Barron's: Don't Touch That Dial
By Alexander Eule
(FROM BARRON'S 8/5/13)
Netflix is having a good summer. The Internet streaming service garnered
14 Emmy nominations last month, including a Best Actor nod for House of Cards
star Kevin Spacey. Four days later, the company announced that U.S. subscribers
to its video-streaming service hit 30 million.
Netflix shares (ticker: NFLX) are up 170% on the year, making them the
best performer in the S&P 500. But it's the future of TV that investors are
really excited about, and Netflix is not shy about putting itself in the center,
declaring on its Website, "Over the coming decades and across the world,
Internet TV will replace linear TV . . . . As Internet TV grows from millions to
billions, Netflix is leading the way."
The hype is overdone. Netflix may be posting banner numbers, but so is
"linear TV," the traditional sort carried by cable and satellite providers. In
the U.S., advertisers bought a record $63 billion worth of TV time last year,
according to data from IPG unit Magna Global. Cable and satellite took in $97
billion in subscription fees in 2012, or 44 times Netflix's streaming revenue.
And TV content has never been more valuable. Pay TV providers handed over $43
billion last year to content owners like Walt Disney (DIS), Viacom (VIAB), and
CBS(CBS), according to SNL Kagan. All told, the TV ecosystem brought in a record
$160 billion last year, per industry data compiled by Barron's.
Those who argue that television is ripe to be upended by new technology
often compare it with the music industry. But music was distressed at the time
Steve Jobs and Apple (AAPL) effectively took over distribution with iTunes.
Having been seriously wounded by file-sharing, the industry had little to lose.
Not so the cable companies and content providers. "I think both sides
realize they can lose a lot more than either can gain by defecting," says Andrew
Frank, a media analyst for Gartner, the technology research firm.
For now, though, investors are buying into the bullish vision of Netflix
CEO Reed Hastings, who says Netflix will eventually enlist 60 to 90 million U.S.
households for its streaming service. "We believe that consumers want to watch
how, where, and when they want," a Netflix spokesman tells Barron's. "And
they're getting more options all the time for doing that."
It's not as if the cable companies, which are also the country's largest
broadband providers, don't see the Internet coming. Last year, Comcast (CMCSA)
began rolling out a new system known as X1. The interface takes the best aspects
of Netflix's interface, including thumbnail graphics to represent individual
shows and movies. The company has made other common-sense improvements. The
remote's "last" button now displays a row of nine thumbnails on the TV screen,
offering a choice of the viewer's most recent channels. About half of Comcast
subscribers have the new interface, which is already helping them find more
X1 users are viewing 20% more video-on-demand content, says Neil Smit, the
CEO of Comcast Cable. "We've disrupted ourselves so we can innovate faster," he
And yet, investors seem to think innovation is the sole domain of
disrupters like Netflix and Amazon.com (AMZN), which sells its own streaming
service as part of its $79 annual Prime membership plan.
Netflix shares trade at a seemingly untenable 105 times earnings estimates
for the coming year. While traditional TV stocks have soared above their credit-
crisis lows, they still look cheap by comparison, particularly Comcast and
Viacom, which owns Nickelodeon, MTV, and Comedy Central.
Given its growth prospects and national footprint, Comcast, which traded
last week at $46, could have upside of 20% or more. Dan Chung, the chief
investment officer of Fred Alger Management, likes Comcast, and not only for its
dominant distribution platform. He applauds the company's 2011 purchase of
NBCUniversal, one of TV's big four content owners. Alger bought $175 million
worth of the stock in the first three months of the year, after sitting on the
sidelines for most of 2012.
Comcast trades at 17 times earnings estimates for the year ahead. That
compares with a prerecession price/earnings multiple of 30. Based on enterprise
value to earnings before interest, taxes, depreciation, and amortization a more
traditional metric for cable the shares are similarly discounted. Comcast could
be worth $56.
On the content side, Viacom carries the cheapest price tag. After ranging
from 16 to 20 times before the recession, Viacom's forward P/E is less than 14.
Investors are worried about declining ratings for Nickelodeon, the company's
children's channel. But the company says measurement data are not yet accounting
for views on new platforms like tablets and smartphones. Cable companies will
eventually have to pay more for Viacom's content, a fixture in households with
young children and teenagers. (Meanwhile, Amazon recently outbid Netflix for
streaming rights for popular kids shows like Dora the Explorer and
SpongeBobSquarePants for its Prime Instant Video service.)
Viacom has noted that its channels get up to 20% of TV's eyeballs but
average less than 10% of the licensing fees. As the gap closes in the coming
years, its shares should get more credit from Wall Street. At 16 times 2014
earnings, the stock is worth $86, 16% above a recent price of $74. In the
meantime, Viacom continues to use its free cash flow to buy back stock. The
company has reduced its share count by 27% since 2007, a theme we noted last
year in "Viacom's Latest Cable Hit: 'The Big Payout,' " Oct. 8, 2012.
Needham & Co. analyst Laura Martin has studied the pay-TV ecosystem
extensively. In a recent report titled The Future of TV, Martin sees 21st
Century Fox (FOXA) as the best-positioned content player. Following its split
from News Corp. (which publishes Barron's), Fox is a pure-play content firm. The
company is planning to launch a 24-hour sports channel, Fox Sports 1, on Aug.
17. Martin thinks Fox Sports 1 will take viewers from ESPN, just as Fox News did
from CNN. She has a price target of $36 for Fox, 15% above its recent close.
There are plenty of other ways to play pay-TV's continued dominance. Time
Warner Cable (TWC), cable's second-largest player, could benefit from a new wave
of industry consolidation, either as the acquirer or the acquired. Cable pioneer
John Malone has expressed interest in buying Time Warner Cable through his 27%
holding in Texas-based Charter Communications (CHTR), which is smaller but
faster-growing than Time Warner Cable.
