Advanced Television

Prediction 2016: ‘Amazon standalone video service’

January 4, 2016

BTIG, the global financial services firm, has published its top 16 predictions and events to watch for in media and tech stocks in 2016:

1.    Media Companies Forced to Shorten Sports Rights Amortisation Accounting

In 2016, BTIG expects accelerating declines in multichannel video subscribers due to cord-cutting/shaving/nevering, combined with a continued secular decline in TV advertising (excluding political spend).  Media companies that make large investments in sports rights (such as Disney, Fox, Time Warner, Comcast/NBC and CBS among others) are forced to concede to investors that their long-term projections for matching revenues against these rights costs are too rosy.  Media companies have already begun to detail this risk factor in their SEC filings with the risk turning into reality by late 2016.  The end result will be to accelerate sports rights amortisation, reducing near-to-intermediate-term earnings expectations (note: no impact on free cash flow).

2.     Media Conglomerates Seek Acquisitions to Diversify Away from Cable Networks and Fix Mobile Problem

Up until 2014, cable networks were viewed as the most valuable and solid/visible growth assets in the media world.  In fact, companies with fewer cable networks were criticised for not moving fast enough to expand their cable network franchises. With cable network subscriber tallies falling and the need to increase their original programming mix (as reruns no longer drive viewership like they used to), investors are increasingly concerned about the future of cable networks.  Investor concerns are exacerbated by the inability of basic cable networks to go direct-to-consumer, as they have been effectively over-earning for decades through the power of the bundle and limited alternatives.  With cable network earnings struggling to meet investor expectations and company valuations suffering, media conglomerates begin to hunt for assets that reduce their exposure to basic cable networks, while at the same time giving them a stronger mobile presence.  While SVoD acquisitions would be the initial choice, Netflix has grown too large and none of Hulu’s partners want to part with their respective share.  Snapchat and Twitter could both be acquisition candidates, however the valuations and culture would be very hard for media companies to digest.  Video game companies such as Electronic Arts and Activision could be the most compelling targets, particularly as these companies are increasingly focused/succeeding on mobile and appear well-positioned for virtual reality in the future.

3.     Government Launches Movie Exhibition Windowing Investigation

As the IP-enabling of the TV becomes ubiquitous, along with smartphones that have larger and larger HD screens in consumer pockets worldwide, movie studios grow increasingly frustrated with their inability to shorten theatrical release windows (the window between theatrical release and home video release sits at around 90-days, with digital digital sell-thru often occurring at 75-days).  Movie exhibition chains continue to tactically collude to prevent any major movie studio from shortening windows.  Not only are studios failing to maximise their marketing dollars as they need to restart marketing (pressuring margins/profits), consumers are denied access to content they want to see, when and how they want to see it.   With studios taking all of the risk, particularly in an environment where movie performance appears increasingly binary (meaning either success/failure, with little in-between), the lack of flexibility in release windows is increasingly problematic. We think government regulators launch an anti-trust/collusion investigation of the major US exhibitors including AMC, Carmike, Cinemark and Regal.  The catalyst is the release of an increasing flow of movies on Netflix and Amazon Prime that do not show up in major exhibition chains due to the day and date release strategy.

4.     Communications Becoming Gatekeeper for Media Consumption and Commerce (aka Snapchat Envy)

The major media conglomerates have all failed at mobile-to-date.  While many have launched apps, none have become everyday/homescreen use case apps (getting apps downloaded initially is not so hard, while continuous “reengagement” isreally hard).  In 2015, these same content creators agreed to provide unique content to Snapchat Discover realizing that they wanted their brands/content consumed on mobile, even if it meant mobile consumers not using their brand/content-dedicated app.  In 2016, we think Facebook Messenger expands upon Snapchat’s strategy becoming a platform for media consumption and commerce.  For content creators and commerce sites, the allure of being well-positioned in communication apps is that the interaction between consumers is happening continuously, giving users a reason to keep coming back into the app.  In addition, by their very nature of being communication platforms, sharing is seamless, enabling the virality that content/commerce destinations desire, but find hard to execute themselves.  As content and commerce expands on communication apps, media companies increasingly realize they have enabled a new generation of gatekeepers that have far more power than MVPDs wield today.

