However, they are now more pessimistic about the media and entertainment sector compared to earlier times.
“Currently, the media industry is facing a tough period of transition. The established pay TV business model, which was highly successful, is hard to replicate,” Fishman notes in an interview with The Hollywood Reporter. “We’re still learning about the boundaries of the shift towards streaming for most traditional media firms. We believe there are some companies that could come out on top, but it seems more difficult than ever for many others to successfully navigate this change.”
In the past, the industry was powered by a steady growth mechanism and comprehensive content supply, often referred to as the cable bundle. This package offered profit margins exceeding 40% and an additional profitable venture from theatrical and home video releases, boosted by increasing consumer expenditure. However, the streaming wars started when Disney+, Paramount+, Max, Peacock, and others entered the market previously dominated by Netflix.
As a gamer, I’ve noticed a shift in the gaming industry landscape lately. For the first time in many of our lives (the average age being around 38.5 years old), media companies are facing unprecedented challenges. They’re grappling with a video consumer spending market that seems to have hit a plateau, or even started shrinking. Analysts like Nathanson and Fishman from MoffettNathanson have predicted a decrease in total spending at a rate of 0.6% annually, dropping from $143 billion in 2023 down to $139 billion by 2028. In their words, “deflation has silenced the video star.”
Regardless of the obstacles, Fishman remains hopeful that certain industry participants will thrive. “There will still be victors, such as Disney,” he says to THR. “Fox is playing a different game, so we believe it will emerge successful. However, it’s going to be tough for others.”
A MoffettNathanson team’s analysis, conducted on August 22, supported this perspective. In their study, they examined the degree of success various companies within the advertising sector have experienced as they strive to shift ad revenues from traditional linear TV to streaming and other digital platforms. Moreover, they compared the pace at which each company’s linear businesses are shrinking.
According to MoffettNathanson analysts, both Disney and Fox are outperforming their competitors. The analysts noted that Disney has been exceptionally effective in diversifying its advertising revenue streams beyond linear television. They also pointed out that Disney’s linear ad revenues have held up better than those of its peers due to its robust sports content. These factors have collectively contributed to an increase of approximately $200 million in Disney’s total domestic ad revenue over the past five years, equivalent to a 2% growth, they concluded.
Fox’s narrative isn’t far off, as MoffettNathanson specialists have pointed out that it’s experiencing “fairly minor drops in linear ad earnings due to its concentrated focus on sports and news.” Moreover, these experts anticipate that by 2024, linear revenues will only decrease by 8% compared to 2019. However, this reduction is more than compensated by the expansion of Tubi into a nearly $1 billion enterprise. They estimate that total 2024 revenues will increase by 8% relative to 2019.
On the contrary, Nollen expresses little enthusiasm for investors. His views on particular stocks underscore this. For instance, regarding Paramount, he questions whether a shift towards direct-to-consumer (DTC) profitability and further cost reductions can halt the ongoing declines. In his opinion, the Skydance merger does not appear to address this concern.
His assessment on Warner Bros. Discovery is similarly gloomy: “In 2022, WBD aimed for $14 billion in annualized adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) by 2023. We now predict $9 billion annually for the years 2024, 2025, and 2026 instead. The loss of NBA rights is detrimental; we don’t find much positivity in it, but the stock appears undervalued.”
How about Disney? “A solid performance and outlook for DTC and sports was overshadowed by a downturn at parks. We think there is still too much uncertainty over ESPN’s DTC launch and [theme] parks’ slowdown and major investments ahead to take a near-term stance.”
According to the analyst’s assessment, Comcast also faces some hurdles. They pointed out that there’s a persistent decline in broadband performance, and their theme parks have shown a negative trend. However, Peacock, their streaming service, seems promising with the Olympics and the new NBA deal, but it continues to incur losses.
Ultimately, Nollen offered a more optimistic perspective regarding Fox, stating, “While other companies have experienced significant drops, Fox’s increasing revenue over the past few months has driven its stock price upwards. Nevertheless, it faces the same earnings challenges as other companies.”
In the face of numerous hurdles, could the media conglomerates rekindle investor interest in their stocks and if so, how? Teams within Hollywood have been strategically reducing costs and making more careful decisions about the content they invest in to strengthen their financial positions.
The main objective of these initiatives is to adapt the expenses of conventional businesses to fit modern digital standards and ensure streaming becomes profitable. However, the effects of such changes may not appear immediately, and it’s important to be patient. Additionally, one difficulty lies in the swift pace of change and decline in certain traditional industries, like pay TV. This has often left industry experts playing catch-up when it comes to cost cuts, as the benefits have sometimes failed to meet the new demands.
Ultimately, reducing costs can only get a company so far; eventually, they might need to trim down on growth prospects as well. For instance, Paramount is embarking on another round of cost savings, aiming for $500 million in reductions and laying off 15% of their workforce to combat significant profit drops. Yet, experts have been cautioning that Paramount might be skimping on investments, which could hinder its potential for long-term growth.
Leon argued that in the context of Hollywood giants’ streaming strategies and recent cost focus the prisoner’s dilemma is “so fitting” an image. “The prisoner’s dilemma is defined as a paradox in game theory or decision analysis where two individuals act in their own self-interests, which does not end up with the optimal outcome,” the analyst explained. In Hollywood, “the leading incumbents have decided to protect themselves at the expense of hurting performance and shareholder value. Over time, and with steep operating losses in 2022-2023 and modest profits in 2024, each company has begun to pivot away from video streaming subscriber growth to investor-based metrics like better-managed programming and content costs, positive EBITDA, and free cash flow.”
