Recent news from Discovery Communications, Inc. (DISCA) has disclosed the company's interest in developing a streaming service. Discovery is not attempting to offer a direct service to all Internet users, but is rather targeting existing satellite and cable subscribers and looking to charge them $6-8 per month to access produced content 3-18 months old. In essence, Discovery is looking to broaden its revenue distribution base to include cable, satellite, traditional streaming (Netflix and Amazon), and now an additional streaming offering. Also of note, Discovery claims that this is in early development stages and roughly 2-5 years down the road.
Another item of interest is the fact that Discovery has made some progress with its web-based media properties over the past couple of years including acquiring Revision3 and internally developing Discovery News and TestTube. Both Revision3 and TestTube offer Internet-based programming and content which can be streamed for free; Discovery News serves as a content-information property with video as a separate category; more comparable as a mini version of AOL Inc. (AOL) or Yahoo! Inc. (YHOO).
As far as the additional streaming service for Discovery's content goes, this is nothing new. HBO Go, a property of Time Warner, Inc. (TWX) offers a service that is fairly similar to this concept with the exception that there are no additional fees to access HBO Go's online content as an existing HBO cable or satellite subscriber. WatchESPN, a property of The Walt Disney Company (DIS), also allows satellite or cable subscribers to stream online content from ESPN with no additional fees. It is possible that HBO Go and WatchESPN do not offer as much comprehensive aged content compared to what Discovery is conceptualizing to deliver its existing subscribers.
What is interesting as streaming models progress is the fact that over time, streaming may be the silver lining which leads us to a media company-based "a la carte" content distribution model. There are many critics for Netflix, Inc. (NFLX) out there, but one thing that Reed Hastings has successfully accomplished over time has been his ability to steer Netflix in the right direction; transitioning from a mail DVD model to streaming was the right move. Today, Netflix continues to spend a considerable amount of capital to enrich its content library, but as we all know, the company is also investing in its original content production. This is a clear sign that content is the most valuable piece to the puzzle and directly relates to considering how Discovery, among similar media companies, may become direct threats to the likes of Netflix and Amazon.com Inc. (AMZN), or other streaming services.
Discovery serves as the world's number one nonfiction media company and claims to reach more than two billion cumulative subscribers in 223 countries and territories. Discovery operates 162 worldwide television networks, led by Discovery Channel, TLC, Animal Planet, Science and Investigation Discovery, as well as U.S. joint venture networks the Oprah Winfrey Network, or OWN, The Hub and 3net, the first 24-hour 3-D network.
Across the Nordic region, Discovery owns and operates SBS Discovery Media, a top-three portfolio of 20 TV brands that feature leading nonfiction content, as well as locally produced entertainment programs, sports, and scripted series and movies from major studios. Discovery also is a leading provider of educational products and services to schools and owns and operates a diversified portfolio of digital media services.
Discovery's online digital media properties consist of 19 U.S. brand destinations, including Discovery.com, TLC.com and AnimalPlanet.com, as well as HowStuffWorks, TreeHugger and Petfinder. These properties reached an average of 23 million cumulative unique monthly visitors in 2012.
Most recently as of the first quarter 2013, Discovery generated roughly $2.2 billion in distribution revenue, $2.1 billion in advertising revenue, and $235 million in other revenue for a total of $4.5 billion over the past trailing twelve-month period, or TTM. U.S. TTM network revenue was $2.8 billion while international TTM network revenue was $1.7 billion. As a cable network, Discovery has generated roughly $4.3 billion in TTM revenue.
Comparatively for cable network TTM revenue:
- Time Warner generated $14.3 billion,
- Disney generated $14.1 billion,
- Twenty-First Century Fox, Inc. (FOX) generated $10.3 billion,
- Viacom Inc. (VIA) generated $9.2 billion,
- Comcast Corporation (CMCSA) generated $8.9 billion,
- Scripps Networks Interactive, Inc. (SNI) generated $2.2 billion,
- CBS Corporation (CBS) generated $1.8 billion, and
- AMC Networks, Inc. (AMCX) generated $1.4 billion.
Collectively, this group of nine companies generated over $66 billion in TTM cable network revenue.
Discovery's distribution revenue includes the following:
We have contracts with distributors representing most cable and satellite service providers around the world, including the largest operators in the U.S. and major international distributors. Typically, our television networks are aired pursuant to multi-year carriage agreements that provide for the level of carriage that Discovery's networks will receive, and, if applicable, for scheduled graduated annual rate increases. Carriage of our networks depends upon channel placement and package inclusion, such as whether networks are on the more widely distributed, broader packages or lesser-distributed, specialized packages.
It is quite clear the Discovery is able to leverage its distribution carriage agreements to generate significant advertising revenue, close to 50% of cable network total revenue.
STREAMING SUBSCRIPTION MODEL POTENTIAL
Discovery's streaming concept does not sound like an overly ambitious plan, and it is puzzling that the company has given such a long timeframe for implementation. I have chatted with Discovery's investor relations a few times and the company has not ruled out the consideration of a streaming subscription-based model; I get the sense that Discovery is being extremely cautious regarding how it considers the streaming environment.
