By Joe Furmanski and Joshua Cummings, CFA, and Tom DeLong, CFA
Our latest podcast from Janus Henderson Radio: Streaming platforms are changing the way we consume TV and video, creating challenges for traditional pay-TV providers. As consumers increasingly "cut the cord" and switch from cable and satellite TV to streaming video over the Internet, the outlook for providers that lack a global footprint may become increasingly challenging, Janus Henderson analysts say.
- In a boon for content creators, streaming services are boosting spending on video in a bid to compete.
- Data-driven programmatic advertising has the potential to substantially increase the relevance of commercials.
- As traditional cable TV declines, 5G mobile may be a further threat to the cable providers' broadband businesses.
Dex McLuskey: Good morning, good afternoon, good evening, and welcome to the Janus Henderson Knowledge Shared podcast. I'm Dex McLuskey.
In this episode of our series on disruption, we're talking about television with analysts Josh Cummings, Tom DeLong and Joe Furmanski.
Remember the days when the Saturday newspaper would include an entire pullout section devoted to the week's TV schedules? Both concepts - getting a newspaper delivered and planning your weekly video consumption according to someone else's schedule - seem so alien in the era of on-demand video.
Back in the days when we were at the mercy of the network schedules, our viewing habits were akin to reading a chapter of one book at 7 p.m., a chapter of another book at 8 p.m., and a chapter of yet another at 9 p.m., and doing that each day of the week.
This so-called linear consumption pattern has morphed into binge watching, largely an invention of Netflix (NASDAQ:NFLX), so that now, as with books, we start one show, watch it all the way through at our own pace, before moving on to the next one.
Netflix has always been a disruptor. When it first appeared in 1997, it upended the bricks and mortar DVD rental business of Blockbuster by offering videos via mail - without those pesky late fees.
Then, on January 16, 2007, it disrupted itself by introducing a streaming option for its 5.7 million DVD subscribers, even though critics at the time questioned the quality of its content and issues like low-res video and frequent buffering.
That success is forcing others to play catch-up, though a 15-year head start gives Netflix a significant advantage, says analyst Josh Cummings, who leads the consumer team at Janus Henderson in Denver.
Josh Cummings: There is no question that Disney (NYSE:DIS), through properties like Pixar, Marvel and Star Wars, has some of the best content in the world. And there is also no doubt that it has a tremendous track record of execution. But it earns several billion dollars a year from affiliate fees through cable distribution, and you have to factor in what might happen to that revenue if it leaves existing platforms to go direct to consumers through its own streaming apps.
McLuskey: Disney plans to launch the Disney Plus app in late 2019. To drive initial subscriptions, the on-demand streaming service will be priced below Netflix and will initially include exclusive Star Wars and Marvel series, original films and documentaries from National Geographic.
In addition, Disney in April 2018 released the ESPN Plus streaming app, which for $4.99 a month offers content not available on existing sports channels. And when it completes the purchase of Twenty-First Century Fox's (NASDAQ:FOX) (NASDAQ:FOXA) movie and TV assets sometime next year, the company will gain majority control of Hulu, which it is expected to use as an outlet for more adult-centric content.
Disney's channels, largely because of ESPN, account for about 8% of total cable television viewership, yet they soak up 31% of affiliate fees - that's the revenue content creators generate per cable subscriber, according to SNL Kagan research. Here's Josh again.
Cummings: By contrast, Discovery's family of channels accounts for 18% of total cable viewership, yet take just 7% of total affiliate fees. More generalist channels like USA Network may struggle to persuade people to download and pay for an app. When you compare that with what Netflix and Amazon (NASDAQ:AMZN) in particular have to offer, there doesn't seem to be a compelling reason to pay for this kind of generalist, scripted drama content. However, companies with more niche offerings, such as Discovery, which is also planning an app for its channels, including the Food Network, HGTV and Discovery ID, may be better able to make the transition.
McLuskey: A further headwind may be the ability of generalist, scripted drama and entertainment channels to compete in an era of rampant production cost inflation.
