The way in which Americans are consuming media is undergoing a revolution.
Early 2015 marked the first time in history that the number of pay-TV subscribers in the United States dropped. During Q2, 566,000 customers “cut the cord” to pay TV, making it the industry’s worst quarter on record. With the exception of Verizon Communications Inc. (NYSE: VZ), all pay-TV companies lost subscribers during the quarter. And this follows a lousy 2014 when approximately 1.4 million households didn’t sign up for any service or cancelled their existing pay-TV subscriptions.
The loss of half a million customers in a 100 million U.S. pay-TV market alone does not spell the end of an industry. Although this was the sharpest contraction on record, the collapse was nowhere near the declines seen in other media businesses such as newspapers and recorded music.
Still, the cable-cutting mega trend threatens the entire cable TV ecosystem. And nervous investors are taking notice. When Walt Disney Co. (NYSE: DIS) announced that growth projections at its flagship offering ESPN were revised downward, the stock fell over 13% in two days. Other media stocks were swept up in the Disney-induced sell-off as more than $50 billion was wiped from the market value of major media companies in a blink of an eye.
The iPhone Generation’s Challenge
The pay-TV industry faces a single great challenge: the iPhone generation is tuning out of television in favor of advertising-free offerings by newfangled streaming services. Today’s kids are not growing up to be tomorrow’s pay-TV customers. A recent study from PwC found more than half of eight-to-18-year-olds said streaming TV was their favorite way to access media. Streaming ranked ahead of cable and network TV shows, games and short videos.
That said, consumers of all ages have moved gradually away from watching the “boob tube” to consuming media on phones, tablets and computers. Thus, we have witnessed the rise of streaming services such as Netflix Inc. (NASDAQ: NFLX), Hulu and Amazon.com Inc.’s (NYSE: AMZN) Prime service and the nervousness of both traditional content providers and the pay-TV companies that deliver it.
The Pipe Providers
Traditionally, there have been two ways Americans have consumed media content: satellite and cable.
Between the two groups, satellite is faring worse. Dish Network Corp. (NASDAQ: DISH), one of the two big U.S. satellite-TV groups, lost 151,000 subscribers in the second quarter versus a loss of 44,000 for the same quarter a year ago. DirecTV, the largest satellite-TV service provider, which AT&T Inc. (NYSE: T) recently acquired, also had its worst quarter ever, posting net customer losses of 133,000 versus 34,000 in the same period last year. This has forced Dish executives to diversify by launching Sling TV — where customers get to pick and choose channels — and by buying spectrum for tens of billions of dollars to deliver broadband services. Unlike with cable operators, it is difficult for satellite companies to offer a high-speed broadband connection — which is essential for anyone wanting to watch streaming services such as Netflix or Hulu.
The prospects for cable operators are better. After all, even if customers ditch their pay TV and move to Netflix or HBO, they still need a high-speed Internet connection. And on this front, cable trounces broadband. Even if the pay-TV industry suffers from cord-cutting, cable still wins in the long term. Comcast Corp.’s (NASDAQ: CMCSA) cable subscription business has already steadied, as it lost 69,000 subscribers last quarter versus 144,000 during the same quarter a year ago. Time Warner Cable Inc. (NYSE: TWC) lost 43,000 in the just-ended quarter, compared with a loss of 147,000 in the second quarter of 2014. In fact, starting in Q2 Comcast boasted more broadband subscribers than video ones.
That’s not to say that the move away from pay TV isn’t painful. Comcast and Time Warner Cable still make a lot of money on providing content. Today, if a customer pays $100 a month for cable TV, half goes to the broadcasters for content, while the other $50 goes to the pay-TV provider. Broadband services are less lucrative. And if cable companies get too greedy and hike prices too much, the regulators just might step in, as they have for traditional utilities.
The Content Providers
The greatest asset of the big media companies like Walt Disney Co. (NYSE: DIS), DreamWorks Animation (NASDAQ: DWA) and Viacom (NASDAQ: VIA) is their content. If content is attractive enough — think of a live sports event — consumers are willing to pay up.
But even the “moat” of high-quality content is being challenged as traditional media companies face competition from online-only programmers. Both Netflix and Amazon are investing in original content as well as licensing popular programming from the traditional big players. Just last week, HBO struck a five-year deal to carry Sesame Street on its premium channel and digital platforms.
Meanwhile, Viacom’s channels have suffered sharp ratings declines as kids shift to watching programs on demand on various digital devices. According to Bernstein Research, viewership across Viacom’s networks was down 18% in the second quarter. No wonder Viacom dropped 20% over two days as it missed revenue estimates and reported a 9% decline in U.S. advertising sales.
Business models for media companies are changing. Viacom is launching a subscription online streaming service aimed at preschoolers. Bob Iger of Disney said that he is ready to “flip the switch” on making ESPN a subscription service if need be. The cash cow of cable is getting long in the tooth.
Value in Traditional Media Stocks
So what does all this mean for investors?
Well, as is often the case, the growth stories trade at a premium, while the “old news” stocks get hammered. And that leads to some massive discrepancies in valuation.
Even as companies like Netflix Inc. (NASDAQ: NFLX) and Amazon.com Inc. (NASDAQ: AMZN) trade at price-to-earnings (P/E) ratios in the triple digits, traditional media companies seems like a bargain.
After its recent drop, The Walt Disney Co. (NYSE: DIS) now trades at a forward P/E of 19. Meanwhile, Viacom trades a forward P/E of just over 7, after having almost halved in price over the past 12 months.
Disney, a recent recommendation in my Alpha Investor Letter newsletter, has a broadly diversified business which will be able to withstand the challenges thrown at it by the iPhone generation.
While I wouldn’t bet against the likes of Netflix and Amazon, I wouldn’t count out the old media stalwarts just quite yet.
In case you missed it, I encourage you to read my e-letter column from last week about whether the bull run in biotech is over. I also invite you to comment in the space provided below my commentary.