Actively Speaking Podcast

Cutting the Cord: the Content, the Competition, and the Chaos

October 31, 2019 Epoch Investment Partners Episode 10
Actively Speaking Podcast
Cutting the Cord: the Content, the Competition, and the Chaos
Show Notes Transcript

One of the biggest battles of this century is happening right in your living room. As more people say goodbye to their cable company, established players and big, new entrants including Apple and Disney are looking to transform how we consume media. Epoch Co-CIO and Portfolio Manager David Pearl walks us through the stakes of this heated fight for your screen time. (October 31, 2019)

Speaker 1:

Hello, and welcome to Actively Speaking. I'm your host, Steve Blyk. Join us each episode as we discuss current issues concerning capital markets and portfolio management from the perspective of an active manager. Hello, welcome to another episode of Actively Speaking. Uh, my guest today is David Pearl. Uh, welcome David.

Speaker 2:

Nice to be here. Thanks,

Speaker 1:

Steve. Uh, David is the, uh, co CIO and a co-founder of Epic. Also manages, uh, some of our US equity strategies. And today we're gonna talk about cutting the cord. That's, yes. We're gonna talk about childbirth. No, no. Uh, actually we're gonna talk about the disruption that's going on in cable TV and, uh, which is ironic because cable TV was once a disruptor itself as we're able to talk about, uh, broadcast television. So, David, why don't we, uh, sort of break this discussion down into two parts. The first, let's talk about sort of the history of how we got here, uh, to the situation that we're in today, where all these, uh, people are, uh, you know, cutting the cord and, and canceling their cable service and going to all sorts of streaming services. So, talk about how we got here, and then where we go from here and, you know, what's the road to profitability and what's the experience could be like for consumers going forward. So, why don't you tell us a little bit first about the history of how we got here.

Speaker 2:

Yeah. Uh, it, it, it goes back a while back to, uh, even before my childhood. Amazingly, uh, when television television first came out, uh, the limitation was actually the number of frequencies that would carry channels. And so it really required scale. There were only about 10 frequencies usable, and in most cities, it really came down to about three networks. Uh, a public television network came later. So for most cities, you were working with less than, uh, 10 channels. Most people really think of it as five or six. So these had to be very mass market because they appealed to a broad audience. Only niche programming would mean you'd fail in the ratings versus somebody else. And it was limited. In other words, there was an oligopoly based on distribution, the fact that there really were only so many frequencies. A new competitor just couldn't come in and offer content. So the big networks became what they were, at least up until a few years ago, really dominant. Mm-hmm.<affirmative>, uh, they have been losing that due to the disruptions with streaming and cable. But to start with, they were what everyone watched. So up to a third of America might be watching one television show at that time. Right. And the only way to get it was over the air. Those funny bunny rabbit ear aerials on top of your tv. Every television would have its own aerial until someone had the brilliant idea of putting a big antenna on the top of your house. But that was the only way to get television content. Uh, and again, the issue for consumers was it was very limited, uh, choice, uh, due to the fact there were so few options. So cable came in, uh, more or less in the 1960s, became very, very dominant over the seventies and particularly eighties by offering hundreds of channels over time, really increasing consumer choice very, very broadly, and began a, um, disruption of network TV by offering niche programming to special interests. By special, I mean very broad categories, but people who couldn't get enough sports, people who wanted comedy only nature programs, it could accommodate those interests in

Speaker 1:

A way, in this World War II documentaries.

Speaker 2:

Oh, love those. Yeah. The history channel, right. And many, many, many more. Uh, so, so cable became a phenomenon. Uh, over time it got to very high penetration of the United States households, probably about two thirds of households. Those who had jobs literally would have cable tv. Uh, but, um, even though there was more consumer choice in the sense of programming, there was less consumer choice as far as who they got it for and the price. There was one monopoly company serving your area due to the fact it cost billions, literally billions of dollars to lay cable. Mm-hmm.<affirmative>, uh, either underground or on, uh, telephone poles to get to your house. Only one company could do it at a time. And in fact, they were awarded monopoly contracts. Right, right. So, um,

Speaker 1:

And you, and you also, you didn't really have much choice in terms of in those days, which channels you got. You, you bought the package. I mean, there were maybe a few packages, but, you know, you couldn't, there wasn't really an a la carte kind of situation where absolutely you could say, absolutely, I just want this sports channel and, you know, and maybe the nature channel and, and that's it.