5.    Comcast Realises Wi-Fi is Not Enough and Makes Bid for T-Mobile

Following the collapse of Comcast’s attempted acquisition of Time Warner Cable, we raised the question: “Is Wi-Fi First Good Enough” as a mobile/wireless strategy for large US cable system operators.  BTIG TMT analyst, Walt Piecyk stated that if Wi-Fi First did not satisfy the wireless needs of Comcast, an acquisition of T-Mobile or Sprint could be of interest.  Furthermore, in a July 2015 blog post “Can Verizon Crush Comcast’s Wi-Fi First Dreams”, Piecyk noted the risk, “if Comcast waits too long there might not be available choices.”  With an increasing amount of consumer time shifting to mobile, Comcast realizes it needs a far more robust wireless strategy relative to Verizon and AT&T, with T-Mobile the most compelling target.  Importantly, we believe this deal would NOT have trouble gaining regulatory clearance as it would lead to an even stronger player in wireless to compete against the two main incumbents.

6.    Amazon Creates Standalone Video Service Distinct from Prime to Re-Bundle Content

A standalone Amazon Prime Video service has been talked about before.  In fact, a few years ago we were confident it would happen as a result of a clause inside of a specific programmer/content creators’ licensing agreement with Amazon.  For reasons that were never clear, it failed to materialise as Amazon focused on the importance of SVoD to enhance the overall value of a Prime membership (Prime Video users spend more time and money with Amazon over the course of a year).  So what has changed, why would Amazon consider this change now?  First off, we do not believe Prime Video is leaving the existing Prime membership.  However, as Amazon has begun to reimagine the multichannel TV bundle we believe they are looking to create their own standalone bundle of on-demand, and potentially linear (live event) video programming.  In December 2015, Amazon announced it was offering add-ons to Prime such as Showtime, Starz, Lifetime Movie Club, among many others.  And, this is just the start, as we expect other services such as WWE Network to become available in the future.  We doubt you would be able to subscribe to just the existing Amazon Prime offering without subscribing to free-shipping, but for consumers looking to build a new bundle of video programming beyond what is in Amazon Prime today, we believe there will be a way to sign-up for this new bundled offering before year-end 2016.  Maybe they will even call it Amazon TV.

7.    Activists Re-Enter Time Warner Seeking Breakup

In the summer of 2014, Time Warner’s board rejected 20th Century Fox’s unsolicited bid for the company without even bothering to hold formal negotiations.  An analyst meeting in October 2014 excited Time Warner investors with the promise of meaningful cost-cutting, the launch of HBO over-the-top (eventually called HBO Now), increased investment in programming at Turner to improve ratings and an aggressive movie/TV slate tied to DC Comics.  18 months after rejecting Fox’s bid, Time Warner shares finished 2015 at $64.67, 13% below the value Fox was offering adjusted for the decline in FOXA shares over that time (1.531 shares of FOXA plus $32.42 in cash per TWX share).  With Time Warner’s market cap now sitting at just over $50 billion, we believe it will be very tempting for activists to take a fresh look at Time Warner (remember Carl Icahn’s plan back in 2006?.  As we noted in our November 2015 blog, Time Warner Chairman and CEO Jeff Bewkes remains committed to keeping the company together.  However, with a shrinking market cap and eroding industry fundamentals pressuring valuation multiples, we have a hard time seeing what will keep activists at bay in 2016.  We continue to believe there are minimal synergies between Turner and the rest of Time Warner and the possibility that there may even be dis-synergy, as we noted in the break-up concept blog post (there is also some question about the sense in keeping HBO together with Warner Bros if you want to fully maximise shareholder value).  We see many buyers for a standalone HBO/Warner Bros either together or in separate entities and believe Turner is no worse positioned than current cable network pure play equities such as Discovery and AMC.

