By the end of a brutal trading day on May 18, Wall Street had delivered a wallop to Hollywood that will change the course of business as surely as the COVID pandemic accelerated the pace of transformation during the past 26 months.
Last week’s market crash that saw the Dow Jones Industrial Average plunge 1,164.52 points, or 3.57%, was not just a one-day blow but the culmination of a months-long correction for Big Media stocks. Disney, Netflix, Warner Bros. Discovery and Comcast have seen tens of billions of dollars in market capitalization wiped out over the first five months of the year, as have tech titans like Amazon and Apple. Investors have spoken.
“Wall Street is not rewarding subscriber growth anymore,” says Liska Schmitz, managing director and partner at consulting firm BCG. “Investors are looking more at profitability.” There’s a higher level of scrutiny on spending and proving the economics of streaming, and that could lead some players to become “hesitant about spending as much as they have,” she says.
The crash marked the end of investors’ irrational exuberance for the content business with an exclamation point — on the same day last week that the TV industry was pitching content strategies to advertisers at upfront presentations in New York and the elite of the world’s movie business were being wowed by Tom Cruise and “Top Gun: Maverick” at the Cannes Film Festival.
Indeed, the streaming bubble that boosted shares of media and entertainment companies in 2019 and 2020 has all but burst. Falling stock prices are coinciding with rising interest rates, inflation and heavier-than-usual debt loads at the largest conglomerates. The heightened pressure to deliver earnings and the need to pay more to service debt will inevitably force a pullback — at least in the short term — in the tidal wave of spending on content production, marketing and distribution.
That in turn will have a major ripple effect across Hollywood’s creative community and the global content production ecosystem, which in recent years has been primed to operate in an environment of seemingly endless demand for new TV shows and movies. Morgan Stanley this month projected the rate of content spending by the 14 largest players in global media to expand at a 13% compound annual growth rate from 2022-25, when the tally will top $200 billion. But a steep and sustained economic downturn, of course, would put a damper on that.
Hollywood’s real dilemma is how to power through more years of transition and uncertainty as business models continue to evolve, observers predict.
After more than a decade of disruption, Hollywood has hit the most precarious point of its digital revolution, wherein aging linear operations in TV and film are growing weaker faster than the new platforms can become profitable.
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Among institutional investors, enthusiasm is waning for the thesis that streaming services will drive enormous growth for traditional Hollywood players. As macroeconomic conditions worsen, there’s more scrutiny of strategic road maps that require tens of billions of dollars of investment before generating meaningful profits. Entertainment giants that have gone all-in on streaming — Disney, Warner Bros. Discovery and to a lesser degree Comcast and Paramount — have taken more of a drubbing than those with less riding on costly build-outs of direct-to-consumer platforms, such as Fox Corp., AMC Networks and Sony Corp.
As Robert Fishman, principal at research firm MoffettNathanson, suggests, the immediate challenge is not to retreat from the direct-to-consumer pivot but to fine-tune plans and tap the brakes on some of the more ambitious world-building efforts around content production and distribution. In other words, Hollywood needs to get real with itself.
“While we would argue that there is really no turning back on the path that they have chosen, it would seem to make sense that Netflix’s hitting of the subscriber wall should force each company to re-estimate their spending plans and their own long-term estimates of their [total addressable market],” Fishman wrote in a May 2 research note.
Netflix, the pioneer disruptor that showed consumers the path to commercial-free, on-demand subscription platforms, has taken the biggest hit of all, losing nearly 50% of its equity value in four weeks — and even more since the start of the year. The warning Netflix delivered on April 19 of subscriber losses of as many as 2 million for the second quarter has been interpreted as a sign that the entire sector will hit a speed bump, particularly in the U.S., where consumers are overwhelmed with choices.
The streamer’s bombshell subscriber miss sent the stock, already suffering from Wall Street concerns about the company’s slowing growth, spiraling to four-year lows. The swiftness last month of Netflix’s about-face on bringing advertising to the platform — after years of strenuous denials that sponsor messages would ever cross the Big Red N — was another indication that its internal forecasts for revenue and subscriber gains were slowing considerably.
The shock sent Netflix into unfamiliar cost-cutting territory after years of heavy debt-fueled spending on content. The company last week laid off 150 employees, mostly in the U.S., after trimming 25 positions in its marketing group in April. The cutbacks included the elimination of 70 contractor roles in its animation division.
The May 18 market stunner was spurred in large part by disappointing earnings and forecasts reported by the nation’s largest retailers, Walmart and Target. That news was bad for the entertainment business because retail sales are an important gauge of consumer discretionary spending. Pay TV services are easy for families to cut at a time when the price of everything from breakfast cereal and shoes to gas and electric utilities is shooting up. Moreover, the spread of free, ad-supported streaming channels (aka FAST or AVOD services) through such platforms as Paramount’s Pluto TV has made it clear to consumers that there’s plenty of free content out there. In fact, analysts speculate that the growth of Pluto TV’s ad business was one of the prime draws behind the recent purchase by Warren Buffett’s Berkshire Hathaway of at least $2.6 billion of Paramount Global shares.