Speaker 2:

Right? So I literally, that would've been my next point because the cable companies had this power. They did not want you to pick and choose your options and pay small amounts. They came up with a brilliant idea of bundling mm-hmm.<affirmative>. And this way they could sell you a package for$50 at a time when people were used to get paying, uh, nothing for over the air tv, uh, but give them a lot of channels of which probably they only used 10% on average, but you had to pay for all of them. So this bundling, uh, was a hallmark of cable TV up until very, very recently, although it still exists today. Um, so consumers, as I said, had a lot of choice of content, but could not pick and choose, as Steve just said, which particular ones they want and didn't want. It got to the point where of a$50, uh, bundle,$6 went to ESPN as an example, as a dominant sports network. And for, you know, the broad audience, maybe 20% or fewer watch D S P N at any time. But everyone had to pay that$6 a month mm-hmm.<affirmative>. So this created a opportunity if one could disrupt this business model and give you a la carte programming and pick the ones you want. And that's where the internet came in and allowed companies to provide content and go around the cable TV bundle and cable TV company. And we called it over the top, which meant sending you content over the internet or streaming. Uh, you know, the first company to become big on this was Netflix, but many others are, have already happened, and many more are coming, in fact in the next few months. So what it has allowed is for you to pick a content, um, any kind of content you want from one of these new cable streaming, actually not cable streaming providers and pay only for that content. Now, some of them, like Netflix have become big enough. They're offering you many, many types of content mm-hmm.<affirmative>, but they in fact can offer so much that it is niche oriented. So if you like romantic comedies, there will be dozens of those dozens of science fiction nature shows all within one streaming provider, Netflix, but at a relatively lower price than cable. The issue now is that with the amount of competition coming, uh, the business models are going to be somewhat challenged from a profitability point of view because there is no barrier to entry, unlike the original TV due to the lack of frequencies or cable because the cable company had a big say in what channels would be provided. Mm-hmm.<affirmative> here, the consumer can pick anything that's provided over the internet. So we're going to see a huge increase in competition over the next year. Uh, you know, literally today the big providers are Netflix, Hulu, and Amazon. We're going to see Disney, uh, launch literally next month in November. Then N b NBC is calling it the Peacock network. Mm-hmm.<affirmative>, uh, and HBO o is going to reformulate to something called HBO O Max, which will be a much broader version, including all of the Time Warner companies, including TBS and the, uh, Turner Networks. So there's going to be a real battle of content providers. This is great for consumers. There's no question about it. Uh, the issue is really for the companies themselves, how will they make money? And the biggest problems are that they're, the competition will put a cap on pricing. It is really hard to raise price if your competitors are not willing to go along with you. And as we know, currently the new entrance, apple TV and Disney are pricing at$6 and Netflix standard package is 12. Mm-hmm.<affirmative>. So there is already a huge price difference of the new competitors, which will limit the ability to raise price from here. The other aspect is that content is going to be really critical to who wins. And the competition for content is driving up costs. You're gonna have to have lots of new content and you're gonna have to pay more for it. Cuz there aren't that many more places to get the content. So it's a great time if you are a pure content provider. In other words, a TV or a movie studio, that part of the business is seeing huge demand and price in elasticity because of the demands of the streaming channels to get content. So costs are going up, that's the point. And prices can't go up commensurately. So we actually think this will be a very tough time from an investing point of view to be in these pure play companies. But again, great for the consumer, it transforms the content business and there are winners of pure content companies in here.

