Frenzy in old media, NBN dystopia and a2 milking fantasia

In case you didn’t notice, consolidation in traditional media is cranking up on a global scale. First, we had US telecom giant AT&T swallowing up Time Warner. This was followed by Walt Disney buying up a substantial chunk of our very own Rupert Murdoch’s Twenty-First Century Fox’s media assets. Then there is the current battle for Sky PLC in the UK, a pan-European satellite pay-TV operator boasting 23 million subscribers being pursued by Comcast and 39% shareholder Fox.

The primary catalyst driving this frenzy is the unrelenting pace of digital disruption, causing unprecedented changes in media consumption behaviour. As advertising and discretionary entertainment dollars follow eyeballs, the financial impact on traditional media has been debilitating. It has forced incumbent operators to consolidate, in a bid not only to gain a greater share of the entertainment and advertising dollars while eliminating duplicate costs, but to also expand their audience base over which they can amortise the escalating content and programming costs to keep this fickle audience. They also hope the increased scale from consolidation would provide greater capacity to invest in content and digital capability.

In the audio-visual entertainment sphere, subscription video on demand, or SVOD, has been a key instigator of disruption for traditional media. It is a streaming phenomenon that bypasses traditional distribution platforms (satellite, cable, terrestrial broadcast) and directly reaches consumers via digital, broadband-enabled means.

The undisputed kingpin of this SVOD incursion is Netflix, a company to which Morningstar has assigned a narrow moat rating but its shares are rated 1-star, trading at a substantial premium to our US$120 per share fair value estimate. Its popularity has been growing at a break-neck speed and the group now boasts 56 million subscribers in the US (from 29 million five years ago) and an even more impressive 68 million outside it (from just 7 million five years ago). Remember, these are paying subscribers and there are millions more freeloading on Netflix on either a trial basis or password-sharing among family and friends.

In our view, the desire to compete against this streaming juggernaut, as well as other SVOD insurgents such as Apple, Youtube and Amazon Prime, has been the main motivation for traditional entertainment firms’ recent “urge-to-merge”. Size and scale are critical to compete against Netflix’s estimated US$12 billion to US$13bn spend on programming in 2018 — a budget that dwarfs those of traditional content powerhouses such as HBO and BBC (about US$3bn to US$4bn a year).

In fact, Netflix’s forecast 80-plus original feature film slate in 2018 almost puts the output of traditional film studios to shame (Warner Bros will release just over 20 films in 2018 and Disney about 10). And just to prove Netflix’s original shows are more than cheap, tacky daytime soapies, the group this year garnered 112 Emmy nominations from 40 of its original shows, surpassing HBO (108 nominations) for the first time. All this is augmented by a formidable database of user preferences and viewing habits that Netflix expertly mines and exploits for programming decisions, granular to some 2,000 “taste cluster” levels.

Brian Han is a senior equity analyst at Morningstar, covering telecommunications, media and leisure. Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar.

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