Rich Greenfield, partner and analyst at LightShed Partners, has been vocal and bullish on streaming’s potential to put traditional TV out of business. He sees Netflix’s current woes as influenced by the curveball of the pandemic.
“What’s obvious is the overwhelming majority of the space is still attached to advertising, whether we’re talking about Disney or Paramount or Facebook, so the whole sector is affected by an economic slowdown,” Greenfield tells Variety. “The double whammy for traditional media companies is you have cord-cutting and now the ad market is falling. The reality is, all of these companies have been dealing with a very chaotic couple of years because of the pandemic and its impact on live events and TV and video consumption.”
Traditional entertainment giants have been able to justify huge investments in original content production because they could monetize that through multiple release windows with different partners. But studios are now forgoing billions of dollars in licensing money they used to rake in from aftermarket sales of movie and TV shows to outside buyers. These days, media conglomerates are reserving most of those rights in order to keep high-wattage content exclusive on proprietary streaming services for years.
Disney offered a granular example of how it has had to spend money to claw back rights to content previously sold to outside platforms. The company disclosed a nearly $1 billion expense for the quarter ended April 2 for buying back its own shows, likely to account for the cost of re-acquiring library rights to seven Marvel series produced for Netflix from 2015-19, including “Daredevil,” “Jessica Jones” and “Luke Cage.”
Disney is approaching an inflection point with its DTC strategy as Disney+ heads toward its third birthday in November. The company recently outlined plans to hit the gas on local-language production, with some 500 projects in the works for territories in Asia, Europe, Africa and Latin America. In key markets such as India, Disney is venturing into the world of pricey sports rights for soccer and cricket leagues to drive Disney+ Hotstar subscriptions.
All of those content costs are about to pile up at the same time the company faces a bill of at least $8.5 billion due to Comcast as early as January 2024 if NBCUniversal exercises an option to sell its 33% of Hulu to Disney. Disney and Comcast in 2019 worked out a deal that gave Disney full operational control of Hulu. In return, Disney is on the hook to buy out Comcast’s Hulu stake by 2024 at a purchase price that values the streamer at a minimum of $27.5 billion. Observers note that a silver lining for Disney in the market downturn of the past few months is that it will probably keep a lid on the price tag for Hulu.
However, Disney watchers say, it’s not a given that the company goes all-in on Hulu or even the Disney+ flagship.
Disney may be better off from a return-on-investment perspective not chasing Netflix down the local content and general entertainment path with a massive super service, according to Michael Nathanson, principal at MoffettNathanson. Rather, it may make more financial sense to use the Disney, Marvel, Pixar and Lucasfilm brands and content libraries to deliver a more targeted service to a smaller number of higher-paying core fans, he suggests.
“The market is now worried that the combination of [the Disney+] subscriber guidance and rising costs to compete more broadly with non-Disney brands will result in a less impressive business at steady state,” Nathanson wrote in a May 12 research note.
Meanwhile, the stock-market meltdown might give rise to more M&A activity in the months ahead that could further shake up the industry. LightShed’s Greenfield has floated a potential scenario in which Disney offloads Hulu to Comcast — and uses the sale proceeds to partly fund a Netflix takeover. “To me, Hulu feels duplicative for Disney. Instead of spending those dollars [buying out Comcast’s stake in Hulu], they can deploy that capital elsewhere,” he says. With an estimated $18 billion in cash from selling Hulu, a Disney tie-up with Netflix wouldn’t be out of the question given that Netflix’s market cap has collapsed by two-thirds this year to less than $90 billion.
“Disney buying Netflix is not as crazy as it sounded a few months ago,” Greenfield says.
In the fall of 2016, rumors swirled that Disney might be interested in acquiring the industry’s leading streamer, but a deal never materialized and opinions on Wall Street were divided about whether that would be a good match-up or too big a risk for the Burbank entertainment giant.
In today’s precarious economic environment, investors may balk at a gargantuan transaction that forces a company to amass serious amounts of new debt.
Look at Warner Bros. Discovery, whose shares are down about 30% since they started trading April 11. The combined company marries the marquee brands of Warner Bros., HBO and Turner with a wealth of Discovery’s lifestyle, how-to and sports content. But CEO David Zaslav’s newly configured team takes the reins with a whopping $55 billion debt load on the balance sheet after adding more than $40 billion in debt from the WarnerMedia deal. Down the line, that stands to be even more costly to service as interest rates tick up. Given WBD’s high leverage ratio, Zaslav has been repeatedly promising to be responsible on the cost front.
“We are not trying to win the direct-to-consumer spending war,” Zaslav told investors last month.
At this juncture, the narrative Wall Street wants to hear is fiscal discipline. That sentiment — coincidentally or not — was encapsulated in a key addition Netflix made this month in updating its famous corporate-culture memo for employees: “You spend our members’ money wisely.”