Speaker 1:

Uh, well, well, so is it really great for the consumer? I, I'm just gonna play devil's advocate here for a second. Uh, you know, there's, there's all these arguments in economics about, uh, people having too much choice, sometimes not, not being that they get paralyzed by choice. So, uh, while it's true that in the old days you, you paid for this cable bundle and yes, there were a whole bunch of channels you never watched. But, you know, it was sort of a one decision thing. I just, I'll go with this level package, you know, cuz you, you often had a choice of, of a few Yes. You know, do I want 100 channels or 300 channels or 500 channels? So you went with your package and then you got what you got and yes, there were be some you didn't watch, whereas, so now you're gonna have like, come on, do I want, do I want Netflix and Disney or just, or just what Apple's offering and, and Amazon or it's, it's kind of, uh, and, and it's gonna change over time too because there may be some one service that you don't subscribe to that then suddenly comes out with a show that becomes wildly popular and everybody's watching it. You wanna watch it. So, oh gee, now I have to sign up for that one too. It, it's, uh, you know, is there a potential for this to actually become kind of annoying for consumers?

Speaker 2:

So, you know, cable is not losing subscribers at the degree people had assumed it is going down in maybe 2% per year. Mm-hmm.<affirmative>. So really those who are comfortable with cable and, you know, clearly skewed to an older demographic are not as likely to change because,

Speaker 1:

Wait, what are you saying about me? Yes. The,

Speaker 2:

The confusion of this new fle technology, it is going to happen generationally and slower than I think originally thought. In other words, early adopters immediately cut the cord mm-hmm.<affirmative> like myself. Uh, but many, many others are keeping that cable bundle because of habit, because of comfort and ease of use. So it is a new world with this. Um, and the two points I would make is if you added every, um, streaming package I mentioned today, and there's actually a few more, you would pay way more than a average cable bundle.

Speaker 1:

Right? Well, that's the other thing. Good.

Speaker 2:

You'd be paying$75 a month to buy all of these. Right? But the difference is you can cut one of them on a month to month basis without any cost. All you do is go online and say cancel. Right. And so your ability to switch, and this is happening already, is increasing the churn mm-hmm.<affirmative> of customers to all of these services and will actually increase more over time due to this competition. So again, another problem with the business models for streaming companies is the lack of stickiness of their services at the moment. This is why Disney has twice offered contracts for a year to three years at a discount to even the$6 as low as$3 and 83 cents Hmm. To lock you in for that exact reason. So yeah, it will be a different world where instant gratification can be had.

Speaker 1:

Oh, it's gonna be a whole new world, uh, with Disney. Yeah,

Speaker 2:

I just saw that.

Speaker 1:

And I just can't, can't resist these terrible jokes.

Speaker 2:

So, so really this is quite a fundamental change in the, uh, in, in all of content, both distribution, um, content production, um, and for the consumer as far as choice and pricing. It is very, very big. And in fact, last point on this, there are streaming channels that reproduce the entire cable package. This almost sounds nonsensical mm-hmm.<affirmative>, but you can get a skinny bundle for$30, which includes like 15 to 20 cable channels if you are, you know, missing some of your old favorites that aren't available today on one of the new streaming channels.

Speaker 1:

Gotta see that. International house hunters,

Speaker 2:

Yes. This is, this is where we are. It is really only beginning to heat up, as I said, because we're going to see Apple TV and Disney launch this month. And then two more, the reformulated hbo, which is much, much broader than the old H B B O and NBC's network coming in. By the way, CBS has their own content as well. Mm-hmm.<affirmative>. So we've splintered the network content. You're gonna have, you know, again, you could pay a lot more if you wanted to reformulate your old cable bundle. There's no question about it, but most consumers will probably pick a few favorites and switch back and forth over time in this new regime.

