In an ever-shifting media landscape, both content creators and distributors spent most of 2017 chasing scale.
With changing consumer habits and growing appetites for more choice, lower prices and true on-demand availability, that pursuit is expected to continue well into the new year.
Scale economics is nothing new to the cable industry — the business was based on the concept that giving consumers more channels would create more customers who would require more channels. The real shift is in how companies in the video space are defining big. Toward the end of the year, more companies were asking themselves, how much scale is enough?
On one side of the argument is The Walt Disney Co., which late last year decided that there is no such thing as too much scale, agreeing to plunk down $66.1 billion for 21st Century Fox’s TV and movie studio, FX and National Geographic cable channels, 22 regional sports networks and U.K. satellite assets.
But Fox, a pioneer in the cable and broadcast business for decades, saw an opportunity to scale down, paring its holdings to a streamlined few — its Fox broadcast network and stations, Fox News Channel, Fox Business Network and national sports networks FS1, FS2 and Big Ten Network.
For Fox, scale is important, but it’s the right type of scale — news and live sports — that is best.
Distributors weren’t immune to the impact of scale during the year, either. Riding a wave of optimism that tax reform and a friendlier business environment would serve as a catalyst to bigger distribution deals, overall cable operator stocks were up 25% in the first nine months of the year, as speculation swirled around possible deals between Charter Communications and Verizon Communications, Charter and Sprint, and Charter and anybody else. But those hopes were dashed in September after Comcast said it would lose video customers in Q3. Add to that an apparent slowing of cable’s biggest profit center — broadband — and distributor gains began to shrink.
“Investors are transitioning to more of a higher data monetization, wireless market share, still-solid overall financial growth and increasingly large capital return strategies,” Pivotal Research Group CEO and senior media and communications analyst Jeff Wlodarczak said. “At the end of the day, I think we are in the seventh inning of the transition for cable.” He expects to see seasonal subscriber gains in the fourth and first quarters, he added, which should help the stocks.
While most investors remain sanguine about the cable business, they are also leery of the blood-letting power of the so-called FAANG stocks (Facebook, Apple, Amazon, Netflix and Google). With a combined market capitalization of almost $3 trillion, those five stocks not only dwarf the pay TV distribution business, which has a combined $800 billion market cap — these companies have the resources to upend the entire distribution model, snapping up sports and entertainment content at will, or at least driving the prices paid for that programming into the stratosphere.
As the new year begins, we chart how the three biggest sectors of the pay TV industry performed in 2017 and the prospects — good and bad — for 2018.
Distributors
Best Performing Stock in 2017: Charter Communications (16.7%)
Worst Performing Stock in 2017: WideOpenWest (-35.9%)
Distributors rode an optimistic wave for most of 2017 — Comcast and Charter were up nearly 20% and 40%, respectively, heading into September — that came unceremoniously crashing down after investors panicked over video subscriber declines. Comcast touched off the mini-firestorm with its Sept. 7 announcement that it would shed between 100,000 and 150,000 video customers in the third quarter, nearly erasing the 161,000 customers it gained in 2016.
Investors headed for the exits, with Comcast stock falling 7% on Sept. 7, but gradually came back to the fold. The sector in general rose 9.2% for the year, backing out new entrants Altice USA and WideOpenWest; the stocks fared better, up 11.2% for the year.
On the telco side, AT&T was down 8.6% mainly after the government moved to block its deal to acquire Time Warner, and Verizon was relatively flat as investors struggled to decipher its video strategy.
Continued pressure from over-the-top competitors only added to the panic after distributors lost a collective 827,000 video customers in Q3, well above the 559,000 the lost in the prior year. Adding insult to injury: Broadband growth, the one consistent bright spot for cable operators over the past decade, was showing signs of slowing down. Comcast and Charter added 818,000 and 908,000 broadband customers, respectively, in the first nine months of 2017, about 17% behind the prior year’s pace.
While most analysts believe cable broadband will hold its own in the coming years, video is expected to play an increasingly minor role in the overall business. UBS media analyst John Hodulik estimated video would account for 20% of total cash flow in 2018, dropping to 10% by 2020.
Tax reform also will play a big role in added profitability, with Hodulik estimating it would help drive 20% increases in earnings per share and free cash flow for AT&T, Verizon, Comcast and Disney. And while some have already given back some of the expected windfall — AT&T and Comcast announced $1,000 cash bonuses for employees in December — what the companies do with the money is up to them.
“Capital freed could be used for capex, buybacks, dividends or strategic investment,” Hodulik wrote, adding that future deals also could be added to the mix. “Despite the uncertainty cast by AT&T-TWX, we expect M&A to remain a focus with the potential for further media and infrastructure deals.”
Wireless also is expected to play a big role in the coming year, with Charter’s much-anticipated wireless offering — through its mobile virtual network operator (MVNO) pact with Verizon — expected to debut later in the year.
Comcast introduced its wireless product Xfinity Mobile in April, also via the Verizon MVNO, and has more than 250,000 customers for the service. Hodulik estimated that could rise to 500,000 by the end of the year and coupled with Charter, cable operators could have more than 1 million wireless customers by the end of 2018. That’s about one-third of the wireless industry’s net annual growth.
Programmers
Best Performing Stock in 2017: WWE (66.2%)
Worst Performing Stock in 2017: Discovery Communications (-18.4%)
Faced with the havoc that a direct-to-consumer world could wreak on the programing business, content providers struggled with whether to take a more is better or bare bones approach. Both concepts were at play as the year drew to a close.