It appears that multiple sources agree: there’s no simple fix here. Fishman explains to THR, “The key lies in which companies can assure investors they can expand in streaming, not just for immediate profits, but substantial growth to rival Netflix on a global scale over the long term.” He continues, “If the expansion or achievement in streaming is not substantial enough to counterbalance the continuing losses in the traditional TV business, then from a holistic viewpoint, the company is still unable to expand. Thus, investors are primarily concerned with not just the performance of one segment, but the overall shape of the company.”
Mergers and acquisitions (M&A) are frequently proposed as a solution. By increasing size, companies can compete more effectively against tech behemoths who have vast resources for content and human talent. Additionally, streamlining operations that currently overlap is a significant advantage of such transactions. However, it’s important to note that past M&A deals and proposed combinations have sometimes been viewed as larger entities further solidifying their positions in the shrinking cable networks industry, which could be likened to giants doubling down on a melting ice floe.
Case in point: the mega-merger that created WBD, which recently unveiled a massive $9.1 billion goodwill impairment charge to write down the value of its traditional TV networks amid cord-cutting and advertising challenges. Paramount Global similarly took a charge of $5.98 billion for its cable networks unit. Last December, analysts reacted with doubt, some even with concern, to reports that WBD could acquire Paramount. The phrases they used equated a possible deal to catching “a falling knife” or even a “financial death sentence.”
Analyst Nollen has revised his stance on WBD shares from “outperform” to “neutral” and lowered his stock price prediction from $13 to $9 following news that TNT lost the bid for renewing its NBA rights to Amazon. He stated, “Losing these crucial rights significantly diminishes a critical content asset for both its traditional broadcast networks and the Max streaming service.” The analyst elaborated, “The decline in ad revenues on traditional networks, starting from the fourth quarter of 2025, and reduced bargaining power during cable affiliate renewals are concerning. However, the potential impact on the Max streaming service over the long term is our primary concern. We have perceived Max as a comprehensive and varied streaming service encompassing content from Warner Bros., HBO, Discovery’s lifestyle networks, children’s shows, and sports. But with the NBA no longer part of its sports offering, Max will be missing an essential component.”
From my perspective as an enthusiast, it’s often about the synergies created when assets are combined in M&A, the approval from regulatory bodies, the deal’s structure, and the potential impact on a company’s debt and cash flow.
In her recent analysis, Bank of America’s Jessica Reif-Ehrlich suggested that strategies like selling assets or merging could potentially boost shareholder value for WBD.
She’s part of those on the street who think an entertainment company or a significant investor might transform into a consolidation vehicle, swallowing up cable network businesses for greater profitability. This could be achieved through leveraging economies of scale and cost reductions.
Instead of proposing it herself, she along with her Bank of America team put forth WBD as a potential significant player under such circumstances. This strategy involves divesting all its traditional TV assets into a standalone entity, burdened with an approximated $40 billion in debt. Consequently, the remaining part of the company – encompassing its studios and streaming business – would then be freed to concentrate on recovering growth.
The separated TV division might have the opportunity to purchase additional linear TV properties from various companies within the industry, such as Walt Disney, Comcast/NBCUniversal, AMC Networks, and others, according to Reif-Ehrlich & Co. They stated that many other businesses are encountering similar circumstances as Warner Bros. Discovery (WBD), but they find it challenging to discover suitable alternatives because there aren’t many buyers for these assets that are experiencing long-term decline. As a standalone company, this Linear Spinco Asset could potentially act as a consolidator for other struggling assets, likely at affordable prices.
Beyond transactional activities, Reif-Ehrlich emphasizes the importance of tangible outcomes from WBD and similar companies, demonstrating that profitable growth can indeed be achieved. In summary, the expert stated: “Given the continuous challenging market conditions, along with the potential loss of the NBA, we believe it’s crucial for the company to exhibit significant advancements in studio and DTC profitability to instill confidence among investors regarding the consolidated entity’s ability to expand.”
In his analysis, Nollen emphasized Hollywood’s transition towards streaming services. He pointed out that while Netflix has emerged as the clear leader, there are still other players that can thrive in this competitive landscape. His prediction is based on the ability of these companies to consistently increase Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA), without falling short of their projected enterprise operating cash flow and free cash flow targets.
The CFRA expert even warned: “Video streaming providers that are not very profitable may be running out of time.” He differentiated between the top-tier group, consisting of Google’s YouTube TV, Amazon Prime Video, TikTok TV, Netflix, Apple TV+, and Disney+ with ESPN and Hulu, saying it is “likely to gain market share from viewers and advertisers.”
In simpler terms, the second group in terms of subscriber numbers consists of Comcast’s Peacock, Paramount+, Warner Bros. Discovery’s Max, and smaller providers. According to Leon, these companies might face greater difficulties in achieving significant EBITDA and profitability. He believes that the idea that both traditional television (linear) and streaming services are complementary may be overstated due to the increasing shift from linear networks to streaming platforms.
Some people on the street are optimistic that streaming package deals might revitalize the appeal of media and entertainment stocks for potential investors once more.
“The increased demands from shareholders have led certain businesses to scale back their streaming plans and collaborate with other entities in order to sustain their operations,” Nollen framed this development in a more protective perspective.
Analyst Doug Creutz from TD Cowen has highlighted the bundle of Disney+, Hulu, and Max as a potential game-changer for major players and potential investors. In his recent report, he stated that this move could make media an attractive investment opportunity once again. According to him, companies like Warner Bros. Discovery (WBD) and Disney can benefit from marketing cost savings, lower customer attrition rates, and reduced pressure to maintain the costly content production side of direct-to-consumer (DTC) services.
According to Creutz, “It’s likely that the economic benefits of this package will persuade the remaining media group to announce comparable deals.”
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2024-08-27 19:55