We know that there are around 70 million broadband Internet subscribers in the U.S and that there are roughly 300 million worldwide. Considering Discovery's reach with respect to the global market, it appears that the company has a strong international brand, which could appeal to a majority of broadband subscribers.
However, based on current bundled packages for cable and satellite subscribers, many channels are included in basic packages, with advanced packages usually including the highest demand networks. This raises an important point; Discovery would need to determine a monthly subscription price reflective of its content to meet consumer preferences and demand.
Charging existing cable or satellite subscribers an extra $6-8 per month on top of already paying upwards of $100 per month begs the question; should Discovery's content library command equal value compared to Netflix or Amazon?
Pricing Model Scenarios
Let us take a look at the $6 per month price of Discovery's suggested pricing model, with a slight adjustment; assuming it is a product deliverable to any Internet subscriber through any Internet device. To be conservative we can assume that all Discovery channels would be available and that the company would most likely provide new episodes on a weekly basis. This high-end rate will be compared against a low-end rate in the section below.
At a pricing point of $6 per month, it would be prudent to assume a lower near-term penetration rate for worldwide broadband subscriptions; 30% yielding 90 million subscribers. At this rate, Discovery would generate roughly $6.5 billion in annual streaming revenue, or three times current distribution revenue (it is assumed that streaming subscriptions would replace distribution revenue over time). Even with a 20% penetration rate, Discovery would generate two times more revenue versus existing TTM distribution revenue.
Another factor to consider would be Discovery's transition to Internet video advertising revenue versus TV advertising revenue. Hulu provides a comparative advertising product and we could assume Discovery would likewise provide fewer commercials to subscribing viewers.
Last year, Hulu generated roughly $700 million in revenue, with an estimated 4 million subscribers. Simple math tells us that Hulu's subscribers contributed roughly $390 million and that advertising revenues generated just over $300 million, or $75 per subscriber. Considering this metric, with 90 million subscribers Discovery would generate $6.8 billion in annual advertising revenue, and with 60 million subscribers would generate $4.5 billion in annual revenue; these numbers are fairly close to a 50% split which Discovery currently maintains.
All-in-all, Discovery would generate anywhere between $9-13 billion in annual revenue assuming a $6 per month subscription fee with a 20-30% worldwide broadband market penetration rate.
Based on Discovery's potential total content value, it would be beneficial to consider a low-end $1.95 monthly subscription rate. This would potentially lead to a higher penetration rate for worldwide broadband subscribers; 50% or higher.
At $1.95 per month, with 150 million subscribers, Discovery would generate roughly $3.5 billion in annual subscription revenue. Based on this number of subscribers, the company would generate over $11 billion in annual advertising revenue. This may illustrate a flaw in assuming Hulu's simple math calculation and sticking with the existing 50% split may be a better measure. Regardless, through this model Discovery would still generate 50-240% more revenue.
On the advertising front, as streaming demand continues to increase, advertising trends will continue to significantly shift to video, potentially leading to higher advertising revenue versus streaming subscription revenue.
Discovery has grown into a solid global media company. While we may never get to decide whether we want to watch the Discovery Channel or Animal Planet exclusively, a company like Discovery does offer the potential to subscribe to a suite of networks, which would provide value for many consumers.
Similarly, companies mentioned above could potentially offer equivalent streaming subscription services. If this type of environment were to blossom, it would make a lot of sense for companies like AMC Networks, DreamWorks Animation SKG (DWA), Lions Gate Entertainment Corp. (LGF), Starz (STRZA), and even possibly Scripps Networks to consolidate into larger companies seeking to diversify their content offerings and bolster subscription revenues.
Positive trends have emerged in broadband subscriber growth for cable companies (6-8% per year) and larger communications companies like AT&T, Inc. (T) and Verizon Communications Inc. (VZ). Video subscribers are continuing to decline at modest rates around 1% per year; yet cable bills continue to increase (Comcast $149 per month as of the end of 2012, which has led to a 0.5% sequential increase in quarterly revenue the previous eight quarters).
Since December 2011, Netflix domestic paying subscribers have grown roughly 7% per quarter to 27.9 million while international paying subscribers have grown roughly 34% per quarter to 6.3 million for a total of 34.2 million paying subscribers. Total streaming members have grown 22% per year over the past two years for Netflix.
I find it rather ironic that Netflix would create a show entitled "House of Cards." Currently the distribution of content via existing streaming models is possibly standing on a house of cards. Which media company will pull its card first is still at question. What is clear is that any media company owning significant content has the capability to create a direct streaming platform.
Subscriber revenue being generated by cable and satellite companies as well as Netflix and Amazon will be at risk in the event media companies transition their revenue models to subscription-based ones. I would argue that this is one of the reasons why no one attempted to acquire Netflix this past year near $50 per share. As time goes by it only becomes more clear that companies like Comcast, Dish Network Corp. (DISH), and Netflix are generating revenue that major media companies could themselves through a direct streaming product.
Past carriage agreements have yielded consistent revenue and cash flow growth for the conventional TV platform, but access to consumers through mobile devices and Smart TVs will continue to put pressure on Discovery and other media companies to adapt their revenue models. In Discovery's case, the potential for a streaming model seems quite advantageous.