8.    Netflix Watch Time Per Subscriber/Household Exceeds 3 Hours

In April 2015, Netflix disclosed that it reached 10 billion streaming hours globally in Q1 2015, which we calculated equated to 121 mins/day/sub in the US.  Netflix original programming began to ramp notably throughout 2015 and will expand significantly in 2016, with multiple series/movies scheduled to launch every single month.  Once a consumer learns to binge, they want to binge more and more content – there is simply no going back to linear TV with commercials and a week or more between episodes.  With more fresh/original content on Netflix combined with the increasing penetration of IP-enabled TVs, bigger smartphone screens for watching long-form video, mobile operators like T-Mobile making it easier to watch on mobile networks and rising penetration of Netflix’s (premium-priced) four stream per subscriber plan, we expect streaming hours per subscriber (household) per day to exceed three hours by the end of 2016. Increased watch time should further drive down churn at Netflix, enabling the company to maintain solid subscriber growth even as gross adds slow.  Also worth noting that a significant increase in original programming at Netflix, along with Amazon and Hulu, not to mentioned more originals at HBO, Showtime and Starz, will lead to accelerating declines in linear TV ratings in 2016 and beyond.

9.    Charter Closes Time Warner Cable/Bright House, But It’s Painful

In November 2015, we raised the question of whether we were too optimistic about regulatory approval of Charter’s pending acquisition of Time Warner Cable and Bright House.  While we continue to believe there are no inherent public interest benefits of the transaction, we expect Charter to agree to anything to win regulatory approval.  While Charter has agreed to three years of settlement-free peering and no usage-based pricing for broadband, we expect the FCC/DoJ to require at least seven years within a consent decree, if not 10 years.  We also believe the government will require some level of overbuilding to increase fibre-based competition.  The cost of the overbuild will cannibalise a portion of the financial benefits of Charter’s acquisition, but will be far less painful than the alternative of walking away from the transactions with a $2 billion break-up fee and less size/scale (not to mention negative investor reaction).  The government will also look for ways to protect consumers from programming contracts/MFNs that stifle OTT video competition to the cable bundle.  It remains somewhat unclear how this will play out, but a mandatory FCC review of future programming contracts may be necessary to verify that they do not contain clauses akin to what Comcast and Time Warner Cable contracts have historically included.  Regulators may also force some form of clause requiring New Charter to offer unbundled “naked” broadband at a fixed price, enabling consumers to more easily subscribe to bundles without video (imagine 25 Mbps standalone broadband for $30 or $35).  While Charter will likely succeed in closing its acquisition, the question for investors is how interesting is the new company, given a painful consent decree, increasing competition (i.e. Google Fiber), and an increasingly harsh regulatory environment (Title II).

10.    YouTube Significantly Increases Investment in Red

YouTube launched its subscription service, YouTube Red, in October 2015 offering consumers ad-free content, offline access and background play capabilities.  The last piece of Red’s value proposition is original content only available to YouTube Red subscribers.  The first original/exclusive YouTube Red content launches in Q1 2016.  So far, YouTube has greenlit 10 series, with budgets below $10 million each.  In 2016, we expect YouTube Red to grow increasingly ambitious increasing the number of series produced and the level of investment in each series.  While we are not expecting YouTube to commit big dollars to a single series, similar to what Netflix did for House of Cards ($60 million-plus), we believe its budgets will rise meaningfully.  While penetration of paid subscribers is likely to be a very small number for YouTube, with over 1.4 billion monthly users, even 1-2 per cent penetration for YouTube Red would create one of the largest global SVoD businesses that exist.

11.    Organic TV Ad Spend Declines Accelerate as Ratings Fall Rapidly

With the expansion of original programming on Netflix, Amazon and Hulu (all offering vast amounts of ad-free content) and the ability to subscribe to HBO, Showtime and Starz without the cable bundle, linear TV rating declines accelerate.  With consumer engagement, even when watching TV shifting to mobile screens (remember what CBS admitted back in August 2015), advertisers accelerate the shift of advertising dollars to mobile with Google and Facebook the two biggest beneficiaries (and Snapchat coming on strong).  As the TV screen becomes “appified,” competition for TV viewing time increases well beyond SVoD services like Netflix (the focus of our September 2015 blog on the new Apple TV).  While the benefit of a Presidential election in 2016 and the Summer Olympics will lead to a modest increase in TV advertising spend, we estimate organic TV ad spend will be down low-mid single digits.  Not only does 2016 TV advertising disappoint, but the stage is set for a dramatic decline in 2017 when both political spending and Olympics-spend disappear.

