Navigating the convergence: a look into the telecoms and media sectors
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In the glitzy world of awards shows, satellite arrays, and packed-out concert arenas, telecoms and media stand as two of the most captivating and interconnected industries. Despite their apparent differences, investors often treat telecoms firms, responsible for building communication infrastructure, and media companies, producers of content, as part of a unified, massive $5 trillion sector. This blog post aims to unravel the complexities of this convergence, exploring the workings of the telecoms industry, the impact of 5G, and delving into the intricate landscape of media companies.
Telecoms: building the digital backbone
Telecoms firms, or telcos, play a crucial role in connecting people’s devices to the content they love. Divided into infrastructure firms and service providers, telcos build the technology, such as chips and towers, and offer services that enable users to access this infrastructure.
As the industry undergoes a transformative shift to 5G technology, the landscape is poised for change. With 5G’s potential to connect a myriad of devices, from doorbells to self-driving cars, the telecoms sector anticipates substantial revenue growth. While service providers explore alternative revenue streams, infrastructure firms, led by market leader Huawei, are set to benefit from the need for extensive 5G upgrades.
Valuing telecoms stocks: balancing debt and dividends
Telcos love debt. They’ve traditionally funded much of their expansion by borrowing, and that’s largely been for tax purposes. High levels of debt mean high interest payments – lowering profit and therefore taxes due. And because telcos have stable, recurring revenues, along with lots of valuable physical assets, lenders are only too happy to offer them credit.
This desire for debt means that investors’ priority isn’t really telco profits, which are calculated after tax and interest payments. Instead, they tend to look at the amount of cash the company makes (“free cash flow to the firm”) less capital expenditure (or capex – the amount the firm spends on infrastructure and so on). It’s these figures which the telcos try to optimize, and from which the hefty dividends they pay out to shareholders emerge.
That said, telecoms capital expenditure is “lumpy”: it comes (like, appropriately enough, a 5G signal) in waves, rather than remaining steady each year. And because not all telcos spend on infrastructure at the same time, looking at free cash flow minus capex can make it hard to compare one telco to another. So alternatively, investors might look at EBITDA as a proxy for a firm’s profitability, and EBITDA multiple as a way for companies to be ranked against one another.
But if you’re buying AT&T, you’re not just buying a phone business… you’re also buying a TV channel. Or rather, a Not TV channel…
The average American adult spends over 4 hours a day watching TV. And that translates to an awful lot of money for the companies producing those programs: the television networks. In the US, there are two main kinds. Of the free networks, the “Big Four” are NBC (owned by Comcast), ABC (owned by Disney), CBS (owned by ViacomCBS), and Fox (owned by… Fox), with The CW (owned jointly by ViacomCBS and AT&T) in fifth place. These make money either by selling advertising or by selling their shows to “affiliates”. Affiliates comprise those TV stations – like Los Angeles’ KTLA – which pay “reverse retransmission fees” to networks in exchange for carrying their content.
These affiliate stations join the second type of TV network – featuring premium channels like Showtime and Starz – in making their money from both advertising and subscriptions which are often bundled together into cable packages. The ultimate value chain is therefore pretty complicated. The viewer pays their cable provider – the cable provider pays the TV stations – and some of those stations then pay the parent network whose content they use.
The big challenge facing all parties is “cord-cutting”: people are increasingly canceling their cable subscriptions and instead choosing to cherry-pick the content they actually want. This trend is affecting different players in different ways – but many networks are now looking to go direct-to-consumer, launching streaming platforms that a user can sign up for with no need for cable (like HBO Now, CBS All Access, and NBC’s Peacock).
That trend could eventually lead to these being the only places you can watch the networks’ content. That’ll lead to lower advertising and affiliate revenue for the producers – but also more subscription revenue. The affiliate owners, meanwhile – companies like KTLA parent Nexstar – may find themselves without a product to sell. And other potential losers include the likes of Disney-owned ESPN: a default network in cable bundles now, but unlikely to get the same number of viewers paying for it as a standalone.
Valuing TV Networks
A good place to start when valuing a TV network is to look at revenue per subscriber. You can break that down further, seeing how much it makes from a direct subscriber versus an affiliate one, for example. The average network receives a retransmission fee of around $2.10 per affiliate station subscriber per month – but those numbers don’t always correlate with viewership. For example, CBS earns about the same per subscriber as drama specialist AMC, even though its programming gets many more viewers – perhaps suggesting CBS could boost its profits by selling to people directly.
