Who Will Win the Streaming Wars? (It may not be investors)

With the launch of both Disney+ and AppleTV+ this month, the streaming wars have officially kicked into high gear.  These two new challengers are joining Netflix, Amazon Prime, YouTube, CBS All Access, and Hulu, among others.  More competitors will be launching next year including NBC's Peacock, and AT&T's HBO Max services. With this massive clash of the titans about to take place, I think it is only natural to wonder who is going to be the eventual winners and the losers of the upcoming battle.

Potential Financial Rewards

Of course as investors we obviously want to know who will win, as there are enormous potential financial rewards for being able to pick the winners (spoiler alert: I don't know who is going to win, though I do have some ideas on who has a better chance).  But even if we can't figure out who the eventual winner will be, I think we can learn something by taking a look at the industry and thinking about the businesses themselves. Although all of these companies essentially are providing a streaming service that looks and feels pretty similar across all platforms, the companies themselves are vastly different and how they've chosen to approach streaming has often been quite different.

Netflix is the closest thing to a pure streaming company. It is the pioneer in streaming and it derives almost all of its revenue from subscriptions.  In contrast, the tech companies, Apple (AppleTV+), Amazon (Amazon Prime), and Alphabet (Youtube) likely see their streaming services as a compliment to their existing businesses or as an enhancement to them to try and retain and engage their customers.  As such they might not be as concerned about making a profit on streaming alone, as long as their streaming customers drive profits at the other aspects of their businesses.  

HBO (HBO Max), DIsney (Disney+), CBS (CBS All Access), and Comcast (Peacock) are more traditional media companies who are focusing on streaming out of self preservation. Their customers are becoming more and more likely to 'cut the cord' and get rid of their cable packages in favour of streaming services.  In order to avoid losing these customers, the traditional media companies need a competitive streaming option. What has come with all of this competition is tremendous amounts of spending.  In the past year these companies have spent over 100 Billion dollars on new content.  That's about the same amount of money that was invested in America's oil industry in 2019.  And that doesn't even include the cost of acquisitions and mergers, such as Disney's purchase of 21stCentury Fox's assets earlier this year.  

Necessary Content

The companies are spending in order to ensure they have the content necessary to compete, and because the potential reward for success is so great, they are willing to spend a lot to ensure that success.  However with that spending comes risk also. Netflix has borrowed billions of dollars of cash over the past few years in order to fund the largest content budget in the industry. That spending has produced very valuable content such as Stranger Things, House of Cards, and Orange is the New Black, as well as a host of feature films, documentaries and other content.  This content makes Netflix subscribers less likely to jump ship.

However, it's unclear whether or not Netflix can maintain the current level of spending long term.  Netflix spent $3 Billion more cash then it generated last year and in order to break even they would need to raise prices substantially.  For every hit show, there are probably two or three duds that don't get any traction. Based on current cashflows, Netflix still needs to grow significantly in order to maintain its current budget. It's unclear if that growth will be possible in a world with so many streaming options available.

Frontrunner in the Streaming World Held by Netflix

Netflix is still the frontrunner in the streaming world though. They have over 160 million subscribers (Disney only hopes to get to 90 million subscribers in 5 years) and they have a global footprint.  As I mentioned, they also have a huge library of content which has been built up over the past 10 years.  Their subscribers are likely pretty sticky as Netflix has done a great job of catering to their subscribers and producing many hit shows and movies.  

A recent poll by CNBC found that only 28% of Netflix subscribers planned to sign up for Disney+ and another poll found that only 11% of viewers who subscribed to Netflix, Hulu, or Amazon Prime thought that they'd drop one of their existing streaming services to sign up for Disney+ or AppleTV+. I tend to think it's unlikely that too many people will cancel their Netflix Subscription to purchase another service, so the fact that Netflix has such a big subscriber lead does give them a big advantage overall.  

Advantage of Global Reach

Another advantage they have is their global reach as they have many subscribers in different countries around the world, as well as country specific content to match. Apple is playing more of a long term strategy as they are offering up AppleTV+ for free for someone who buys an Apple Product.  They also have much less content currently than the other competitors but they are spending to build up their content.  

Some people are speculating that Apple may try and bundle their TV, Music, and news products into one mega service.  Apple should have deep enough pockets to weather any slow start that they might have.  And in pairing with their existing services business, they would create a formidable value proposition to the billions of people who already own Apple products. Apple is off to a slow start but they may surprise people in this space.