In the first quarter of the year, there were $4.9 billion worth of cable
deals, with buyers paying an average of $4,934 per subscriber, according to
SNL Kagan. That's the highest figure since 2000.
For several years, the satellite providers Dish (DISH) and DirecTV (DTV)
have been taking share from cable companies, insulating them from the
cord-cutting talk. Ironically, though, it's the satellite companies that have
the most to lose if consumers do cut the cord. Unlike cable, satellite firms
don't have broadband pipes to fall back on. Satellite technology limits data
transmission. In the long run, that makes them a risky proposition.
"The changing nature of television is not a new subject," says Irwin
Gotlieb, the chairman of GroupM, the parent group for WPP's media agencies, and
the world's largest buyer of TV ads. "I don't think any medium has had its death
predicted for as long as television has."
Just a year ago, Apple was viewed as the disrupter of the future, as
investors awaited the imminent launch of an Apple television. Analysts predicted
the same game-changing impact the iPod and iTunes had on music and the iPhone
had on wireless. Shortly before he died in 2011, Steve Jobs famously told his
biographer Walter Isaacson that he had a revolutionary plan for television. "I
finally cracked it," Jobs said.
Jobs' vision seems increasingly unlikely, though the media can't seem to
let it go. Just last month, reports had Apple in discussions with TV players
about a new set-top box that would enable consumers to skip commercials. Apple,
the rumor had it, would compensate programmers for the lost ad revenue. "Dead on
arrival," is how one senior executive at a big content company described the
proposal. "I guarantee that goes nowhere," he told Barron's.
The economics tells the story.
Even Apple, with its $150 billion in the vault, would struggle to cover
the lost TV ads. The $63 billion advertisers paid last year comes out to about
$545 per American household, or $45 every month.
"We have an ecosystem where advertising pays for a significant portion of
the total cost of content production, and if you were to take that away, the
consumer doesn't have the wherewithal to offset the difference," says GroupM's
Craig Moffett is a veteran cable analyst who recently left Bernstein to
start his own firm. He says, "A lot of what you read about over-the-top video
and the reinvention of TV amounts to wishful thinking rather than real analysis.
It gets wrapped in fancy rhetoric about more choice and more viewer control and
being able to watch whatever you want to watch whenever and in any location. But
if you scratch the surface behind those high-minded ideals, what people are
really saying is we wish TV was cheaper."
Moffett, who now runs Moffett Research, adds, "I think it pays to start
with economics rather than the technology. Technology can support all sorts of
cool stuff. It's the economics that's the impediment."
And content owners and cable companies aren't going to roll over for
anyone, including one another. For example, on Friday afternoon, Time Warner
Cable dropped CBS from its system, the latest move in an ongoing dispute. The
fight is over how much Time Warner Cable should pay to carry the CBS network, a
feed that is still free over the airwaves.
Day Quarter Consensus Year Ticker
Vornado Realty Trust 2Q $1.21 $0.96 VNO
Twenty-Frst Cnt Fx A 4Q 0.34 0.32 FOXA
Regeneron Pharm 2Q 0.87 0.70 REGN
FirstEnergy 2Q 0.54 0.60 FE
Cognizant Tech Sol 2Q 0.97 0.82 CTSH
Davita Hlthcre Part 2Q 1.84 1.49 DVA
CVS Caremark 2Q 0.96 0.81 CVS
IntercontinentalExch 2Q 2.15 1.95 ICE
Disney (Walt) 3Q 1.02 1.01 DIS
Health Care Reit 2Q 0.92 0.89 HCN
Spectra Energy 2Q 0.32 0.33 SE
Archer-Daniels-MdLnd 2Q 0.44 0.38 ADM
Sempra Energy 2Q 1.31 0.79 SRE
CF Industries Holdg 2Q 7.64 8.71 CF
Marathon Oil 2Q 0.71 0.59 MRO
Parker-Hannifin 4Q 1.97 1.96 PH
Emerson Electric 3Q 0.98 1.04 EMR
Dominion Resourcs 2Q 0.65 0.59 D
AMETEK 2Q 0.52 0.47 AME
CenturyLink 2Q 0.67 0.65 CTL
EOG RESOURCES 2Q 1.73 1.16 EOG
Ralph Lauren 1Q 1.94 2.03 RL
Green Mt Coffee Rstr 3Q 0.76 0.52 GMCR
Time Warner 2Q 0.76 0.59 TWX
Duke Energy 2Q 0.94 1.02 DUK
Marsh & McLennan 2Q 0.67 0.61 MMC
Prudential Fin'l 2Q 1.99 1.32 PRU
Mondelez Intl 2Q 0.34 0.68 MDLZ
Devon Energy 2Q 0.95 0.55 DVN
T-Mobile US 2Q 0.08 0.82 TMUS
Progressive 2Q 0.41 0.20 PGR
Priceline.com 2Q 9.38 7.85 PCLN
Scripps Ntwrks Inter 2Q 1.05 0.93 SNI
Monster Beverage 2Q 0.64 0.59 MNST
BEAM Inc 2Q 0.60 0.58 BEAM
(Earnings are diluted and report dates are tentative. All forecasts and
historical numbers exclude extraordinary items by accounting definitions.)
Source: Thomson First Call
Day Time Consensus Est Last Period
T 8:30 June International Trade -$43.5 bil -$45.0 bil
W 3:00 June Consumer Credit $15.0 bil $19.6 bil
F 10:00 June Wholesale Inventories 0.3% -0.5%