Speaker 1:

So do you think people are gonna end up with still having a, you know, a cable bundle plus some streaming services? Because the cable, like if you want access to certain, you know, like the local, the local tv, the local network stations, that kind of thing, um, you know, things like, uh, you know, vol tens to still be available on the shown on the major networks. Right. Uh, is that, do you where you think we're gonna go or, or will people, you know, go the other way? Just drop cable bundles, just go with streaming services and then eventually sort of all programming will move to the streaming

Speaker 2:

Services? So one of, one of the technological advantages, uh, over the last 15 years has been on demand, which has been a fabulous service for any sort of, um, pre uh, taped programming. Whether it's scripted or reality tv, you can have it on demand. Right. The two exceptions that you're bringing up, Steve, are sports and news. Mm-hmm.<affirmative> and the occasional, you know, event show like the Academy Awards or Tony Awards, something like that. Those live shows, uh, are the exception to the on-demand rule. Generally speaking. Now there's a, a lot of quirks about this. We have moved through this whole, um, uh, disruption pattern, but yet we still have over the air TV for free. So many cord cutters put up an antenna to get local programming, live sports and news from these basic networks, the same networks that they started with in the 1950s Right. Over the year for free. However, if it's remitted to you in any other fashion, either by cable or from streaming, you have to pay for it. Yeah. So there are people who will pay for s, ESPN and sports la carte, but the problem for Disney's ESPN is instead of$6 a month from 60 million households, they might get$15 a month from five to 10 million households. And it won't make up for the loss of the cable revenue. So the optionality will be there for live tv. It will cost you. So, yet again, there will be some group of people that find the cable bundle value worthwhile, particularly for those live events. Uh, but others will do it through streaming a la carte. But again, it is a business model issue for the legacy companies who are losing that cable revenue. And cable revenue is incredibly lucrative. When I talk about ESPN and as an example, now their programming is definitely expensive, but having such a large base of customers that must pay month in, month out, um, you know, is irreplaceable. Right. Right now. Right. So, um, you know, the other factor I should talk about is the cable companies themselves, because one would think, wow, this disrupts the cable business. And yes, to a degree it does. But interestingly and perversely it's good for them. The margin on, uh, doing cable TV as a service is actually rather low. The cable company is literally marking up the cost of content from the cable, um, providers, the content providers, uh, to the consumers. So they get a small markup, 10%. It really isn't that high. However, the only way you get internet today is from your local cable, or in case of FSA fibrotic provider, that margin is in the 80% range. Mm-hmm.<affirmative>. So as they lose cable subscriptions, their profit margins go up. Yes. Dollars are impacted slightly, but the margins go up. And by the way, given that all of what we're talking about depends on having internet, you are pretty stuck on a price elasticity basis. And pricing of internet over the last 10 years has more than doubled. Mm-hmm.<affirmative>. And, um, really what is your choice? I call up every year to threaten them to leave, but they look at me and go, well, you don't have another choice, do you?

Speaker 1:

<laugh><laugh>?

Speaker 2:

So, so it is a monopoly for cable. Um, technology is providing a potential competitive threat through 5G technology. It's a new, uh, version of cellular technology that will be fast enough to provide broadband to your house over, uh, over the air from a cellular network. But that's the subject of maybe another, uh, podcast that's a little too much today and it is not realistic in the next few years. Right. So as of today are only, um, you know, most people have only one or two choices for internet, and those companies are doing very, very well, even with the loss of cable packages.

Speaker 1:

Mm-hmm.<affirmative>. Okay. So I, I see you brought your, uh, your crystal ball here, sitting here on the table. So tell us how you think this is going to shake out. Yes. Uh, what is the road forward? How do you, you've said that right now because of the so much competition, it's uh, sort of the business models are challenged with these low pricing from Disney, et cetera. So how do you see it shaking out in the future? Will there, will some of these companies have to eventually drop out? Uh, will they all be able to raise prices? You know, where does it go? Right.

