Member Mailing #288: Why Growth in Streaming May Be Too Expensive for Shareholders
Key Takeaways
Both Netflix's and Spotify's recent pivots create a stark contrast to legacy media companies doubling down on streaming.
After user growth plateaued in 2021, higher content spend may be increasing their execution risk and not solving for it.
Through the lens of growth, higher content spend also creates additional risks to future profits.
The growth stories of legacy media streaming services increasingly reflect long-term risks from higher content spend.
In October, Spotify doubled on down on its investment in Anchor by making it more creator economy-friendly, opening it up to video podcast uploads for all podcast creators. But the move was an additional pivot away from its more Hollywood talent-centered approach to podcasts, to date.
It also recently pivoted its in-app video platform towards TikTok-like music videos.
So, now, Spotify has expanded its platform beyond music and podcasts, and has begun "converging" multiple formats and business models within its platform.
Netflix's launch of gaming within its mobile streaming app and its recent acquisition of VFX studio Scanline Studios also reflected convergence, though more narrowly of both gaming and virtual production into its content production and distribution models.
These were both pivots towards "post-streaming wars" convergence of legacy media, streaming, gaming, audio, e-commerce, and the creator economy.
Both pivots have growth as the objective.
Spotify, in particular, has fundamentally changed its value proposition of distributing podcasts and investing in Hollywood-talent-led podcasts to a much creator economy-focused value proposition of hosting and monetizing podcasts alongside creators.
That expands its target customer base from audio listeners who like music and/or podcasts and adds in creators who want to create audio and video podcasts for Spotify's aggregated user base. The pivot put Spotify in a position to monetize both, as I wrote in A Short Essay on Growth in Hollywood-meets-Creator-Economy.
Netflix's launch of gaming expands its customer base from consumers who stream video on their smartphones to consumers who also may play games casually on their smartphones. Estimates have that consumer base to be as high as 2.2B worldwide.
That said, Netflix's bet on gaming is much more focused on reducing churn and engaging consumers more.
By contrast, in the streaming marketplace, the opposite has occurred recently: despite growing evidence that demand for streaming services has plateaued, legacy media streaming applications are solving for growth by doubling down on their existing value propositions, and increasing content spend.
The backdrop of both Netflix's and Spotify's tactical pivots – both focused on software – creates a stark contrast to legacy media companies doubling down on their streaming strategies. It ends up highlighting how, after user growth plateaued in 2021, legacy media companies may be increasing their execution risk and not solving for it.
Doubling down on streaming... with caveats
I wrote about both Starz and AMC Networks last month in Starz, AMC Networks Reach A "Genre Wars" Crossroads.
Both are doubling down on their respective "genre wars" strategies, but with caveats.
Lionsgate & AMC
After sharing it grew Starz by 1MM subscribers in the quarter, Lionsgate also shared that its Board of Directors authorized management " to explore potential capital markets alternatives for its Media Networks business (STARZ) including, but not limited to, a full or partial spin-off, split-off, issuance of a tracking stock or other transactions."
The rationale, according to the call transcript, was shareholder value:
While we continue to realize substantial synergies from bringing Lions Gate and Starz together, we also see the opportunity to potentially unlock significant shareholder value under a scenario where investors had the ability to value our studio assets and Starz separately. Recent transaction multiples in the media space give us confidence that exploring alternate path is prudent. Additionally, we believe that a number of the structures we're considering will also allow Lions Gate and Starz to preserve many of the operational benefits we're currently achieving within a single corporate structure
It also plans on growing content spend from $1.6 billion to "$2.5 billion-ish".
The caveat is that, despite its success and greater content investment, Lionsgate sees more value for Starz as an independent entity.
AMC Networks CFO Christina Spade shared their predictions for the road ahead:
Our new outlook for the full year of 2021 sets the stage for a strong 2022 and continued proven execution toward our long-term subscriber goals of 20 million to 25 million by year-end 2025. We are reinforcing our plan to grow to at least nine million aggregate paid streaming subscribers by the end of 2021. We have experienced ongoing subscriber growth momentum consistently every quarter, and we are on track to achieve our aggregate year-end subscriber goal for 2021. Streaming subscriber growth continues to be driven by our curated programming investments and supported by strategic subscriber acquisition and retention marketing investments. We will continue to invest to drive future streaming growth, particularly in new original programming, efficient subscriber acquisition marketing and platform enhancements.
The caveat lies in that bullish quote: AMC does not yet have enough content to grow its portfolio of streaming services to 20MM-25MM. They will be getting more soon, according to Spade, but she also implies it is not enough:
As our current deals with Netflix and Hulu expire, we'll have hundreds of hours of high-quality shows and films coming back to us, such as critical hits like Halt and Catch Fire, Turn and Rectify as well as all 11 seasons of The Walking Dead a few years out from now. Great AMC content to be discovered and rediscovered by fans, driving growth and driving value across our portfolio. We see this as a huge area of opportunity that the company is only now beginning to fully leverage.
