Hollywood is on the edge of the next phase in the streaming revolution as more and more executives and investors have come to realize how significant the implications of the transformation on the entertainment business and its profitability are.
That’s the word from an influential team of Wall Street analysts at MoffettNathanson in a new research note on Jan. 18. Echoing similar recent predictions, but in stronger language, the media-tech finance experts wrote, for example, that “Investors and executives have accepted that streaming is, in fact, not a good business — at least not compared to what came before.”
The report came out just before the start of Hollywood earnings season, which kicks off with Netflix on Thursday. In the coming weeks, management teams in the sector are expected to provide commentary on their companies’ performance during the final quarter of 2022, including advertising trends amid economic challenges and high inflation. But for many analysts and investors, the states of cord-cutting and streaming businesses are top of mind. Among other things, they are eager to hear updates on direct-to-consumer streaming’s progress toward profitability and organizational changes in traditional TV units that sector companies have been unveiling or considering with an eye on reducing costs and boosting the bottom line.
Given Bob Iger’s surprise return as CEO of The Walt Disney Co., for example, Bank of America analyst Jessica Reif Ehrlich in an earnings preview recently wrote, “We anticipate Disney is likely to introduce structural changes as well as cost cuts.” She continued: “We believe priority number one for Bob Iger will be Disney Media and Entertainment (DMED) and the structure of the content division (versus Bob Chapek’s restructuring in 2020 that consolidated all content under Distribution). In addition, there is likely to be a significant focus on cost containment.” And Reif Ehrlich noted: “We would not be surprised if there is a change in the DTC (direct-to-consumer) forecast for Disney+ subs.” The guidance has long been a topic of debate on Wall Street about whether Disney will meet its own target projections for the service.
But the streaming narrative is likely to continue to change across the entertainment sector this year, a growing number of financial experts expect. “The greatest story America’s story-telling industry ever produced is not The Godfather, Star Wars or even Minions: Rise of Gru,” the MoffettNathanson team of analysts wrote in their Wednesday report entitled “Hurtling Towards Act 3.” “It is, of course, the story of the industry itself over these past 15 years. And, like almost any story produced in the Western tradition, this one follows a basic three-act structure.”
In Act 1, “Media companies printed money,” only to see things change due to Netflix’s innovations, the analysts wrote. “An upstart company took advantage of rising broadband speeds to deliver a seemingly magical experience: watch what you want, wherever, whenever, for far less. … Act 1 ends with the company that promised its customers the world well on its way towards taking over the world, and with the established order scrambling to muster a response far too late.”
Act 2 was about Hollywood companies pushing into streaming amid cord-cutting, or “attempt to replicate the playbook that had worked so well for the upstart,” as the MoffettNathanson team put it. “But even though the subscribers showed up en masse, profits remained elusive.”
Which takes us to the present day. “Now, we find ourselves at the precipice of Act 3,” the analysts argued. “Cash flows are sorry ghosts of their former selves. Balance sheets are loaded with debt in a higher interest rate environment. Rather than being the new sliced bread, investors and executives have accepted that streaming is, in fact, not a good business — at least not compared to what came before.”
So what happens next? “In Act 3, we find ourselves hurtling towards a climax where once-great companies will have to face the reality that they can no longer afford to light money on fire chasing profits that do not exist,” the MoffettNathanson team concluded. “For some, this simply means a new age of rationalization. For others, acquisition may prove the only salvation. For all, the present state of affairs cannot continue.”
Bank of America’s Reif Ehrlich struck similar notes. “We believe several media companies are set for strategic pivots as the industry inches toward seemingly inevitable consolidation,” she wrote in a Jan. 13 report. “Streaming operators [will be] shifting towards a more balanced approach that includes a focus on driving profitable growth.”
