Good afternoon,
The Medium identifies a few key trends each fiscal quarter that reveal the most important tensions and seismic shifts in the rapidly and dramatically changing media marketplace. The key trends help you answer a simple question: "What's next for media, and where's it all going? How are the pieces lining up for business models to evolve, succeed, or fail?"
Read the three key trends The Medium will be focused on in Q3 2023. This essay focuses on "Legacy media companies are throwing in the towel on their bets to own the consumer relationship in streaming and beyond."
In last month’s “The Daisy or The Flywheel?”, I wrote about how the consumer's needs in the retail/direct-to-consumer model are far more multivariable and complicated to be served by *only* a streaming service, or only a news subscription.
The Publisher of The Athletic has previously explained The New York Times (NYT) bundling strategy with a diagram of a daisy. The diagram starts with a core value proposition — news from the NYT — and then builds out complementary services for which subscribers will pay a marginal subscription fee. Subscribers may sign up for only one of those services (e.g, Cooking or Games), or multiple. I also discussed AMC Networks as an aspiring daisy model.
Disney and Sony anime subsidiary Crunchyroll have business models that can be explained by a “flywheel”, or a connected ecosystem of businesses where improvements in one business segment can help to boost the performance of other business segments. The flywheel is a growth model popularized by Walt Disney’s famous 1957 multispoke diagram.
In recent quarterly reports, we learned more about how both the daisy and the flywheel models are evolving. Both AMC Networks and the NYT shed valuable new light on their respective pursuits of daisy models. Also, Disney’s ESPN partnership announcement with Penn Entertainment this week shed new light on its ongoing attempts to reimagine its famous flywheel with direct-to-consumer models.
Key Takeaway
It is rare to receive any clarity on the future of consumer first, retail first business models from media companies. That is why The New York Times' Q2 2023 earnings call was significant.
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AMC Networks
On the previous earnings call in May, CEO Kristin Dolan told investors “it's essential” that AMC Networks evolve into “a more customer-centric organization.” CFO Patrick O’Connell recently told the Gabelli Funds 15th Annual Media and Entertainment Symposium “streaming for us is just one tool in the toolkit”, implying the challenge now is to figure out what the other products — or, in daisy terms, “petals” — should be.
On last week’s earnings call we got some marginally valuable updates to both promises. Total streaming subscribers dropped by 2% to 11 million subscribers, and they offered three explanations. First, a focus on “higher-value subscribers”, a term which they implied in the previous earnings call reflects higher average revenue per user, but also lower churn and less price sensitivity, as Dolan investors earlier this week. Second, they identified those subscribers on promotions who do not subsequently convert to retail pricing, and decided they would allow them to churn out (“promotional roll-off”).
Last, they have focused on expanding the central value proposition of their library. They announced a deal with the Walt Disney Company and Hulu “to resecure streaming rights for a significant number of high-quality titles” that they own. The deal enables AMC Networks “to offer all seasons of shows they had been licensing to Hulu like Fear the Walking Dead, Killing Eve, Brockmire, The Terror, The Son, Preacher, Lodge 49 and others” across its streaming platforms and potentially license them to other platforms as well.
This announcement answers the question I asked last month:
“what does AMC Networks offer digitally that can be at the center of that model that is (1) already generating recurring revenues ($500 million from domestic streaming in 2022) and (2) has a built-in, loyal base of subscribers (11.5 million as of Q2 2023)? Because AMC historically and purposefully has not invested in building its own content library…”
Their newfound, retail-first corporate mentality seems laser-focused on expanding the value of its content library across seven streaming services (and five linear channels). It remains to be seen whether this will lead them down a path to building out a "daisy" of complementary services beyond streaming.
It is also worth noting that the Hulu deal was cash flow positive. They also announced “future cash payments were accelerated and paid in the second quarter”, resulting in free cash flow being up 380% year-over-year for the quarter. That helped to tell a story of profitability at a time when inventors are hungry for it. But the stock price has been flat since earnings.
The New York Times
I wrote last month that “The New York Times is unique in telling a story that, as circulation declines, consumers are still spending money within its ecosystem and for more services than news.” It tells that story through a unique slicing and dicing of average revenue per user (ARPU), calculated over a 28-day billing cycle during the applicable quarter. Management announced that it is now reporting three mutually exclusive digital-only subscriber categories — bundle and multiproduct, news-only and other single-product — “which collectively sum to total digital-only subscribers, as well as the average revenue per user for each of these categories”.
That is a helpful change from its recent annual report, where it reported 10.26 million digital-only subscriptions and also reported 11.55 million digital-only subscribers across the three digital-only subscription tiers in Q4 2022. CFO Will Bardeen explained on this week’s earnings call that a metric they had been using — digital-only subscribers with news — had been causing the confusion:
"To make it easier for investors to understand the key dynamics that are driving changes in total ARPU, we are breaking out digital subscribers and ARPU into three mutually exclusive categories, bundle and multiproduct subscribers, news-only subscribers and other single product subscribers...."
“With this change, we will no longer report digital-only subscribers with news as a separate metric. We are now disclosing news-only subscribers and all of our bundled subscribers as well as the vast majority of our multiproduct subscribers pay for access to the news product. So the sum of subscribers in these two categories serves as a good proxy.”