Lionsgate and AMC Networks are telling investors they have good growth stories, with the caveat that they may not have those stories despite increasing content spend.
HBO Max, Discovery+, Disney
Three other growth stories with caveats emerged in streaming from Q3 that are also worth highlighting.
HBO Max and Discovery+ are interesting for different reasons, though related because both will be merged within the next year.
HBO Max had a DTC growth story – up to 69.4MM subscribers from 67.5MM in Q2 and 56.9MM in Q3 2020 – but a negative quarter for Wholesale subscribers because of a loss of Amazon subscribers.
CFO Pascal Desroches explained on the Q3 2021 earnings call:
...domestic subscribers were down due to our proactive decision to shut down the Amazon wholesale platform. This was partially offset by new wholesale relationships. Retail-subscriber growth slowed down the timing of new content, but we expect retail subscriber growth to accelerate in the fourth quarter due to strong content slate. We have new seasons of success in the Curb Your Enthusiasm debuting, the return of Sex and the City, as well as the much-anticipated premieres of Dune, King Richard and The Matrix: Resurrection.Given our upcoming content slate and expanding global footprint, we expect to end the year at the higher end of our year-end global subscriber target.
Discovery had a growth story, too – adding 3MM subscribers worldwide and reaching 20MM subscribers – but the caveat is it was not about Discovery+, alone (which is in ~20 countries, to date). It offers other apps, which are included in that number: "Food Network Kitchen, GolfTV, MotorTrend on Demand, and Eurosport Player among others".
The implication is that Discovery+ may be growing, but not enough to break out on its own (something a recently launched rebranding campaign implies).
But, arguably the most interesting growth story was Disney's. It grew total subscribers by 5MM between Q2 and Q3 to 179MM subscriptions, but added the caveat in the FY Q4 2021 earnings call:
I want to reiterate that we remain focused on managing our DTC business for the long-term, not quarter-to-quarter, and we’re confident we are on the right trajectory to achieve the guidance that we provided at last year’s Investor Day - reaching between 230 and 260 million paid Disney+ subscribers globally by the end of fiscal year 2024, and with Disney+ achieving profitability that same year.
It is not the most confident assurance to investors after a quarter where Disney only grew by 2.1MM subscribers from the previous quarter.
But it is an assurance.
What makes Disney particularly interesting is a recently released 10-K for FY 2020 and a recent article from Puck's Dylan Byers (highlighted in Monday's Mailing).
In the 10-K, it disclosed it spent $25.3B on produced and licensed content (which includes sports rights) in 2021, and plans on spending $33B in 2022. The increase of $8B is "driven by higher spend to support our DTC expansion and generally assumes no significant disruptions to production due to COVID-19".
Byers added that CEO Bob Chapek is rumored to be doubling down on Hulu:
A source familiar with Disney’s roadmap says that Chapek plans to budget up to $7 billion annually for Hulu content—a mind-boggling increase from previous annual budgets of $2-$3 billion that would put Hulu spending almost as high as the $8-to-$9 billion that Disney plans to spend on Disney+ content in 2024.
The concern is "Families and superfans are an extremely loyal audience, but the slowdown suggests they’re also a limited constituency."
Putting the two together, increased content spend is necessary but the necessary target audience for growth currently does not buy into Disney's current value proposition.
That is a big caveat with no immediate or obvious solutions. Chapek's bet on Hulu is one potential solution, but with few immediate payoffs.
Growth / The "g"
The doubling down with caveats of Starz, AMC Networks, HBO Max, Discovery+, and Disney echoes some points made by The Entertainment Strategy Guy in You Can’t Split The “G”, an essay from August built upon PARQOR's Curse of the Mogul framework and the concept of Terminal Value, or a calculation of future cash flows.
He wrote:
The challenge right now is that Wall Street sees streaming as a high growth business. The “g” is premised on past tech stocks like Facebook, Google or Amazon.At the same time, nobody is profitable. Meaning studios and streamers are losing cash each year in hopes of that future “g”. The high prices on streaming stocks (Netflix and Disney in particular) are predicated on lots and lots of future growth leading to sky high future profits. (Again, Netflix is profitable in an accounting sense, but not in a cash flow sense.)
And the incentives shift too. Disney, Warner Media and Netflix can make unprofitable decisions, but they will see their stock prices go higher. Again, because an analyst somewhere kicks up the “g”. (To be fair, growth rates aren’t the only way to boost a model, but it’s an easy one.)
Knowing this, using the “curse of the mogul” framework, talent could try to demand a split of future profits. And should. And that’s what Scarlett Johansen is doing. If ScarJo’s movie is being sold on Disney+ in expectation of future profits–meaning lose money now to make more later–she could demand more of that future money.
But, I mean, how? What will that future profit actually be?
That’s the key challenge: in the olden day, a film was immediately profitable. Even if the cash would flow in over a decade or more, everyone knew (within a margin of error) what it would be.