Speaker 2:

So it is really unlikely that everybody can win. I mean, the competition is going to be incredibly brutal. And what we're seeing are big companies with incredibly deep pockets getting in and, you know, Disney has literally said they're going to have lower earnings for the next few years because of the investment in over the top streaming channels. Apple TV has committed at least 3 billion this year, but it's gonna be tens of billions over the next few years just to create the content necessary to have a Apple TV streaming channel. All the original content, um, companies that do have some content, the networks like Disney, uh, universal, the movie studios are pulling their content back from companies like Netflix, which will cause them to have to even ramp up further their investment in original content. Right. So the question is how long this can go on with the caveat that I don't believe prices can go up much at all in the near future. There is one saving grace for most of these companies, and that is advertising. Some of them already do this like Hulu, but Netflix seems quite committed not to at the moment. We'll see. Um, Amazon, which we hadn't talked much about, clearly it's not a money maker for Amazon, but a great loyalty item. Mm-hmm.<affirmative> to give you all this content as an Amazon Prime member, Amazon has no, uh, uh, advertising. But one thing about streaming, they know who you are, unlike broadcast TV and even to the degree cable. They know who you are, what you're watching, uh, and you know, you, um, if anyone has been streaming, undoubtedly when you watch a TV show, you get a suggestion for another show based on your choices and likes. So it is a great medium, not quite as good as, um, Facebook or Google search, but they do know a lot about your demographic and can advertise quite, uh, successfully to you. So we're gonna see more placement. If you go on Amazon today, there are definitely ads on the, uh, program guide, not so much within the program, but when you turn it on that are geared specifically to you and very customized. So that would be the one money making, saving grace to streaming, given that price is not going to be one of those mm-hmm.<affirmative>. Uh, but it's going to be very difficult over the next few years. Companies are going to invest a lot of money. It's gonna be fantastic for consumers. I can only see more promotions. We're seeing bundles between, let's say music streaming and video streaming where they're discounting both to get your sticky loyalty, um, over this period because, uh, again, customers are up for grabs given the tumult in this area.

Speaker 1:

Well, one of the things we talked about, um, prior to recording this was, uh, uh, a theory that some people have about what this is going to do to the content of television shows. And what I mean is that for many years now, the, the content, the the shows that networks have wanted to create are ones that, uh, the so-called, uh, you know, the coveted demographic wants to watch the advertising demographic of people. What is it like 18 to 35 that, um, that's, that's who advertisers want. And so TV networks would create shows to appeal to 18 to 35 year olds. Uh, that used to baffle me. Cause I always thought, well, older people have more money. Uh, but it, the answer I believe is, is that, well, it's the people who are 18 to 35, their preferences are still malleable. Uh, they can be convinced by advertising to change brands try new brands. Whereas people who are older, even though they have more money, are more set in their ways and unlikely to be influenced by an ad to change, you know, the laundry detergent they buy. Cause they've been buying the same one for 20 years already. Um, and if you go to a world where it's not so much advertising supported, but simply subscriber supported that, uh, the, the, the content creators will have incentive to create content for everybody out there. Uh, you know, cuz as, uh, you know, the, the$5 or$6 a month from a person, you know, a 50 year old person living in the Midwest is just as good as the$5 from a 25 year old living in New York City. And they're gonna want to have, get all of them. So they'll need to create content for everybody. If we go back to an advertising supported world, eventually, of course that would go right back and would go right back to all the programming being aimed at young people. Well,

Speaker 2:

You know, that's very insightful, but it's, it's even more, uh, complicated. So, um, cable TV subscriptions have gone down and ratings for mass, uh, markets like football, sports, um, you know, big award shows have actually gone down over the last number of years due to the splintering of the audience. Mm-hmm.<affirmative> yet the actual advertising rates keep going up because advertising requires multiple different groups. And if you want to launch a product and you want to have the broadest possible audience, you go to the Super Bowl or the Academy Awards or a big news event, but for most other content you hit a really specific demographic that you could never hit on mass market TV only slightly hit on cable, but clearly you could do on streaming channels. In other words, who watches the Nature Channel? It is a very specific demographic. It actually has a hugely high female audience as it turns out. Mm-hmm.<affirmative> and advertisers do know this, so they can be much more specific if they want a narrow group versus a broad group. But there is room for all of the above in this new world. Again, it makes one feel like privacy yet again will be an issue. Yes. Uh, but nevertheless, you are trading off your privacy for having a whole lot of choice at a very, very low price. Um, there are already ads preceding shows that ask you to choose which commercial you would like before watching this show. Hmm. Both because they feel it will work better and also they'll learn more about you. Right. To do that. So, you know, we are on that slippery slope. I'm not sure other than government regulation what would change it, but again, if you cut advertising revenue, prices would have to go up at some point. Uh, or companies will go outta business faster. That's