12.    Spotify and Apple Take Meaningful Share of Free Listening from Pandora

In 2015, the major music labels finally grew comfortable with Spotify’s free mobile streaming service.  Spotify proved to labels that it could monetise free streaming at or above Pandora’s levels without the massive local salesforce that Pandora invested in, and that it could drive meaningful uptake from free-to-paid.  In 2016, Spotify will focus on educating consumers that its free service is superior, capturing meaningful user and listening hour market share from Pandora.  While the Apple Music subscription service has not been as successful as Apple or the music labels had hoped, Apple’s Beats 1 is an undisputed success story.  In 2016, we expect Apple to leverage its Beats 1 success and create a suite of online programmed radio stations with DJ’s, akin to what DASH radio has done.  We expect the combination of both Spotify and Apple focusing more energy on their free offerings and the first full-year of Amazon Prime music having all the music labels will lead to declining domestic users and listening hours at Pandora in 2016.

13.    Twitter Domestic MAUs Fall for Full Year 2016 as Facebook, Instagram and Snapchat Encroach

Twitter Moments has failed to reinvigorate user growth and engagement at Twitter.  While Twitter hoped Moments would be their Snapchat live story equivalent for an older demographic, the reality is that older generations are learning to use Snapchat.  In addition, Instagram is increasingly trying to incorporate a video highlights reel as they did for major holidays throughout the second half of 2015 (most recently New Year’s).  While we continue to love the Twitter product ourselves, we struggle with how it becomes mass market enough to live up to its still lofty valuation.  In 2016, we expect Snapchat, Instagram and Facebook to further encroach on Twitter’s core news/information use case. With other platforms offering far more exciting growth and total engagement/time spent, we fear advertisers may grow more selective on what/how they spend on Twitter.

14.     Lionsgate Acquires Starz and Sells EPIX

Lionsgate has clearly become John Malone’s content roll-up vehicle of choice following the investment by Malone, along with investments by Discovery and Liberty Global (both of which Malone has significant stakes in).  We believe step one will be an acquisition of Starz, followed by a Lionsgate sale of its stake in EPIX.  We suspect Viacom/Paramount would love to take majority control of EPIX, particularly as Paramount is in the midst of rebooting its television production efforts.  Beyond Starz, we sense Lionsgate has far bigger ambitions, the only question is what assets make the most sense?  AMC? MGM?  The only risk to Malone’s strategy of using Lionsgate to consolidate the content space is that he is also trying to convince regulators that Charter is not vertically integrated in the same way Comcast was (Malone is trying to assure regulators he is not “actually” pulling the marionette strings across a vast empire of investments #goodluck). Moving too quickly to consolidate content/programming in 2016 could make Charter/Time Warner Cable/Bright House approval more challenging.

15.    Comcast Launches Nationwide vMVPD

Under increased regulatory scrutiny, Comcast looks for a way to increase video competition and improve its relationship with consumers.  In 2016, we believe Comcast will look to expand its college-based virtual MVPD (vMVPD) service to markets where it does not have video franchises and wired broadband infrastructure.  While this will put Comcast’s Xfinity into direct competition with its cable industry peers (such as Charter), it will have enabled Comcast to offer a national video platform, which would then better allow them (economically) to acquire prior season SVOD rights akin to Netflix, Amazon and Hulu.  Comcast’s new OTT version of Xfinity would be a direct competitor to DISH’s Sling, which we believe could exceed 1.0 million subscribers by year-end 2016.

16.    Major Distributor Drops a Major Programmer

This was one of BTIG’s key predictions for 2015 that never happened (#7 in our Top 15 for 2015). While all eyes will be on DISH/Viacom in early 2016, we believe it is hard to imagine another year going by without the size of major programming drops growing, beyond Cable One and Suddenlink (both of which dropped Viacom back in 2014).  As cable operator profitability is increasingly driven by broadband, with Verizon illustrating that consumers do want fewer channels and more choice, we expect at least one high profile channel group to be dropped by a major distributor in 2016.  We expect programmers to continue to resist legacy MVPDs from offering smaller bundles without some/all of their channels, forcing distributors to drop a programmer.

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