With future discounted cash flows for Netflix, WarnerMedia and Disney? No one knows.
This excerpt highlights an important problem with streaming services making these caveats: it is not only that chasing growth to boost stock price is risky, but that also these caveats reflect additional uncertainty to future profits.
So, the outcome is the pursuit of higher stock prices at the expense of shareholder value, and the caveats appear to create even more risk to shareholder value. In turn, that creates even more execution risk.
WarnerMedia and Discovery are merging under the assumption that additional content spend reduces execution risk because larger libraries will attract more users. But, the implication of these earnings calls and the argument above is that content spend may not be not enough for growth.
Moreover, it implies that more content spend becomes increasingly more expensive to the business and shareholders in the long-term.
Netflix & Spotify
The backdrop of Netflix's and Spotify's pivots both reinforce this point and add valuable color.
The "g" of Netflix's bet is that games can grow engagement, as it told investors in its Letter to Shareholders from Q3 2021 (which I wrote about in October in After Q3 2021, Does Netflix Have the AVOD Model In Its Sights?).
We are still quite small, with a lot of opportunity for growth; in our largest and most penetrated market, according to Nielsen, we are still less than 10% of US television screen time. Our approach as always is to improve our service as quickly as we can so that we can earn a greater share of people’s time.
Games help them accomplish that.
As for Spotify, I wrote about them in A Short Essay on Growth in Hollywood-meets-Creator-Economy back in September. Something CFO Paul Vogel said in the Q3 2021 earnings call is worth highlighting on this point:
I think we often get lots of questions on the podcasting side of the monetization side and the revenue side. But Anchor, which was an acquisition of ours about 2.5 years ago or so, three years ago. There's been a huge boost to the growth in podcasters and creators on the platform. So over 80% of new podcasters on our platform are using the Anchor platform and our understanding is that Anchor has about 50% market share across the entire podcast industry in terms of usage. It's been a huge help and a huge driver to the creators in the creative process.
CEO Daniel Ek told investors on the same call that "the biggest impact on Q4 will just be continued growth in podcasts and in inventory".
The notable difference between how Spotify and Netflix define growth is how each defines their target customers. Netflix is still defining growth through subscribers, only. Even with gaming, it faces similar questions to other streaming services, though with better marketing and better technological back-ends.
But Spotify has expanded its definition of growth by expanding its definition of customers beyond free users and subscribers to include podcast creators and advertisers. It can monetize all of them.
The "g" for Spotify has exponentially more paths to profitability than any video streaming service, including Netflix. That is, on its face, a better deal for shareholders than a legacy media company.
Spotify seems like an important, if not ideal, point of comparison and contrast for evaluating growth in streaming going forward.
Conclusion
The market shock of 2021 was the pull-forward impact of the pandemic. The obvious implication of a pull-forward impact is either streaming growth slows down, plateaus, or ends altogether.
There is evidence for all of these scenarios, and no convincing evidence that we are witnessing one more than another.
But, the pivots of Netflix and Spotify imply that we should be looking at and thinking about growth in streaming differently. I have touched on this previously in A Short Essay on Growth in Hollywood-meets-Creator-Economy, when I quoted something Spotify CEO Daniel Ek told investors on the FY Q2 2021 earnings call:
the platform we are building is all about moving from 8 million to 50 million creators and from 400 million to more than 1 billion users on our platform. For each improvement, we will turn more listeners into super fans, give voice to more types of creators and offer users multiple of ways to interact and engage with the talent they love. When we connect creators at every stage with fans around the world, our flywheel moves faster and faster, unlocking even more potential growth. We are still early in moving linear radio to on-demand audio, which just goes to show the growth opportunity still out there is significant.
No streaming service is close to building a flywheel. Even Disney CEO Bob Chapek has been selling investors on a theoretical flywheel between Parks and Streaming:
a tremendous amount of information on our consumers from our parks business and what would happen if we married that and actually mine that data to help people subscribe to Disney+ knowing what we know.
It sounds great, but it is also a conditional statement built upon "what would happen if".
So, the backdrop of Netflix and Spotify focusing on investing in and evolving their software ends up raising a surprising red flag about increased content spend in streaming. Because Netflix and Spotify are creating more content for their platforms as a by-product of their investment in software, and at an exponentially lower cost than media companies investing in new content.
An investment in new software is a sunk cost with minimal marginal costs associated with management and updating. But as Disney's planned 30% YoY increase in spend reflects, content investment is the same sunk cost annually and growing.
Legacy media companies seem to be wasting both capital and shareholder value on an inefficient business model, an increasingly undefined target customer, and an increasingly uncertain terminal value. That is not immediately evident, but it is a logical implication of a continued plateau in streaming subscribers.
This market plateau has exposed how the ambition of legacy media businesses to evolve into software businesses is less a growth story, and increasingly a story about growing long-term risks from increased content spend.