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Daniel Hertzberg for Variety

It’s the affiliate fees, stupid.

No matter how many positive indicators emerged from media companies’ fourth-quarter earnings reports last week, Wall Street sent a resounding signal to the sector that investors remain preoccupied with one big issue: the erosion of $50 billion in revenues from pay-TV distributors.

One conglomerate after another saw its shares droop immediately after its earnings calls, with the Dow Jones Broadcasting & Entertainment Index dropping nearly 9% from Feb. 8-10, before inching back up later in the week.

“I think it’s hard to call the stock movement an overreaction, because we saw a further weakening of affiliate revenue trends,” said Guggenheim Securities analyst Michael Morris. “When I think about comfort and security in my investment in this industry, it’s more impactful than anything else to the business model.”

“When I think about comfort and security in my investment in this industry, affiliate revenue is more impactful than anything else.””
Analyst Michael Morris

But the focus on affiliate fees — which aren’t actually declining, just not growing as robustly as they used to — seemingly ignores the fact that the other major revenue driver for the congloms, advertising sales, is doing unexpectedly well. Every media company last week saw healthy increases in the fourth quarter except for Viacom, whose 4% decline was not as bad as projected.

Drexel Hamilton analyst Tony Wible believes content companies’ ad-sales gains are being canceled out by the rising cost of programming in the face of new competition from subscription VOD services like Netflix. “When programming-cost inflation is increasing 7%-10%, the problem is that good ad revenues aren’t good enough,” he said.

To some extent, the media sector was caught up in the broader market doldrums of the past week, as the fragile state of the global economy got inside investors’ heads. Still, it’s a worry that might not soon subside.

“There’s lingering concern that while advertising was great in the fourth quarter and holding up well in the first quarter, you look at the fears over the economy, and it could be a matter of time before it catches up to the ad market,” Morris said.

The downturn also felt like a virtual replay of the panic that seized the sector last August, when a full-on meltdown depressed most conglomerates’ stocks at low double-digit levels through 2015.

Click Image for Large Preview
Date from fourth quarter of 2015

While the February sell-off wasn’t as steep as in the summer, a recalibration of a single company’s affiliate-fee growth projection again loomed large: Disney had been the party responsible in August, but this time around it was Viacom. Not long after changing guidance from a high-single digit to a “low mid-single digit” uptick on a global basis, the company experienced a 21% nosedive, compounding an already massive 40%-plus erosion since last year. Strangely, Viacom’s other metrics weren’t all that bad, with most of its cable networks registering ratings growth.

The neverending boardroom drama surrounding Viacom founder Sumner Redstone was a factor, prompting CEO Philippe Dauman to lament, “Our outlook and the facts have been distorted and obscured by the naysayers, self-interested critics and publicity seekers.”

But the decline of Viacom had observers speculating on the company’s fate — from the cheap buying opportunity the company’s still-solid fundamentals presented to investors, to the possibility of an acquisition for some or all of the conglom itself.  While Dauman painted a rosy picture for Paramount’s slate in 2016, that got Wells Fargo analyst Marci Ryvicker wondering if he was putting the asset on the block. “While management stressed the organic investments and potential long-term profitability of this segment, we also felt a little bit like CEO Dauman was ‘selling’ the studio — to anyone who might listen,” she wrote.

Disney also had a good story to tell, not just on the film side, where “Star Wars” powered an extraordinary $1 billion in operating income for the quarter, but across its entire business. Nevertheless, the company’s stock fell 3.8% after its Feb. 9 earnings report.

What’s more, Disney CEO Bob Iger clearly came ready to counter Wall Street anxiety, armed with evidence of a subscriber rebound at ESPN. But again, the problem was global affiliate sales growth of 3.5%, lower than many analysts expected. Cowen & Co. analyst Doug Creutz was incredulous at the sell-off. “We see investors as focusing on a tiny pimple and missing a pretty face,” he observed.

Giving No Quarter
Even though fourth-quarter earnings reports contained some positive information, entertainment stocks still were sent plummeting.
$1b Disney’s fourth-quarter operating income
-3.8% Fall in Disney stock price after Feb. 9 earnings report
800k Subscriber figures for HBO Now
-5% Fall in Time Warner stock price after Feb. 10 earnings report

Iger also touted ESPN’s presence on Dish’s Sling TV service, an over-the-top alternative to traditional bundles. HBO CEO Richard Plepler took a similar tack on Time Warner’s earnings call, for the first time revealing subscriber figures (800,000) for HBO Now.

The message was clear: Congloms are beginning to make headway by co-opting the broadband pipes that are eating away at their traditional business. But investors didn’t get the message. “The revenue generated from the golden goose of affiliate fees is massive,” Morris said. “It’s very difficult for investors to accept that something new can make up for what a great business that’s been.”

With just 1% subscription growth at its Turner division, Time Warner took a 5% ding that could have been a lot worse had it not touted strong long-term affiliate-fee projections.

And while no company emerged unscathed last week, 21st Century Fox and CBS Corp. took smaller lumps, likely on account of the former’s 10% affiliate fee growth number and the latter’s reliance on retrans revenues, which looked more robust than ever.

Now all eyes remain on whether the sector’s wild ride will continue into the spring. “It’s really amazing how much these stock prices can whip around,” said Wunderlich Securities analyst Matthew Harrigan. “The market can be a bit of whack-job sometimes.”

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