TV’s Wild New Frontier

Apologies to Newton Minow, but TV isn’t a vast wasteland — it’s a jungle. And the jungle just got a lot meaner.

In just the past two years, cable networks, which had grown fat and happy feasting on double-digit affiliate-fee increases and strong advertising growth over the past several decades, have seen the core of their business begin to crumble before their eyes.

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Ad-revenue growth, once a given in the TV business, started to soften about five years ago for the major network groups, as younger viewers took to their laptops, tablets and smartphones to consume content.

After years of reliable double-digit growth, cable network ad revenue fell into negative territory in the first quarter, according to MoffettNathanson media analyst Michael Nathanson.

Skinny bundles and competition from over-the-top services like Netflix, Sling TV and DirecTV have eroded the linear-TV customer base as even once-invincible networks like ESPN have watched their customer shrink. ESPN has lost an eye-popping 12 million subscribers since its peak in 2011, according to Nielsen.

And subscription video-on-demand pioneer Netflix, which expects to spend about $6 billion on original content this year — second only to ESPN — now accounts for 30% of all home entertainment revenue, according to Internet guru and Kleiner Perkins Caufield & Byers partner Mary Meeker.

All of this has exacted a heavy toll on the cable programmers. Since August 2015 — when most cable-network stocks got hammered after it was revealed that Disney lost about 3 million ESPN subscribers in the prior 12 months — the stocks are still down by double-digits. When the dust settled in the summer of 2015, the media sector had lost a combined $60 billion in market capitalization during the period.

Content Stocks Languish
While those notoriously news-driven stocks have had some good days — on Nov. 20, 2015, Disney stock reached $120.07 per share after some investors saw opportunity in the downturn, the closest it has come to its Aug. 4 closing price of $121.69 each — only three of the top 10 network groups have been able to recover from the bloodbath of 2015.

The three that did, CBS, Scripps Networks and Time Warner Inc., have grown for reasons other than strong ratings and ad sales. Time Warner had the largest growth — 25% — mainly because in October, it agreed to be purchased by AT&T for $108.7 billion. CBS has risen on strong retransmission-consent fees, expected to top $2.5 billion by 2020, and the promise of its over-the-top services, CBS All Access and Showtime. Scripps Networks, which grew its ad revenue by 5% in the first quarter, has grown on its low cost of programming and its availability in several skinny bundles.

Collectively, the stocks of the top 10 publicly traded cable networks fell nearly 10% between April 26 and May 31, building on a decline that has been weighing on the industry for the past several months. The stocks have been on a steady decline since February, when the sector was down a collective 7.3%.

The most recent declines are just as troubling in light of other factors, said Telsey Advisory Group media analyst Tom Eagan.

The average price-to-earnings ratio for entertainment stocks was 15.6 times in July 2015, Egan said, just prior to the big sell-off that year. In August 2015, it fell to 12.8 times. Today, it’s 12.3 times.

The delta is even starker when compared to the Standard & Poor’s 500 Index. According to Eagan, the P/E ratio for the S&P 500 was 16.6 times in July 2015, meaning that the average entertainment stock was priced at a 6% discount to the average S&P 500 stock. Today, the S&P 500 is around 17.7 times, meaning the entertainment discount has risen from 6% to 30% in less than two years.

“The most interesting thing is not just the discount, but that the discount to S&P has widened so materially,” Eagan said.

Media stocks have always been event-driven, and cable-network stocks are no different. Eagan pointed to the P/E multiple for the entertainment sector in September 2016, which was about 11.9 times. One month later, after AT&T made its bid for Time Warner, that multiple rose to 13.1 times.

“AT&T making the bid lifted the whole average more than one point,” Eagan said. “But it was short-term nominal inflation. Despite that, they’re still down.”

Deals Won’t Stop the Bleeding
Eagan doesn’t believe that another big deal would erase the deficit. The problems in the sector are much deeper, he said.

