Thoughts on Media Companies

U.S media stocks have been under pressure for quite a while. Exacerbating the fear was some comments from Disney’s CEO Bob Iger during Disney’s earnings call last summer, which unleashed another round of fear of cord-cutting. All media companies sold off as a result. Most of them have recovered quite a bit but on appearance, they don’t look expensive. In fact, 21st Century Fox (FOXA, Financial) is one of the most owned media stocks by a few gurus such as Don Yacktman.

The million dollar question of course is – how much do they worth? In this article series, I am not going to answer this question unfortunately but hopefully to share some thoughts and facts that are relevant to the question.

First of all, every media company is different. They have different revenue mix, different cost structure, different content mix, different digital strategy, and different geographic mix, to name a few. Therefore, to say Viacom (VIAB, Financial) is cheaper than Disney (DIS, Financial) because Viacom (VIAB) is trading at 9.67 times next year’s earnings whereas Disney (DIS) is trading at 16.2 times, is with very little merit.

Secondly, there are a few very important questions that merit some serious thoughts before investing in media companies. You may not find the answers to some of them but you have to think about them. For instance, here are a few questions on my list.

1. When will the pricing escalator for affiliate fees and retransmission fees reach a tipping point? At what point would media companies lose their bargaining power in terms of getting the pricing escalators?
2. How are the challenges faced by the media companies similar to and different from the challenges faced by the newspaper businesses?
3. Is there a big fat sports right bubble? If so, who’s going to be hurt the most?
4. If and when will the current pat TV ecosystem be broken?
5. What is the impact of Netflix, Amazon, Hulu, Sony Playstation Vue and the like on the pay TV ecosystem?
6. To what degree can we gauge the demographics of current subscribers and to what degree this information could be used to gauge the potential rate and magnitude of subscriber loss.
7. How do advertisers view the world? What options do they have? What is the advertisers’ ROI on pay TV versus the other platforms? How will the ROI change with less subscribers and more digital content?

With those big picture questions in head, now let’s look at different revenue models just to get a feel of diversity that is abundant within the media space. In my opinion, there are at least six or seven major revenue models dominated by advertising and affiliate fees.

Most familiar to investors is probably advertising revenue. Arithmetically this can be expressed by CPM * M. CPM is the cost to reach 1,000 viewers and M is the number of 1000 views. Both CPM and M are driven by overall economic conditions, network ratings and availability of inventory. In general, there is this perception that TV revenues have been greatly challenged by the emerging digital platform as well as the viewership shifting to Subscription VOD services, which are mostly ads free.

Second, there is the affiliate fees revenue. The mathematical equation is revenue per subscriber times number of subscribers. No doubt the number of subscribers have been declining due to cord cutting, skinny bundles and SVODs but more than offsetting that is the increase in revenue per subscriber, especially for sports networks.

Third, and less familiar to some investors is retransmission and reverse retransmission revenues for broadcasters. This is only relevant to the broadcasters such as FOX (FOXA, Financial) and CBS (CBS, Financial). It is essentially affiliate fees under another name. The growth has been substantial as they were virtually non-existent until a few years ago and still in the playing a little catch-up phase for the foreseeable future.

Then there are content licensing fees and syndication fees. The way this works is that a TV studio produces a show for X million and usually they can recoup half of that X million through first run syndication on some network. After the first run, if the show is successful, the studio then subsequently distributes the show for off-network syndication domestically, internationally and through SVODs. The off-network syndications usually are where the big bucks are made. This type of revenue fluctuates wildly and it all depends on the quality of the show.

No. 5 is movie revenue. Movie studios produce movies and distributes and license them to movie theatres for the right to participate in the premier revenue globally. Then they can license the title to DVDs, SVODs and specialty movie cable networks for a fee.

No. 6 is the OTT single channel or bundle subscription fees, which is similar to affiliate fees model. The difference is that the OTT model often bypass the distributors. Examples are CBS All Access, HBO Now, and EuroSports Go. The revenue model is again revenue per subscriber x number of subscribers. This is a relative small market now but the trend is clear.