Again, this disruption is being driven in large part by Netflix, which in 2018 set a budget of $8 billion for programming. It's this kind of spending that has helped it to attract stars such as Jason Bateman in the critically acclaimed series Ozark, and producers such as Shonda Rhimes, the creator of hits such as Grey's Anatomy, Scandal and How to Get Away With Murder. Netflix lured Ms. Rhimes from Disney's ABC with a multiyear contract reportedly worth some $150 million.
Others are following. Amazon Prime has produced big-budget dramas starring John Krasinski and Oscar winner Julia Roberts, and in November 2017, the UK's Guardian newspaper reported that the company agreed to pay $250 million for the rights to JRR Tolkien's Lord of the Rings and will spend an additional $750 million to make five series of shows based on the trilogy.
Tom DeLong: The tech platform's global business models changed the rules of the media landscape because they can justify a higher level of spend per episode than traditional TV.
McLuskey: That's Janus Henderson analyst Tom DeLong.
DeLong: They're all creating very high-budget shows, and that means it's a great time to be a content creator. But it also means that you need to have a global footprint or large ancillary revenue streams to make the financial model work.
McLuskey: As a result, the future may pose challenges for traditional content providers, such as local broadcasters and the big four U.S. networks.
DeLong: Internet distribution frees TV from the constraints that have defined its business model since inception such as a linear number of programming slots, which force TV networks to try and reach the broadest possible audience with a single piece of content. Digital networks like Netflix and Amazon don't face these constraints because they have an unlimited number of programming slots, which allow them to offer more selection of content, more genres and serve a broader variety of demographics through a single user interface with mass personalization.
As TV viewing moves toward Internet-based delivery, traditional TV providers without a strong online presence are likely to see their market share decline and also risk losing relevance with the younger generations that watch the majority of their video online.
McLuskey: The growth in streaming is also impacting advertising. As content becomes more compelling and as streaming apps get better at using data to target viewers efficiently, the old adage that "I know half of my ad spend is wasted, I just don't know which half" could become increasingly redundant. Back to Tom.
DeLong: The promise of programmatic advertising is the ability to reduce wasted ad spend for advertisers by improving the relevance of the ads that consumers see. So as an example, a couple that is over 60 years of age and doesn't have children in the household could potentially see fewer ads that are less relevant to them. So they wouldn't see ads for baby food or diapers. Today, a single-digit percentage of the overall TV advertising market can be purchased programmatically. But over the next five years, as TV is increasingly delivered over the Internet, the number of ads that can be personalized for consumers is going to rise substantially. And that's going to lead to a change in how the advertising market operates. As ads become more relevant, that'll lead to less wasted ad spend, a higher return on investment for advertisers, fewer ads for consumers and higher revenue for publishers.
McLuskey: While the total U.S. live TV streaming market numbered about 6.5 million subscribers through the third quarter of 2018, according to estimates from the companies and SNL Kagan research, the number of multichannel TV households declined overall by about 9% from the end of 2014 through the second quarter of 2018, to around 89 million, while cable's share dropped to about 51 million. But the decline in video isn't necessarily bad for cable operators, says Josh, because rising affiliate fees paid to channel owners have outstripped bundle price hikes, causing margin contraction and leading to a switch in sales focus.
Cummings: So, there has been an explosion in data consumption over the past decade, driven most recently by video consumption over the Internet. As content costs have climbed, video has become a far less profitable product for distributors. However, as video consumption moves to the Internet, all of that data traffic has to run through pipes. We believe the cable companies have the best pipes. So, we think the broadband business is a defensible mode for the cable companies.
McLuskey: Streaming services would struggle without the high-capacity, high-speed fiber-optic networks operated by cable providers.
Cummings: Fiber is the core of the Internet, whether you're a wireless or a cable provider. Rising data usage means that cable still has an attractive growth outlook because it provides the toll roads on which data traffic has to pass.