That’s an assumption based on what the company could do, though. To directly compare network stocks as they are, investors invariably look at EBITDA multiples.
The really tricky thing when comparing network stocks, is finding adequate comparisons. Thanks to conglomeratization there are few companies today that represent a simple bet on a TV network: ABC and NBC both make up just a small portion of their parent companies’ revenues. And even with those that are closer to “pure-play” investments – like ViacomCBS and Fox – you’re investing in other things too (ViacomCBS owns a book publisher, while Fox, for some reason, owns a loan marketplace).
It’s also hard to compare the TV networks themselves. CBS’s value is underpinned by long-running procedurals, while Fox’s relies on its controversial but popular news output. While both are TV shows, they have very different revenue drivers. Still, as the TV industry shifts to a direct-to-consumer model, you might argue that entertainment is worth more than current affairs: you’re probably more likely to pay for 456 old Law & Order episodes than 456 old news broadcasts. And then there are the new ways that TV channels will have to monetize their content in the brave new world of streaming…
Netflix, Disney+, Hulu, Amazon Prime Video, HBO Max, Apple TV+, CBS All Access, Peacock… it’s fair to say the streaming market is heating up. As viewers cut cable subscriptions and stop visiting movie theaters, they’re turning to online video libraries instead. Investors, meanwhile, just want to settle down in front of something good – easier said than done, because success looks completely different depending on the platform.
The current leader is Netflix, which kickstarted a revolution when it launched online video in 2007. That first-mover advantage helped it build a massive, stable revenue base of 158 million subscribers. And that, in turn, allowed Netflix to borrow billions, which it spends building a library of exclusive original content in the hope of keeping you glued to the platform.
Times have changed, however. Netflix is no longer the only player in town – and some think its once-innovative business model could prove to be a distinct disadvantage. Netflix is a pretty simple media company, really: it makes content and then sells it. The drivers of that are correspondingly simple: profit is a function of how many subscribers it has, how much it charges them, and how much it spends on getting content out.
The other streaming players work differently, however. Amazon openly admits that its goal with Prime Video is simply to keep you subscribed to Prime so you spend more shopping – Prime subscribers spend an average $800 more on Amazon each year than regular e-shoppers do. Disney, meanwhile, is selling its streaming services at a cut-price rate, in part because it can later monetize that by upselling users cruises, theme park tickets, and merchandise. And Apple, for its part, hopes that star-studded shows will entice you to buy a bundled subscription that includes its much more profitable iCloud services – and perhaps a new iPhone every year.
Others are betting big on advertising. Hulu offers a cheaper subscription than Netflix but attempts to make up the difference with ad revenue. And NBC’s hoping its new (free!) Peacock service will allow it to make more from traditional TV ads: it’s investing heavily in technology that will let it run synchronized ad campaigns across both TV and streaming, hoping to charge a premium for more targeted tat-touting.
In other words, streaming is a “loss-leader” for many of Netflix’s competitors: it exists to lure users in who can then be monetized in other ways. For them, profits are a function of how many subscribers they have, how much they’re charged, how much content costs, and how much they can make from subscribers in other areas. Those extra revenue streams mean they can charge less for subscriptions or invest more in content and still, potentially, make the same profit. That presents a major problem for Netflix, which might find itself outspent or undercut by its revenue-mixing rivals.
These different business models also mean investors have to value streaming products differently. For Netflix, it’s fair to focus on cash flow and profit. But with the others, streaming can only be understood in the context of the wider company. It’s early days for all these platforms, so financial reporting is murky – but the best metric to keep an eye on is probably “average revenue per user”, or ARPU. When calculated comprehensively, that should include the revenue generated from adverts and related product sales. It’s perhaps impossible to fully figure out how effective a streaming business is here – you’ll never know if you would have gone to Disney World even if you weren’t a Disney+ subscriber. But ARPU goes some way towards estimating this.
