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The Medium delivers in-depth analyses of the media marketplace’s transformation as creators, tech companies and 10 million emerging advertisers revolutionize the business models for “premium content”.
Each fiscal quarter, The Medium identifies three or four new trends that have momentum and seem poised to play out at a larger scale in 2023. These key trends pinpoint dynamic and constantly evolving developments in the media marketplace that are emerging from incremental shifts or fundamental changes. The bi-weekly mailings analyze these trends as developments emerge in real-time.
Read the three key trends The Medium will be focused on in Q4 2023. This essay focuses on "In the shift from wholesale to retail models, there are many business models that delight consumers but no single, dominant one."
Author's Note: Due to time constraints, there are no curated Must-Read Monday AM Articles today. Apologies for any inconvenience.
This has been a brutal quarter in broadcast and cable TV advertising. Q4 2023 is shaping up to deliver more of the same. Warner Media CEO David Zaslav went as far as admitting on their Q3 earnings call that “we don't see when this [advertising marketplace] is going to turn”. Warner Bros. Discovery saw linear advertising revenues drop 12% year-over-year, and Paramount Global saw linear advertising revenues drop 14%. Disney CEO Robert Iger reported linear advertising “a little bit stronger than we had expected it would be” but “it's not back as much as we would like.” They did not break out their numbers.
As a result, two questions are starting to grow in urgency:
Do synergies still exist between the broadcast and cable assets within these companies? And,
Do synergies exist between broadcast and cable assets across these media companies?
The Wall Street Journal reported Disney “has explored potential sales and discussed putting some of its TV networks into A+E Networks, its joint venture with Hearst”. An internal review found that “Freeform and the National Geographic channel are less critical to Disney’s future”, and notably both channels were dropped in the recent distribution deal with Charter. Friday’s CNBC interview with Liberty Media Chairman John Malone (transcript excerpts here) also generated a lot of speculation about synergies between companies. Paramount Global may need a merger partner sooner than others after Malone listed it as facing “very serious distress” because it “didn’t leverage prudently”.
This emphasis on staff, programming and marketing efficiencies via synergies is the way the media business has always considered “synergy” in broadcast and cable. But, the cost-cutting is starting to appear more drastic as negative cord-cutting and advertising force greater efficiencies in the model across the board.
In listening to Malone’s interview the question is whether his definition of “synergy”—and therefore the market speculation around potential mergers—is too narrowly focused on the economics of cable distribution and not internet distribution.
Key Takeaway
Liberty Media Chairman John Malone argues free cash flow is “dry powder” is to drive future corporate synergies in the linear world. But that seems self-defeating in the DTC world, where that dry powder could drive the smarter build-out of streaming and gaming businesses. This reflects how there are two conflicting rationales for corporate synergies emerging in media.
Total words: 1,200
Total time reading: 5 minutes
Revisiting “The Smart Guys Are Getting It All Wrong”
In August 2022 I wrote “The Smart Guys Are Getting It All Wrong”. Malone had argued then in an interview with The New York Times that scale and “great films and great TV shows” were Warner Bros. Discovery’s competitive advantages (Malone sits on its board). I argued that he misunderstood that ”the real challenge for media companies is that profitability and customer retention require as robust an understanding of consumers as possible.” Also, Malone displayed “a fundamental lack of concern about whether great content may actually reach the consumer in a DTC world.”
Fifteen months later he has changed his tune… somewhat. Regarding creative, Warner Bros. Discovery can only be successful by creating unique content that is not available to Netflix or on Netflix.” The examples he gave were “Barbie” and “Lord of The Rings”, both of which were creative verticals “driven by the fact that they create exclusive uniqueness”.
As for scale, he dialed down his bullishness. Instead, he cited the cable precedent of cable channels Showtime and Starz that “never got to the scale of HBO but they got up to 65-70% of the distribution.” If Warner Bros. Discovery can scale Max to 65-70% of Netflix’s distribution—it is currently closer to 38%— they can be “successful and sustain” second or third position in the marketplace, perhaps fourth.
Private Equity Logic
Both points read outdated in a marketplace where Netflix offers more than 50 exclusive mobile games and is developing a major-publisher-type console game. Also, Sony-owned anime streamer Crunchyroll just announced a similar mobile gaming strategy to Netflix. Deputies of Disney CEO Robert Iger are advocating for a deal to buy Electronic Arts and pivot Disney’s business “from gaming licensee to gaming giant.” As I wrote on Thursday, gaming is now a key sales pitch to Warner Bros. Discovery investors because of its EBITDA ($400 million over three years), its 11 “world class studios” and “unique position” as both a developer and publisher of games.
The new market reality for media companies is that "creative verticals with unique content" now need to put out more than just movies and TV shows to capture subscribers. Malone's rationale misses that and therefore reflects the ultimate problem with the logic of pushing for corporate “synergies” in this marketplace: Synergies either solve for distribution or they solve for DTC but they do not solve for both.
To rephrase this point in terms of earnings before interest, taxes and debt (EBITDA), the best use of earnings could be to pay down debt with steady but declining cash flows from a bundle of cable networks. Or, the best use of available cash could be to invest in creative verticals that succeed across third-party distribution platforms or first-party streaming and gaming platforms. But investors are increasingly struggling to understand why a media company needs to leverage EBITDA for both approaches simultaneously, something Warner Bros. Discovery management learned from its 17% decline in stock price after its earnings call last week.
Something’s Got To Give
Malone predicted that media companies who have balance sheets with “a lot of reasonably near term maturities” in debt “are going to be in trouble.” Therefore, “historically the right thing for a business to do in distress is survive, and if they can take advantage of the distress, focus on what they do with their free cash flow, what they do with dry powder and try and figure out how to take advantage of distress because out of distress usually comes the reduction and competition, increased pricing power, and the opportunity to buy assets at a deep discount.”
From a private equity standpoint, this approach makes a ton of sense. Synergies across mature businesses create shareholder value and cash flow by cutting costs against slow or slowed revenues. But, from a DTC growth model perspective, Malone's perspective is self-defeating. As Netflix and Crunchyroll have proven, growth in the DTC model requires both a consumer first, retail first relationship with the consumer and the resources and abilities to evolve that relationship in real time. EBITDA needs to be allocated toward that objective, and arguably only toward synergies across DTC businesses in order to drive growth. Both cannot be pursued simultaneously.
This points to what may be the biggest flaw in Malone’s thinking: It becomes harder to evolve growth businesses as EBITDA is spread across contradictory business objectives. To Warner Bros. Discovery management, “Games will be even more important to our fans in the future” and “a critical differentiator and a real growth opportunity.” It is crucial to the DTC business. But, to Malone, its $400 million in EBITDA over the past three years is a source of “dry powder” to take advantage of “the opportunity to buy assets at a deep discount” in the next two years.
Is that the best use of cash for shareholder value as sophisticated offerings like Netflix and Crunchyroll find growth while Max lost 2.7 million subscribers over the past two quarters? The answer at Warner Bros. Discovery, Netflix and Crunchyroll seems to be "No."