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The State of Streaming Companies

We maintain that Netflix is overvalued but see potential in ViacomCBS.

AT&T's T decision to spin off WarnerMedia is arguably the biggest event to hit the media industry since the start of the pandemic. We believe the move that teams Discovery DISCA with Warner will create a stronger media business, putting the combined firm on much better footing to compete with Netflix NFLX, AMZN, and Disney DIS in the streaming market.

Additionally, moving under a purely media-focused management team should make it easier to unlock the value in WarnerMedia's strong studios and content library. We believe the shares of both AT&T and Discovery are attractively valued.

On the other hand, we still believe Netflix is substantially overvalued. The firm has performed exceptionally well in recent years in terms of subscriber growth, but we see increasing hurdles to that growth. Competition for streaming audiences is increasingly intense as Amazon, Disney, WarnerMedia/Discovery, and even ViacomCBS VIAC continue to invest in new content. We expect Netflix to keep its content-spending elevated, limiting its ability to generate cash flow.

ViacomCBS remains our favorite media stock, as the firm is well poised to capitalize on the trend toward increased consumer adoption of streaming services with the relaunch of Paramount+ in March 2021 and the success of its other streaming platforms like Pluto.

Where Streaming Companies Stand

Here's how we view the main players in the streaming world:

  • Netflix remains the undisputed leader in the race to win streaming video customers, with a presence in around 10% of global households today. Excluding China, where the service isn't available, Netflix is now in about one of every eight households worldwide and likely significantly more if shared accounts are included. The firm's customer additions disappointed during the first quarter, falling short of management's forecast, but we don't believe it's wise to read into one quarter's numbers, given the impact of the pandemic on consumer behavior. That said, we expect Netflix's customer growth will continue to slow and become increasingly lumpy around the launches of high-profile content.
  • Disney+ delivered solid customer growth during the first quarter, but it fell short of expectations, too. We suspect that the surge in COVID cases in India hampered growth, as the Indian Premier League was forced to suspend play. The Indian service, dubbed Disney+ Hotstar, now accounts for about a third of total Disney+ customers. Also notable at Disney, ESPN+ continues to steadily add customers, though the service remains relatively small. Hulu has carved out a solid U.S. presence that is growing nicely. Hulu minority owner Comcast CMCSA is reportedly unhappy that the service has been usurped internationally by the Star brand.
  • HBO has impressed us with the momentum it has built in the United States, thanks in part to its decision to put new movies on the platform the same day they open in theaters.
  • Comcast has attracted sign-ups to Peacock by offering a free tier, but we're worried that engagement among many of these accounts remains very modest.

With the combination of a huge customer base and strong revenue per customer, Netflix has built a solid foundation that is growing rapidly. The firm's streaming revenue base gives it adequate scale to compete for the best content. Other media players are quickly adapting to the streaming fight, however, with Disney and Warner clearly pushing hard to replicate Netflix's direct-to-consumer position. ViacomCBS has also begun to pivot hard toward the streaming market with its broad array of content now under the Paramount+ umbrella.

We've long held that the traditional media firms will ultimately prove adept at competing with Netflix. Existing content libraries, franchises that can be extended into new programming, and existing customer relationships provide the elements needed to grow streaming businesses. We also expect these firms' willingness to use both traditional and new content distribution mechanisms will ultimately prove highly beneficial. Maintaining a theatrical window of some sort--whether in traditional theaters, through premium access like Disney+ has used, or via high-priced on-demand rentals--remains an important means of monetizing high-profile content, especially for writers, directors, and actors.

Among the big media firms, we're most concerned with NBCUniversal's slow progress in delivering meaningful streaming revenue. The firm's approach to the market makes sense to us. It has attempted to leverage the traditional pay-television business to drive subscribers to Peacock, which has resulted in impressive account growth. But it hasn't yet figured out how to translate that growth into incremental revenue to match the heavy investments it is making in content. We suspect that NBCUniversal still views Peacock as a hedge against the potential decline of the traditional pay-television market, giving it a platform to capture customers who cut the cord. However, its modest revenue figures indicate that it isn't picking up much demand among customers who have already dropped television service or never subscribed in the first place.

2 Promising Entertainment Stocks

We're keeping an eye on the potential of these two companies in the streaming space:

ViacomCBS Morningstar Rating: ★★★★ Morningstar Economic Moat Rating: Narrow Fair Value Estimate (as of June 30, 2021): $61

With the recombination of Viacom and CBS, the new firm has the content breadth and depth to ensure that its roster of channels remains entrenched in any traditional television offering while also providing plenty of material for Paramount+. ViacomCBS' roster of paid streaming services, which also includes Showtime, has posted strong growth recently, even though the shift from CBS All-Access to Paramount+ only happened in March. The free Pluto TV platform is also growing rapidly. Finally, as movie theaters reopen, the firm's film studio should benefit nicely.

Discovery Morningstar Rating: ★★★★ Morningstar Economic Moat Rating: Narrow Fair Value Estimate (as of June 30, 2021): $42

Discovery has long been known as a firm that produces and owns unique content with proven appeal to audiences across cultures and languages. As a result, its traditional networks have wide distribution, reaching 85 million U.S. households and more than 200 million internationally. The launch of Discovery+ earlier this year leaves the firm a bit late to the streaming game, but it now has an outlet for fans who don't want traditional television service. The plan to join forces with WarnerMedia should provide opportunities to accelerate streaming adoption as the new firm crafts bundled offerings.

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