Lastly there is this category which we will lump together as others. For instance, Disney (DIS, Financial) has the park and resort segment and CBS (CBS, Financial) has a publishing business. This can be material for some business such as Disney (DIS) but not as material for others.

Another important point is domestic versus international market. The international market is vastly different than the domestic market with very low and rising pay-TV penetration, rising pay-TV affordability from rising per capital GDP, as well as faster growth.

Now let’s compare two well-known names to illustrate the challenges and nuances in evaluating media companies – 21st Century Fox (FOXA, Financial) and CBS Corp. (CBS, Financial).

There are a few things I like FOX better than CBS and vice versa. Here are a few things that I like about CBS better.

1. CBS has navigated the U.S. industry concerns admirably and leads that game by a good margin against the rest of the players and it is becoming more clear each day it is most likely going to be the winner with the changing environment, partly because of the nature of the business and partly because Leslie Moonves has done a fantastic job proactively addressing those concerns.

• Skinny Bundle – helps CBS as the per channel fee is higher and CBS is in every single one of them. Showtime and the Movie Channel are premium anyway so no impact.
• Cord Cutting – CBS has captured the cord-cutters with CBS All Access. Although no disclosures on the numbers, management has indicated that it has exceeded their optimistic expectation.
• OTT and SVOD – CBS’s best adopted to SVOD and OTT. More syndication deals with SVODs than any other media company. Also going single channel OTT with ShowTime, which will help them further monetize the additional distribution opportunities for its content.
• Rating’s challenge – CBS’s the only big-four broadcast network that has improved ratings even on the C3 basis. It will only get better with the shift to C7 and including more platforms.

2. CBS’s shows, especially the procedurals such as CSI and NCSI have much better syndication opportunities both with TV networks and with SVODs. The licensing and syndication opportunity for CBS through both domestic and international SVODs cable channels is huge. For CSI and NCSI domestic alone, there will be somewhere between 500 mil to 600 mil revenue opportunities in the next few years.

3. CBS is much better positioned to grow advertising revenues because 1) its ratings are a world better than all other non-sports channels 2) CBS has successfully pioneered monetizing the mobile and OTT platform with dynamic ad insertion so it’s another route for advertisers.

4.The single channel OTT opportunity for ShowTime and CBS All Access. CBS has demonstrated its ability to monetize the OTT market with CBS All Access, which is $6 per month with commercials and $10 a month without commercials, targeting the people who don’t have cable TV access. ShowTime is a premium channel so it’s not in the bundle anyway. Showtime streaming costs $11 a month and CBS is likely to roll this out internationally.

Now with FOX, there are three things I like it better than CBS:

1. Sports networks, which FOX spent a lot of money built since 2011 and now they are ready to reap the benefits after suffering from investment burden on the income statement. The increase in affiliate fees in the next two to three years for FS1, FS2 and FSN is contractual and guaranteed. Three dollars per month, times 12 months, times 80 million subscribers is a substantial amount.
2. International cable TV growth opportunity. FOX has a 2.5 billion to 3 billion international TV network business that has been growing double digits and is projected to grow double digit for the next five years. Similar to the Sports network in the U.S., they rolled out FS1, FS2 and Start Sports internationally in the past two to three years. To give you an example, Star Sports has been a huge success in India since its launch/rebranding in November 2013. The World Cup of Cricket had 1 billion viewers, almost 10 times more viewers than that of the SuperBowl in the U.S. Star has also launched the broadcasting of pro kabaddi league, which is a sport that has thousands of years of history and attracted 435 million Indian viewers in 37 days.
3. Fox’s scale is much larger with many great cable networks including National Geo, National Geo Wild, Fox News, Fox Business Network, FX, FXX and FXM. All of these channels have pricing escalators in the range of 3-8% and while it is almost certain that subscriber count will shrink, the pricing escalators will more than offset the subscriber count shrink and add 15-20 cents to earnings in 2020.

I am not voicing my opinion on either one. The comparison is meant to show how different each media company is. I think these differences have to be considered.

Disclosure: No positions.