Previously their three buckets had been:
Subscribers with a digital bundle or paid digital-only subscriptions that includes access to two or more of the Company’s products, including through separate standalone subscriptions.
Subscribers with a paid digital-only subscription that includes the ability to access the Company’s digital news product.
Subscribers with a paid digital-only subscription that includes the ability to access The Athletic.
Management also explained the new accounting behind the change in their Q2 2023 earnings release:
“Prior to April 1, 2023, we allocated bundle revenue first to our digital news product based on its standalone list price and then the remaining bundle revenue was allocated to the other products in the bundle, including The Athletic, based on their relative standalone list prices. Starting April 1, 2023, we allocate 10% of bundle revenue to The Athletic based on management’s view of The Athletic’s relative value to the bundle, which is derived based on analysis of various metrics.”
And, on the expense side:
“Prior to April 1, 2023, we allocated to NYTG and The Athletic direct variable expenses associated with the bundle, which include credit card fees, third party fees and sales taxes, based on a historical actual percentage of these costs to bundle revenue. Starting April 1, 2023, we allocate 10% of product development, marketing and subscriber servicing expenses (including the direct variable expenses referenced above) associated with the bundle to The Athletic, and the remaining costs are allocated to NYTG, in each case, in line with the revenues allocations.”
The most notable development was the success of its bet on The Athletic as a product, or “petal”, to replace its disbanded New York Times sports department. Subscribers grew by 370,000 to 3.64 million, up 215% since Q2 2022, and up 11% from Q1 2023. Revenue also grew, up almost 9% from the previous quarter and up 55% year-over-year. They also reduced operating losses by one-third from $11.6 million in Q1 to $7.8 million in losses in Q2, and down 40% year-over-year from $12.6 million in losses in Q2 2022.
The overall takeaway is that the details of the daisy strategy were still being worked out until management decided to double down on The Athletic last month. Now, the daisy model has a working model into which we have some insight. The bar they have set for it is to grow total subscribers on the bundle from the current level of 33% of its current of 10 million subscribers to more than 50% of the bundle.
ESPN, Penn, & The Disney Flywheel
The ESPN-Penn announcement brings to mind something I wrote in my recent Medium Shift column for The Information: “Disney doesn’t have a great record of success from investing billions in digital media ventures for its post-linear future.” That means its attempts at adding retail-first digital media businesses to its nearly 70-year-old flywheel have fallen short.
Even though sports betting is a digital retail business, ESPN Bet will be operated by Penn. Penn is licensing the ESPN brand and ESPN will promote the sportsbook to its massive audience across platforms.
For this reason, the deal seems to have more in common with AMC’s focus on building out content offerings than on improving ESPN’s direct-to-consumer business. As Disney’s press release states, “Penn Entertainment will receive odds attribution, promotional services inclusive of digital product integrations, traditional media and content integrations, and ESPN talent access, among other services that collectively generate maximum fan awareness of ESPN BET.”
But, on the other hand, there is one key difference: ESPN will be earning cash instead of burning cash. Penn has agreed to pay $1.5 billion over 10 years to ESPN, and ESPN will also get $500 million of warrants to purchase 31.8 million Penn common shares that vest over the same decade-long period, bringing the deal total up to around $2 billion.
There do not appear to be any deal terms related to consumer data — it is simply ESPN’s brand stamped on Penn’s sportsbook. The upside to that outcome may be limited, as Peter Kafka wrote for Vox yesterday:
On the other hand, ESPN, which used to own sports completely in the US, doesn’t anymore… And this deal can be seen as another indicator of [ESPN’s] reduced status. This afternoon, I asked gambling and media executives why ESPN hadn’t made a deal with more established gambling companies, either old-school brands like MGM or new digital leaders like DraftKings and FanDuel. Their answer: Those guys didn’t need ESPN to thrive in sports betting. And they certainly wouldn’t rebrand their existing sports betting operations with ESPN.
So ESPN does not appear to be getting any smarter about its DTC consumers from its deal with Penn. That seems short-sighted: ESPN+ has relied heavily on the Disney+ bundle with Hulu to grow its subscriber base, and it lost subscribers in Disney’s FY Q3 2023. It needs another offering at a time when Disney management is increasingly promising investors a future where ESPN goes 100% direct-to-consumer. But, in the face of cord-cutting and under-performing streaming business, ESPN needs cash. Effectively, the deal is neither a flywheel nor a daisy.
The Incremental Lessons
The media business is rapidly and dramatically changing. There has not been much clarity as to where the shift from wholesale to retail models will play out, and which retail models make sense, if at all.
For this reason, I think the most notable detail from the quarter was the decision by the NYT to allocate 10% of revenues and expenses from the bundle to The Athletic. Because we now have a clear signal for how management values The Athletic as a “petal” within its daisy model. The valuation is both subjective (10% of costs and revenues) and objective (derived based on analysis of various metrics). But they are also not saying that each petal of the daisy is worth 10% to the business.
It is rare to have this type of clarity from any company in the media marketplace. It offers a helpful precedent for understanding similar moves by other media companies in the coming fiscal quarters. AMC Networks may or may not ultimately invest in building out additional products for consumers beyond a library. Or, if ESPN ultimately will invest in direct-to-consumer in the ways it has promised to investors. But now we now have a valuable reference point for understanding the economics of their model if they do.