On the more is better front, Disney’s planned purchase of certain 21st Century Fox assets was the biggest example, but there were others, too.
In July, Discovery Communications pulled the trigger on a long-awaited buy of Scripps Networks Interactive for $14.6 billion. Discovery had long pursued Scripps — the two were reportedly negotiating a deal in 2014, but ended talks — and the inclusion of its similarly themed networks seemed like a perfect fit.
Some analysts, such as Sanford Bernstein media analyst Todd Juenger, have questioned the concept of going big on programming content in a market where consumers seem to be telling distributors they want less, not more. In a recent research note shortly after the deal was announced in July, Juenger said that while Discovery and Scripps had run into the same trouble as other networks in the changing landscape, bigger isn’t necessarily better.
“If you combine Discovery and Scripps, you now have, literally, 20 networks, many of which MVPD’s don’t want,” Juenger wrote. “That’s already a problem for Discovery, but we think adding Scripps makes it worse.”
Juenger later called the Disney-Fox deal a classic “build or buy” decision, in which Disney determined it was more advantageous to buy added scale, saving the money, time and earnings dilution that a build would entail. But there are disadvantages to the buy scenario, too — buying requires paying a hefty premium for content that may never be realized.
Networks are obviously worried about the future, as many sense an end to the content bubble of new TV series being produced. With distributors pushing back on higher affiliate fees, declining advertising revenue and the growing threat from online giants like Google and Facebook, they have good reason to be scared.
It is no accident that the top performer in the pay TV network segment in 2017 — sports-entertainment titan WWE, up 66.2% for the year — got there mostly on speculation that Facebook would bid for rights to its flagship programs, Monday Night Raw and WWE SmackDown.
While Facebook could look to boost its content holdings, it already has a stranglehold on the advertising business. According to MoffettNathanson media analyst Michael Nathanson, traditional media advertising revenue declined 11% in Q3 2017, while digital advertising rose 22%. And Facebook and Google accounted for 74% of digital ad growth in the first half of 2017.
While the third quarter was the third straight period of decline for national TV ads — “the worst we’ve seen in the past decade,” according to Nathanson — the sluggish performance is expected to continue. He estimated that in 2018, a year with a Winter Olympic Games and midterm Congressional elections, traditional advertising will be down by 1% while overall spending will increase by 7%.
FAANG
Best Performing Stock in 2017: Amazon (56%)
Worst Performing Stock in 2017: Google (35.6%)
Amazon turned heads with its April purchase of streaming rights to a package of NFL Thursday Night Football games not for the amount paid — about $80 million — but for the message it sent to the industry. That simple purchase made it known that the online retail giant was a player in the live content business.
Amazon already is spending about $4 billion annually for content to fuel its Amazon Prime Video service, and the addition of live content could only make a powerful competitor even stronger.
BTIG media analyst Rich Greenfield thinks this may be the year Amazon goes deep with Thursday Night Football, bidding more than $600 million for exclusive rights.
While Amazon is expected to get deeper into the original content business, it will still lag behind Netflix, which is expected to plunk down $8 billion for content in 2018. Facebook, which bid $610 million for streaming rights to Indian Premier League cricket matches last year — it lost out to Fox’s Star India, which bid $2.5 billion — is expected to continue to test the content waters in 2018. In a blog post, Greenfield wrote that he expects Facebook to turn its focus on professional wrestling in 2018 — WWE’s rights deals with NBCUniversal for Raw and Smack- Down expire in 2019, but the programmer has said it plans to secure agreements for the U.S. and the U.K. markets in 2018.
Facebook already has a relationship with WWE: It announced a deal last year for a 12-episode show that airs on Facebook Watch called Mixed Match Challenge featuring Raw and SmackDown wrestlers.
In his blog, Greenfield saw that deal as a test bed for a deeper relationship between the companies, and said he believes not only will Facebook try to acquire digital rights for Raw and SmackDown, but it may also bid for exclusive linear rights in the U.S. and U.K.
“The question for 2018 is will Facebook start ‘winning’ the bidding processes it enters or just drive the price up on legacy media rights buyers?” Greenfield wrote.
But other analysts were puzzled by the social media giant’s video strategy, which so far has been a mix of user-generated short-form content and some short-to-medium professionally produced shows for its “Watch” and “Discover” tabs.
Nathanson wrote in December that Facebook hasn’t been very aggressive, save for the cricket bid, in trying to attract studios or smaller content creators for programming.
In a research note, Nathanson wrote that Facebook appears to be tiptoeing into the video space and that a more aggressive stance is “critical for it to jump start this initiative and get real attention in what is already an incredibly crowded space.”
For Google, the launch of YouTube TV hasn’t created the competitive storm some believed it would despite its attractive price point of $35 per month and lineup of 40-plus channels, including broadcast networks, AMC Network, Disney Channel and sports networks. But that could change in 2018 as the service’s reach expands.
YouTube TV was available in 83 markets as of December, up from five at its April launch. Apps for Roku and Apple TV, as well as for smart TVs, are expected in the first quarter of this year.
On the downside, some media executives see the distribution strategies of some of the new-entrant tech companies — especially Apple and Facebook — as “incoherent,” Barclays media analyst Kannan Venkateshwar said. That perception has caused some reluctance in licensing content to these companies, the analyst wrote, because the absence of a strong coherent distribution plan during the initial window of a deal can adversely affect the lifetime value of the content.
“Those selling content believe there are only about 10 or 11 serious buyers of content despite new entrants, i.e. the four broadcast networks, the top four to five cable networks, Netflix and Amazon,” Venkateshwar wrote.