Amazon Prime and Alphabet are wild cards in this streaming war.  They have services which aren't necessarily meant to be profitable in and of themselves, but are meant to drive business in their other businesses. For Amazon, the Amazon Prime membership comes with perks for E-commerce, which is of course Amazon's main business. Many subscribers regard Amazon Prime Video as an afterthought which is nice to have but not a key part of their decision.  

For Alphabet, Youtube is almost forgotten in these streaming wars, but the fact is that Youtube has over 1.5 BILLION users that regularly stream videos from its website. Many of these are user created of course but they are also adding in their own paid for content.  YouTube is also dominant for music as many people use it as their primary source to listen to music.  Although Alphabet doesn't disclose how YouTube does financially separate and apart from the rest of their business, it is safe to say that YouTube is a key part of Alphabet's business which also helps to drive more people to Alphabet's search and other businesses.

In Protection Mode

The traditional media companies like HBO, CBS and NBC Universal are more in protection mode than anything else.  HBO has 40 million subscribers to its cable service and since their service isn't changing much under the streaming model, it's safe to say that they are looking more on retaining their existing customer base rather than significantly growing their revenues.  If they remain stuck at 40 million subscribers however, they may find it tough to compete in the spending wars for content, although they are backed right now by AT&T Time Warner, one of the largest companies in the world.  

CBS and NBC are of course traditional TV networks who are being most hurt by cable cutters.  It looks as though NBC's Peacock service may be offered free with advertising, which may be the only competitive route available to them, though they will have old popular sitcoms like the Office and Cheers as well as new shows.  CBS already offers their full library of shows for $5.99 a month with limited commercials, or $9.99 a month commercial free.  They have a number of hits such as the Big Bang Theory and the Star Trek franchise which should draw viewers to them.

An Exception

There is one exception for these traditional media companies though.  Although Disney is suffering from cord cutting, especially on its ABC and ESPN cable channels, Disney also has other means of monetizing their content through their parks, licensed merchandise, and in their film and TV franchises.  So they could conceivably afford to make less money on streaming if they can make it up in other areas by strengthening their brands and franchises.  

Disney also has the benefit of those tremendous franchises which are surefire money makers like Star Wars, Marvel, and their animated classics. They seem to have a hit with their new show The Mandalorian and that has helped them grow to over 10 Million subscribers within only a few weeks of launch.  They are also a movie powerhouse with multiple blockbusters released in 2019 alone. That will no doubt help their subscriber base.

So as you can see there are a LOT of different options for streaming as a consumer (we haven't even covered them all), and there are almost as many different approaches to the streaming business.  I think that the technology companies have compelling synergies with their other businesses, as well as deep pocket books, and that should make them formidable competitors in this space.  

I think Disney has probably been the best at creating content over the years and they too have synergies with their other businesses which will help them do well in streaming.  They are certainly off to a good start.  Netflix probably has enough of a lead in subscribers that they will be able to hold their own in the streaming war. Although I think their current level of spending is unsustainable and will come down, they should still be competitive for years to come.  

This does not mean I think Netflix is a good investment at the current market price.  That price is assuming a lot of growth in subscribers, and I think that is going to be very difficult for Netflix to accomplish.

That leaves the traditional media companies.  I'm a fan of HBO and have enjoyed shows like Sopranos and Game of Thrones over the years. So a part of me thinks they will be able to hold their own, even if they are forced to be selective on what content they spend money on.  There is certainly a risk though that without a substantial international subscriber base, they may have trouble competing in streaming.  Their service is also the most expensive which may hurt their ability to grow and retain subscribers.  

I think CBS and NBC are doing what they can to stay relevant with all of the cord cutting.  However I do think they are going to need to re-invent how they create content, as well as focus on the areas where they have a unique advantage (such as sports perhaps).  As an investor I would be worried about their profitability long term.

One thing is for sure: competition is usually not good for profits.  

If content becomes more commoditized (which is already happening to some extent as nobody could possibly watch all of the good shows that are available to us) then these streaming companies will be forced to cut their prices to remain competitive, and that will shrink their profitability. If that is the case, then investors may be very disappointed in their investments in streaming.  As a passive bystander, I'm getting my popcorn ready to watch how this streaming war will play out, but I'm investing our money in other opportunities.

- Craig White, BA, LL.B., CIM

Craig White is an Investment Advisor at Endeavour Wealth Management with Industrial Alliance Securities Inc, an award-winning office as recognized by the Carson Group. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.

This information has been prepared by Craig White an Investment Advisor for Industrial Alliance Securities Inc. (iA Securities) and does not necessarily reflect the opinion of iA Securities. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.