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Easier to Binge on Content Than Cash Flow

Electronic connectivity has transformed the delivery of entertainment and ignited a new paradigm in content creation and delivery. Many companies are attempting to capitalize on the opportunity, including content aggregators; smartphone and watch manufacturers; social media platforms; and e-commerce companies. With so many players attempting to cash in, we warn that fierce competition in this industry may ultimately benefit customers and early speculators, but not necessarily the broader investing public trying to “catch the wave.”

In this newsletter, we review the history of this subject concluding that more programming than ever is available, on demand, at a reasonable cost to billions of consumers, but we tread carefully as to how we are investing in the sector. Consistent profitability is a key tenant of our Global Core Strategy investment philosophy and helps guide our attempts to separate companies with attractive, long-term investment fundamentals from speculative, thematic “bets” based solely on exciting trends or new technology.

Tech Background and Update

It is startling to think the computing power in today’s $1,000 iPhone is on par with 1972’s $30 million Cray Research Supercomputer. Nearly 4 billion people now have this computing power and more at their fingertips through an internet-connected mobile device. The tech industry is delivering sensational chip power and high-speed access, which will be improved with the   current rollout of 5G wireless spectrum. One side effect of this massive increase in connectivity and computing power is a shift in the profitability dynamics between entertainment-content producers, consumers, and delivery platforms. As we discuss next, technology transformations in the industry are nothing new.

A Look Way Back

Taking a long look at history in this regard, live shows were the only option originally, and we suspect the first thespian was a cave person shadow boxing by the fire on shelter walls. Later, early theater and organized Olympics came along in ancient Greece, but we guess the Olympics were not initially commercialized in part due to their mostly naked participants, which reduced opportunities for ancient sports marketers to sell logoed apparel to the masses.

Throughout more recent history, the push and pull of the power between artist and distributor has been constant as the business transitioned, with technology’s help. As artists across genres had increasing opportunities to be filmed, taped and marketed, “stars” were born and the scales started to tip in the direction of those that controlled content consumers would pay for— millions, sometimes billions, of times over.

The omnipresence of mobile devices in recent years point to a transformative era, much as the emergence of motion pictures, radio and television did in the past. As traditional TV viewing declines and “cable cutting” accelerates, the average American adult has been steadily increasing time spent on mobile devices — to an average of three hours per day at present.

Who Wins? You Do!

With the growth of mobile and “on-demand” content, the tables have turned yet again, favoring content producers, including many self-made stars arising from Instagram, YouTube, TikTok, etc. which allow aspiring performers to bypass traditional entertainment power brokers altogether. At the same time, more control has been placed in the hands of users and technology companies themselves. Smart TVs and phones have turned TV and radio channels into apps with data-collection features that enable instant retrieval of personally-targeted content. Algorithms build further on this by suggesting new artists or movies you should like—to keep you “hooked” longer.

Platforms with different business models like Netflix, YouTube, Disney+ and a host of others have emerged to capitalize on this new dynamic, but in differing ways that have implications for the cash being produced for their shareholders. Netflix, for example, creates or buys enormous amounts of content to attract and retain subscribers, collecting data on millions of users’ preferences along the way. Netflix has been growing revenues at high rates as a result, but is spending heavily to do it. From 2015-2019, net content assets grew by 241%, while paid subscribers increased by 138% in the same timeframe. As a result, Netflix has not posted positive Operating Cash Flow in any of those years, while adding $13.8 billion of debt along the way1.

Platforms such as YouTube have skipped over having to pay heavily for content by allowing users to upload videos for free, and at effectively zero marginal cost. Users stay or return because of the constantly updated and curated content they like. YouTube then uses that data to serve ads and is very profitable. Disney+ has paid heavily to acquire content but has also been able to repackage vast amounts of existing programming for targeted demographics, with the added “flywheel” that can nudge users toward Disney vacations and branded retail items.

To us, performers, content-owners and producers are clear winners as platforms compete to acquire rights and will “pay up” to produce original content that can only be seen by subscribers. Likewise, consumers win as we get more niche content, delivered on-demand, often for “free” (i.e. ad supported) or at least at a lower cost than what folks nearly universally paid for cable TV subscriptions and movie rentals not so long ago.

Transformative Tech Shakeout?

As we foreshadowed initially, we are cautious when investing in an industry that is highly attractive from a consumer satisfaction and revenue growth standpoint, but is so competitive and easy to enter that, ultimately, profits are being “competed” down to $0 (or negative in many cases). Investors interested in this “new media” opportunity set may be tempted to simply purchase an allocation to a fund tracking the performance of an index of media companies, but we warn that patience, combined with selectivity, may be warranted. The Dynamic Media Intellidex Index, for example, is comprised of stocks of 30 U.S. media companies which are principally engaged in the development, production, and distribution of goods or services used in the media industry. Of the 30 stocks in the index, 8 are unprofitable as of their most recent fiscal year, including Spotify, News Corp, Snap Inc, and Liberty Media, among others2. This lack of profitability in the sector during a decade-plus economic expansion and bull market gives us cause for concern – not just for those companies in the index, but for their “healthy competition” that has to compete against unprofitable business models.

Still, we agree there is great opportunity and we already have positions in many of the players we believe are handling the transition to streaming in economically-productive ways. Ultimately, we believe the economic rationalization of this industry will result in a smaller number of providers delivering real and substantial economic profits to investors. After all, capitalism eventually requires it, and we intend to further capitalize when those shakeouts create even more attractive long-term opportunities. In the meantime, we will keep following the cash as closely as we follow the new seasons of Peaky Blinders and The Marvelous Mrs. Maisel. It is all great entertainment…and virtually free.


1) Netflix 2019 10-K
2) Bloomberg ETF holdings data as of 2/25/20