Media companies are having their worst year in three decades

We’re doing a special edition because of the media bloodbath on Wall Street this week. Investors are freaked out about the state of the entertainment business, and hopefully we can do a decent job of explaining why that is.

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Media companies are having their worst year in three decades
Disney shares just posted their biggest drop in two decades, bringing an end to a corporate earnings season that Hollywood and Silicon Valley would like to forget.

The media business is on track for its worst year on Wall Street in at least three decades. Shares in the largest US media companies have dipped more than 50% in 2022, far worse than the broader market. (Tech companies aren’t faring much better.)

Melting media
Entertainment stocks have retreated far more than the broad market.

While Netflix’s subscriber loss earlier this year precipitated the initial concerns, the real reason is this: The Pay-TV business is in freefall.

This may not sound like news. We’ve been talking about cord-cutting for almost a decade. But for the past few years, enthusiasm about streaming allowed media companies and investors to forget that their primary ATM was running low on cash.

Disney talked about The Mandalorian instead of subscriber losses at ESPN. WarnerMedia talked about releasing movies on HBO Max instead of falling ratings for TNT.

But now that the growth of streaming has slowed, the market is once again paying more attention to the state of the cable and satellite business. The picture is ugly.

The rate of cord-cutting has accelerated dramatically in the past few years, according to MoffettNathanson. Cable companies are now losing close to 10% of their customers a year.

While Netflix’s subscriber loss earlier this year precipitated the initial concerns, the real reason is this: The Pay-TV business is in freefall.

This may not sound like news. We’ve been talking about cord-cutting for almost a decade. But for the past few years, enthusiasm about streaming allowed media companies and investors to forget that their primary ATM was running low on cash.

Disney talked about The Mandalorian instead of subscriber losses at ESPN. WarnerMedia talked about releasing movies on HBO Max instead of falling ratings for TNT.

But now that the growth of streaming has slowed, the market is once again paying more attention to the state of the cable and satellite business. The picture is ugly.

The rate of cord-cutting has accelerated dramatically in the past few years, according to MoffettNathanson. Cable companies are now losing close to 10% of their customers a year.

Pay TV’s shrinking audience
Cord cutting has accelerated for the cable and satellite TV industries.

TV networks were able to offset subscription declines by charging cable and satellite distributors higher fees. But the decline in subscribers has accelerated to the point where higher fees can’t save them anymore.

Paramount Global said affiliate and subscription sales declined 5% in the most recent quarter. Disney, owner of the most expensive network of all, said affiliate fees increased just 2%.

TV networks face a similarly bleak picture when it comes to advertising. For years, networks increased sales even as viewership was tanking. While TV viewership declined by 10% a year, prices went up by more than that. (TV networks also inserted more and more advertising every hour.)

But, at a certain point, viewership dropped too much for these companies to keep it going. TV ad sales slipped 4% in 2019 and 12% in 2020, according to Magna Global.

The latest pullback in advertising has hurt the big tech firms too, which is why you see Meta Platforms Inc., Roku Inc., Snap Inc. and even Alphabet Inc. suffering more than the broader market. Heck, even TikTok has cut its ad sales forecast. But while we can see a world in which ad sales at TikTok or Roku bounce back, linear TV won’t.

Advertising and affiliate fees are the two biggest revenue streams for most traditional media companies. Now they are both in secular decline.

This is why Netflix Chairman Reed Hastings predicted linear TV would be dead in five to ten years. Long-time Disney CEO Bob Iger echoed that sentiment in September. “Linear TV and satellite is marching towards a great precipice and it will be pushed off,” Iger said.

After Disney’s latest earnings report, “it appears that cliff may be closer than any of us thought,” analyst Michael Nathanson wrote this week. Disney has shelled out billions of dollars for sports rights at the same time profits at its TV networks are under pressure.

Streaming is supposed to be the solution. But the streaming business isn’t as lucrative as the cable business – at least not yet.