McLuskey: However, there's a potential threat on the horizon, according to telecommunications analyst Joe Furmanski. 5G holds the promise of delivering a significant advance in the high-speed data capabilities of wireless networks.
Joe Furmanski: It requires a lot of equipment, so it is very cost intensive to build these networks. So, we are unlikely to see much of any impact over the next three to five years.
McLuskey: In the first iteration of the technology, wireless operators plan to build networks that will provide fixed wireless residential broadband at speeds that may rival cable Internet.
Furmanski: However, if we look past 2024, 5G wireless will have a material impact on the broadband market. You are likely to be able to get broadband from one or more wireless providers in addition to one or two existing cable providers. The question is going to be what does this increased competition do to pricing. You are either going to have to offer the same level of service or lower your price to stay competitive.
McLuskey: While Josh says cable operators can't ignore 5G, he doesn't see wireless broadband posing an existential threat to the business.
Cummings: So, while residential broadband has the potential to get more competitive, right now cable broadband has a demonstrable speed advantage over just about any form of telecom-based service. So, what has happened is cable companies have updated their modems to Docsis 3.1. And they have been laying a ton of fiber, right. So, the way you get better speed and better latency is you just have to get fiber closer to consumption, right, either directly into the home or to the node, which just means the intersection near a bunch of homes.
McLuskey: The problem with this is the expense, says Josh.
Cummings: So, years ago, Verizon (NYSE:VZ) rolled out a project called FiOS, which was essentially laying fiber optic cable directly into the home. It works in certain markets where the population density is high enough and/or the customer demographic is wealthy enough to pay for the service, but it doesn't really work on a national scale. The economics just don't work of laying fiber to each individual residence. So, on a national basis, we still think that the hybrid fiber coax cable into the home driven by a fiber backbone is going to be the most competitive service.
McLuskey: While cable download speeds may outpace 5G, wireless broadband may hold sway when it comes to upload speeds, because the copper cables that often run the last mile into individual homes aren't as good as fiber or wireless for two-way data transfer. Back to Joe.
Furmanski: Right now, we stream a lot of videos, which is definitely that one-way. We are not interacting back with that video, we're just watching it. So, imagine now you're playing a video game, say Fortnite or Overwatch, where not only are you getting information back, but also every single movement you make is actually you putting information back into the Internet. And so, if the speeds on download and upload are not the same or your latency is too long, you won't have a quality experience, and it really will ruin the overall enjoyment that you get from that game.
McLuskey: But long term Josh sees the potential of 5G extending far beyond residential broadband as a way to facilitate more gaming and TV consumption.
Cummings: The real benefits and potential of 5G go way beyond that. For fully autonomous vehicles to become a reality on a large scale, they need high-capacity, high-speed data networks with near-zero latency.
McLuskey: On that point, Joe agrees.
Furmanski: So, cord-cutting phenomenon has been going on for actually a number of years, and 5G networks have actually yet to actually be deployed. So, it's hard to say that 5G is really driving cord cutting. However, 5G is going to and will have a big impact on broadband connectivity, which in itself will also have some impact on cord cutting. The big part of 5G, however, is when we look beyond fixed wireless broadband. Here, you have things that are going to require super-low latency, things that require low battery power or significant amount of capacity so you can have thousands upon thousands of things on the Internet. Here, you're looking at things that can enable autonomous vehicles to drive down the streets in a safe manner. You're looking at things like the Internet, things where we are going to be connecting billions of devices to the network, things from smart meters for utility companies to smart parking meters for your local cops walking the street where you can actually identify if there is a car parked there and how long it has been there. And a lot of this requires a lot of advancements that 5G is going to be bringing to us in the future.
McLuskey: Which means that across the ecosystem, the change that we've seen in the delivery and consumption of video is likely to continue to create disruption for everyone involved in the business for years to come.
So there we have it. Thanks for joining us today, and we look forward to keeping you up to date with trends in the business and investment world on the next edition of the Janus Henderson Knowledge Shared podcast.
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