After all, “Linear TV’s secular decline is putting financial pressure on the industry and the inherent challenges in the streaming business model (e.g. high churn, low switching costs, etc.) are creating challenges for sub-scale media companies to recoup the lost economics of the linear ecosystem,” Reif Ehrlich explained. “We believe the confluence of these factors could be the catalyst to re-start movement on consolidation.”
Consulting firm Deloitte, in its 2023 Media & Entertainment Industry Outlook published on Jan. 18, similarly highlighted current streaming challenges in Hollywood. “Studios and video streamers face the reality of their own market disruption, trying to find profits in a less profitable business,” the report noted. “It’s been 15 years since the streaming video revolution began, and we can now see the impact of its disruption. In 2022, SVOD services in the United States — the most mature market for SVOD — finally surpassed cable and broadcast TV. … As a delivery technology, on-demand streaming has radically disrupted video consumption, upending the entire entertainment industry.”
The Deloitte report then warned: “Streaming has also disrupted profitability. Gone are the revenues enjoyed during the cable TV era, which formerly approached those of the global energy sector; by some estimates, streaming generates one-sixth as much revenue per home as pay TV.” In addition, “audiences are fragmented, canceling subscriptions is easy, and advertising has yet to unlock revenues. Content has only become more expensive to acquire and produce.”
Deloitte’s prediction forecasts tumult on the horizon: “The year ahead may see more experiments with content windowing, with cheaper subscriptions having to wait 15 or 30 days to see top new releases. Streamers are also working to re-create more of the lucrative cable TV advertising model in their streaming services. If more advertisers get on board, ad revenues could offset subscription pricing and content spend. Successful advertising requires more data and better ad tech to get the right ads in front of the right eyes. With so many new, ad-supported streaming offerings hitting the market, 2023 may see considerable movement and innovation in streaming advertising.”
Meanwhile, Morgan Stanley analyst Benjamin Swinburne has also talked about a new reckoning in the Hollywood streaming story. “For direct-to-consumer (DTC) streaming, we see a new phase ahead,” he wrote in a Dec. 19 report. “Streaming growth is slowing. We see 2023 industry net adds at roughly half the 2021 pace. Capital intensity has increased significantly, and content asset turnover and returns have fallen. The media streamers (excludes Netflix) will lose over $10 billion in operating income in ’22, by our estimates.”
Swinburne also highlighted: “Over the past five years, the industry has absorbed a largely incremental $20 billion in annual DTC streaming support costs. Even best-in-class Netflix has not been able to leverage its content assets in several years. On top of this, linear TV distribution revenues are now declining (with … unbundled Sunday Ticket … a further incremental risk to pay-TV subscribers), and the TV ad market has rolled over.” The Morgan Stanley expert concluded: “The industry is clearly heading into a new phase, one we think will be characterized by 1) cost rationalization, 2) consolidation (of services and/or companies), and 3) outright exits from the DTC business.”
So which entertainment stocks do the analysts like at the start of 2023? MoffettNathanson maintained its “outperform” ratings on Fox Corp. and Walt Disney, while reiterating its “underperform” ratings on Paramount Global and Roku. “We maintain our ‘market perform’ ratings on Netflix, Warner Bros. Discovery, AMC Networks and Cinemark,” the analysts added. They decreased their price targets for Cinemark by $1 to $13, “reflecting our lower estimates,” and for AMC Networks by $2 to $17 “to reflect our estimate revisions and uncertainty around the direction of the company post-management changes.”
Reif Ehrlich summarized her top picks this way: “For 2023, we are generally bullish on large-cap media (Warner Bros. Discovery, Netflix and Disney) and more cautious/neutral on cable.”
With streaming “entering a new phase (of) rationalization and consolidation,” Swinburne noted that “long-term, this should improve returns.” This year, he is less bullish on big Hollywood stocks though. “For ’23, we prefer the supply side — content owners in sports, entertainment and music (‘overweight’-rated Endeavor, Liberty Media – Formula One Group and Warner Music Group). All offer healthy, often contracted revenue and free cash flow growth.”