Analysts have warned of the bifurcation of the TV market for years, and in the past several months, evidence of it is mounting. In the first quarter, pay TV subscribers declined by 762,000, the largest first-quarter decline ever and more than five times the 141,000 customers lost in the prior year.

The size of the decline, coupled with the fact that the losses weren’t offset by virtual MVPD gains, sends a troubling signal in that it “punishes those networks and companies that are not being carried by vMVPDs and strikes at the heart of a more bullish ‘cord-cutting will stabilize media’ thesis,” Nathanson wrote in a research note, adding that he doesn’t expect any relief in the seasonally weak second quarter.

Networks haven’t been sitting on their hands during this transition.

In February Viacom, which has had its own troubles with falling ratings and disappearing viewership, said it would focus on six core brands — Nickelodeon, Nick Jr., BET, MTV, Comedy Central and Paramount (Spike TV is to be rebranded as Paramount Network) — while placing less emphasis on its 19 other channels. While some have seen the Viacom move as a way of phasing out its less-watched networks, which Viacom denies, it is indicative of a growing trend in the programming business: Less is indeed becoming more.

Within the last year, NBCUniversal CEO Steve Burke has said publicly that the programmer probably would be better off with five or six core channels (it currently has 13 networks), and at Time Warner’s Turner, chairman and CEO John Martin has said all 10 of its networks probably won’t make it to virtual MVPD lineups, but if half do, the programmer will be able to manage just fine. About 90% of Turner’s total affiliate-fee revenue is generated by five networks.

“If we can get four or five, we’re in good shape,” Martin said at the MoffettNathanson Media & Communications conference in May. “If that means you could grow the overall pool of subscribers — because aggregate bundles of networks are being bundled in a way that subscribers like better, so there will be more subscribers — we’ll be fine.”

So far, some have already begun the process of weeding out less watched channels. In February, NBCU shuttered its crime-oriented Cloo network, a month after it had said it would shut down the linear version of Esquire Network, its joint venture with Hearst. Esquire is now available as a digital-only network.

Rise of the ‘Loser Bundle’
It looks as if the “loser bundle” — a term for a package of channels minus the broadcast networks and sports, first coined by BTIG media analyst Rich Greenfield in 2016 — is coming closer to reality.

Networks are also changing the way they look at their audiences. At the same conference, Martin said Turner wants “fans, not viewers,” seeking deeper engagement with, perhaps, a smaller audience.

That mantra is being sung by programming chiefs from Disney — ESPN is launching a direct-to-consumer offering later this year, and will revamp its flagship SportsCenter programming in August to include more updates and exclusive digital content — to Viacom and the Discovery Channel. Viacom CEO Bob Bakish said the programmer was in “very advanced discussions” to be part of a sports-free streaming entertainment package that would retail for between $10 and $20 per month.

At the Sanford Bernstein Strategic Decisions conference in New York last week, Discovery Communications CEO David Zaslav again called for the need for an $8 to $10 monthly video package, without sports channels, similar to what is offered in Europe.

“The rest of the world is a full bundle, a sports bundle, sometimes sports intertwined with a full bundle, and then a skinny bundle,” Zaslav said at the conference. “I believe we will ultimately get there.”

That is a big change from just seven years ago, when programming executives were scoffing at SVOD and OTT upstarts for chasing “digital dimes.” Now, a programming executive without a clear, coherent on-demand and over-the-top strategy is risking a loss of potentially big revenue.

Affiliate fees and retransmission consent are under pressure because of consolidation. And advertising — the other source of network revenue – is under siege as ratings continue to decline.

That could change next year for two reasons: the proliferation of better audience measurement across devices and the carriage renewal cycle. With another year under its belt, the measurement industry may get a better handle on tracking those elusive millennials as they surf between traditional TV, tablets, phones and online viewing. And more importantly, some bigger carriage renewals will come due in 2018 as well.

Eagan noted that AT&T purchased DirecTV in 2015, which could mean that some three-year carriage deals for the largest multichannel video-programming distributor in the country will be negotiated.

“As we get into 2018, a lot of these negatives will start to soften,” Eagan said.