There’s a lot of money at stake. Combined global revenue from streaming subscriptions alone is likely worth around$40 billion already, and that’s forecast to grow. Still, compared to the $150 billion video games industry, it’s small fry…
Avengers: Endgame, the highest-grossing movie of all time, made $2.8 billion. Grand Theft Auto V, the highest-grossing video game of all time, made $6 billion. In fact, it’s the most financially successful media title ever. What’s more, GTA V cost a lot less to produce: $265 million versus Avengers’ $365 million budget. Video games, despite being perennially under-discussed in mainstream finance circles, is a stunningly good business.
But as with every other media branch, it’s also undergoing rapid change. The business is shifting away from its one-time-purchase model in favor of free-to-play and subscription options. Fortnite, a pioneer of the former, made $2.4 billion in 2018 and $1.8 billion in 2019 – mostly from in-game cosmetic upgrades. So-called “microtransactions” have been a boon for the entire industry: GTA V continues to make money selling digital goods online. That could be about to peak, however, with countries like China cracking down on addictive games that seek to exploit players.
This might only drive more people towards games’ other new business model: subscriptions. Apple’s Arcade offering, which gives access to a bunch of iPhone games for one price, is one smartphone example, while Xbox Game Pass and PlayStation Now are similar products for big-budget console titles – both vying to be the “Netflix for games”. And with the imminent rollout of “cloud gaming”, which streams video games from powerful servers, players will soon be able to use such services even without an expensive games console. In theory, you’ll be able to play any game from any device – meaning your smartphone will have the power of a PlayStation.
That poses both opportunities and threats to different parts of the industry. The big console manufacturers – Sony, Nintendo, and Microsoft – currently make $19 billion a year from selling hardware, plus another $9 billion in publisher fees from studios who want to release their titles on their platforms. The hardware revenue could evaporate, while increased competition from tech giants like Google – muscling in with its Stadia – could drive down publisher fees too. Still, subscription revenue could make up for that: $10 every month adds up to a lot more than $399 once every six years. And platform owners are willing to buddy up with Big Tech in order to make sure they bank that money: Sony’s already agreed to host its cloud services on Microsoft’s Azure platform.
Game publishers, meanwhile, may not mind whether traditional console makers or new tech firms end up capturing the nascent market. Investment bank Morgan Stanley estimates that cloud will increase the number of gamers by 10% – meaning publishers’ profits could be $11 billion higher by 2025.
New business models offer more stability, too. Right now game profits are quite “lumpy” – spiking on a new console or hit title. Recurring revenue, whether it be from regular microtransactions or subscriptions, is much more appealing to investors who are then less reliant on any one success.
Investing in the games industry is, fortunately, quite easy. Major publishers like EA, Activision, and Take-Two, and console manufacturer Nintendo are all publicly listed. The companies are less complex than TV networks and telecoms firms, so investors simply look at their stocks’ price-to-earnings multiples to compare them.
You could also invest in a company where gaming is just part of the equation. Console manufacturers Sony and Microsoft obviously make money from more than just games. That’s also true of a potential esports bet: Amazon, which captures over 800 million hours of viewing a month via game streaming service Twitch.
The most dominant force in modern gaming, China’s Tencent, has huge stakes in many big publishers (including Fortnite developer Epic Games) alongside its massive social media business. But the problem with buying any of these stocks is that you’re not just betting on the gaming business’s growth, and it can be hard to tell how much gaming matters to their overall success. That’s true of all media conglomerates, in fact. So finally, we’ll break down just how to go about analyzing the big beasts.
Success in succession
The media and telecoms industries are dominated by a few gigantic conglomerates: Comcast, AT&T, Disney, and ViacomCBS are the biggest. These huge companies operate a diverse range of businesses, which makes it very difficult to value them. The best approach is a “sum of their parts” method, which involves breaking down the business into its core sectors and then applying multiples to each of those.
Pure-play companies like Netflix can command hefty premiums to their relative valuations. But media company bosses in search of scale and synergy hope that conglomeratization will ultimately help them succeed: Disney, for example, can only execute on its grand strategy by owning a wide range of businesses.
As an investor, you have to decide for yourself how much of a discount or premium to apply to a media company. You might think one firm looks overstretched, while another is pleasingly diversified. One of the best ways to analyze companies is to think holistically about the overall business: is it well positioned to do what it wants to do versus its competitors? If the answer’s yes, you might want to invest. If not… well, thankfully there’s a world of internet, video, and gaming content out there to occupy you instead.