Is The Play With Content Producers Or Content Distributors?

by: ValueGrowth

Having followed the Netflix (NASDAQ:NFLX) developments, we ask ourselves the following question. For investors, is the future of the media entertainment sector in content distributors, such as Netflix, Comcast (Majority owner of Hulu) (CCT), Google (YouTube) (GOOG), and Apple (Itunes) (AAPL), or in content producers such as Warner Brothers (TWC), Dolphin Digital Media (DPDM.ob) and Disney (DIS), or both? With the emergence of easily accessible distribution platforms in a digital format, we believe margin contraction for content distribution is unavoidable, as shown through Netflix’s recent debacle of subscription price increases. However, depending on their model, opportunities may exist.

When we discuss “content distributors”, there are first run original content distributors and then there are distributors of previously aired content, such as feature films and television broadcasts being resold in a different forum. The area we have focused on, and believe will materially change the market, are the original first run content distributors and producers. This has been an interesting topic over the past three years given almost every major production company has attempted to develop their digital division, but all have had difficulty effectively managing their margins and dealing with the cost differential between airing first run TV shows or first run web series (while maintaining the same quality of production). To add to the challenge, we believe many of the content producers were very early entrants (potentially too early) into the web series market, and attempted to develop a market that was yet to be defined from a business model perspective and from a distribution perspective. We believe that market is clearly being defined now and is going to represent a very large part of the market for those that can manage the business effectively.

There is absolutely no doubt that the world is pushing aggressively for more online original content. The question is: who will be the victor in such an endeavor? Could it be possible that it is a win-win scenario for all players? We believe for certain players it is very possible if structured appropriately and with a vertical mentality versus a carnage mentality. AOL announced its launch of Cambio in 2010, in partnership with the Jonas Brothers, to offer such premium and original content. Facebook has also furthered its push in the online media environment through the airing of a first run original web series Aim High, which was produced in conjunction with Dolphin Digital Media and Warner Brothers.

Let us define what we mean below when we refer to “vertical mentality” versus “carnage mentality”.

Vertical Mentality: We believe this involves airing first run content online that possess the same quality, standards, directors, actors, etc. as any feature film or first run TV show created with a budget that enables the producer to still be profitable and be able to resell the library post airing to other verticals. Ultimately the value proposition is to use the first run online to affordably and effectively distribute quality entertainment online and then enable the feature to be further distributed via other verticals and additional markets (DVD, TV and feature status) in addition to online with an already established fan base and following. We view this as a forum to provide solid content, but also test market future productions (in other verticals) in a cost effective and profitable manner – reducing everyone’s risk in the process. Many large production companies have had difficulty grasping the concept of such models given their size and production budgets, which are why we believe established players, such as Dolphin Digital Media, can fair very well in this market.

Carnage Mentality: We believe this is the model of the past that was attempted to be adopted by many large production companies looking to enter the online original content market. This model involved either directly competing against their existing platform whereby the budgets were difficult to manage or the productions were developed solely to live in the virtual environment – providing very little potential for life on other verticals or other markets in the future.

Getting back to the topic, what does this mean for content distributors and content producers? We believe they can both be successful if the model is developed appropriately. The traffic provided by quality, first run content can be a strong selling point for distributors that are looking to expand the subscription base, user base and publicity of such distribution. On the production company side, if the content is developed with a vertical mentality, then the quality of the entertainment will enable the production company to gain much needed hype and viewership which ultimately will enable them to up-sell the program to other verticals in the future, while potentially reducing the burdensome marketing costs of unproven programs in the traditional marketplace.

The world of entertainment is changing at a rapid clip. There will be winners and losers that will emerge from all avenues that can potentially capture a very large percentage of the market. As a result we believe we are witnessing an entertainment revolution that will change the way we view entertainment today and into the future. We look forward to following such developments and will be on Cambio and Facebook on December 11th to see the first run airing of Aim High, to judge the quality of such entertainment for ourselves. If the program is as good as it is expected to be, we believe all companies associated with such original first run series are companies to look out for in the future.

Disclosure: I am long AAPL, AOL, DPDM.OB.

Additional disclosure: I have been short NFLX over the last month, but am not at the moment.