Speaker 1:

All in this. Yeah. So I kind of interrupted you. We, we were talking about, you know, where this goes. Yeah. And so will it be that will some of these competitors eventually fall out? Uh, will, will some of them end up having to merge? Uh, you, it sounds like you don't think there's room for price increases at the moment in the market. So the only route to to profitability would, it would seem then have to be that not everybody can survive?

Speaker 2:

Yeah. We, it is unlikely that everyone can, um, can make it through here. There are a number of money losing ventures. Um, and I won't go into that in this podcast, but if, if you are burning cash, the question is how long investors will be willing to let you burn cash if they do not see profitability at the end of the tunnel. Mm-hmm.<affirmative>. So, so we think that's one of the issues. Uh, clearly it depends on whether you own your own content. So I'll name a small one Discovery Channel. Um, you know, they already sell a lot of content through cable. They will be slightly disrupted, but they're starting their own streaming channel at a very low price. It's in the two to$3 range and they think they can make up for it. And the difference is they can repurpose content. Of course, the good and bad of that of nature is it's low cost. You don't have to pay anybody to, uh, you know, to, uh, videotape, um, you know, animals,

Speaker 1:

But not yet

Speaker 2:

Anyway. Not yet. Right. Um, but anyone can do it. It's not really proprietary. So we'll have to see how their brand extends, but in other words, there is a synergy to having your own content. Disney, of course, when a Star Wars movie makes a billion dollars at the box office, it's pretty much paid for itself when they put it on the Disney Right. Streaming channel. Right. So they do have an advantage over those who are only producing content at 10 or$12 a month mm-hmm.

Speaker 1:

<affirmative> mm-hmm.<affirmative>.

Speaker 2:

So yes, it's going to be a real battle. We think it will shake out over time. But you know, most of the companies involved today do have deep pockets. That is the, the question is how much their investors will be willing to tolerate short term profit losses or at least declines in their other

Speaker 1:

Businesses. Right. Okay. Well that was, uh, certainly a lot of information does sound like a, a pretty good time for consumers ahead in the next few years. If you like to watch tv, maybe not such a great time for, uh, the people who are providing all that, uh, entertainment to us. Uh, but we'll certainly be watching closely to see what happens over the next couple years. David, thanks for joining me today. Thank

Speaker 2:

You.

Speaker 1:

And we'll talk to you again soon. Remember to subscribe to actively speaking on Apple Podcast, Spotify, or Google Play. You can find all of our previous episodes and additional content on our website, www.eipny.com.

Speaker 3:

The information contained in this podcast is distributed for informational purposes only and should not be considered investment advice or recommendation of any particular security strategy or investment. Product. Information contained herein has been obtained from sources believed to be reliable but not guaranteed. The information contained in this podcast is accurate as of the date submitted, but is subject to change any performance information. Reference in this podcast represents past performance and is not indicative of future returns. Any projections, targets, or estimates in this podcast are forward-looking statements and are based on epic's research, analysis, and assumptions made by Epic. There can be no assurances that such projections, targets or estimates will occur and the actual results may materially be different. Other events which were not taken into account in formulating such projections, targets or estimates may occur and may significantly affect the returns or performance of any accounts and or funds managed by Epic. To the extent this podcast contains information about specific companies or securities, including whether they are profitable or not, they are being provided as a means of illustrating our investment thesis. Past references to specific companies or securities are not a complete list of securities selected for clients and not all securities selected for clients in the past year were profitable.