Paramount, Comcast Corp., Disney and Warner Bros. Discovery are going to lose about $10 billion on streaming this year. Netflix, 15 years into streaming, is still barely making more than it spends every year. (It will report a profit of more than $6 billion, however.)

This shouldn’t be a shock. The internet has compressed profit margins in almost every business. New players saw an opportunity to re-create physical businesses on the internet. Fueled by venture capital money, they offered products people loved at low prices. That is Amazon with retail. Netflix with TV. Uber with taxis.

This downward pressure on profit has been particularly acute in media. Just look at the trajectory of the newspaper and music industries this millennium. The internet destroyed the value of the written word and the song in just a few years.

Most newspapers and magazines still haven’t figured out how to restore the value of print, though lots of companies are trying. And while music is growing again, the industry is still much smaller than it was at its peak.

Contraction begets consolidation. News outlets have been merging for two decades and are still searching for a steady state. Parasitic private equity firms are causing a crisis in local news. The music business has spent two decades merging and selling to create three big record companies and a bunch of independents. While this may not be in the artists’ best interest, the industry has stabilized.

Hollywood was fortunate in that free video didn’t wreck its business in quite the same way. While piracy, YouTube and TikTok have all had an effect, Netflix, Hulu and Amazon transitioned young consumers to paid models. But streaming offered a credible alternative to pay-TV and movie theaters at a lower price.  The industry is still digesting these changes, and more pain is imminent.

The scariest part for employees and investors right now is that no company or individual has a clear solution.

“It’s very interesting to see an industry where NO ONE has figured it out,” one executive said this week.

It was supposed to be streaming. Is it still streaming? Growth at YouTube and Netflix has slowed. If not, what it is it? Copanies are firing workers, shuffling leadership and cutting their costs without a clear north star.

Here’s the good news. Streaming may not be as good a business as cable TV right now. But it is not a bad business. It’s an immature business. HBO wasn’t a profitable business right away. It took years and years. The same goes for ESPN.

It’s going to take these media companies time to figure out the best way to build a business around their streaming services. Disney+ is three years old. HBO Max is less than three years old. Take a deep breath.

If you take a minute and listen to Disney or Warner Bros. Discovery leadership, they aren’t giving up on streaming. They are just saying that streaming alone isn’t the answer. Warner Bros. Discovery makes money from movie theaters and selling shows to other networks, two practices it wants to continue. That company’s biggest issue right now is debt – not a failed streaming strategy.

Pessimists will point out that Netflix, the big kahuna, has worse margins than cable networks at their peak. True, but. Netflix also makes more than $30 billion in sales a year from subscriptions. That’s pretty good for one revenue stream.

Now it needs to diversify. It’s already gone into advertising. It’s experimenting in video games, live events and consumer products. It’s contemplating sports and how best to use movie theaters.

The company also needs to get more serious about costs. It spent more money than anyone else on streaming to make more shows than anyone could possibly watch. And it didn’t market any of them. It inspired its competition to do the same.

Now these companies are all rethinking their spend. I f the current rebalancing at every big studio leads to fewer projects that are handled with more care, that is good for creative people and consumers. The internet has created an age of abundance, which had led to too many TV shows. An endless feed of new material works on TikTok where the cost of production is zero. That makes little sense when the cost of production is $10 million an episode.

The danger is that these companies cut costs without thinking about what consumers or creators want. That they only think about “shareholder value.”

But we do know one thing. Further consolidation is inevitable. It may feel like the industry has been caught in a cycle of constant change for the last decade. Disney bought Fox, CBS merged with Viacom and Warner was sold twice. But there are still too many services and too many companies. Nobody wants to pay for cable, Netflix, Disney+, Hulu, HBO Max, Amazon, Apple TV+, Paramount+ and Peacock. With the bundle they had no choice. Now they can pick and choose.

The latest sharp drops in stock prices puts companies in play. It is a matter of time before Apple, Microsoft, Comcast or some other buyer makes a play. For some, that will be welcome. “Can somebody please buy us?,” a senior executive at one media company texted this week.  Bloomberg