Commentary: Analyst's predictions gives industry the willies

Anthony DiClemente's forecast more bearish than most

Arguing that the digital age poses a major threat to the traditional film and TV business shouldn't cause a stir anymore. But that's exactly what happened when Lehman Bros. analyst Anthony DiClemente came out of the Fourth of July weekend with a downgrade of the entertainment sector based on that theory.

What caused the ruckus was not so much the basic premise of DiClemente's report but rather the timing (he seemed late to fully express his digital angst) and projected pace of the decline of show business as we know it (he was more bearish than others).

Indeed, most analysts have argued that digital worries are well priced into big entertainment stocks by now. "Digital is and has been a foe for media for many years as denoted by the fact that the sector has lagged the market since 2004," Sanford C. Bernstein analyst Michael Nathanson tells me. "I am shocked that this is still a subject for 'discovery' by one analyst."

Most analysts have asserted that content remains king in the digital age as it draws viewers to whatever screen they might be using -- whether it be movie theater, TV, computer, cell phone or video game console.

In contrast, DiClemente argued that key distributors might start reigning supreme. "Content may no longer be king in the entertainment business, as distribution giants Apple and Google seem to prove again and again," he wrote.

DiClemente also predicted that digital gains -- which entertainment executives often tout without presenting much financial evidence -- might soon be more than offset by declines in physical formats. "The feature film and TV content businesses are on the verge of structural changes that appear to impact the core revenue and profits," he says.

Among DiClemente's scariest projections is how fast physical DVD rentals and sales could decline in the coming years and how slowly digital business might expand in comparison, potentially causing an earnings gap of which the music and newspaper industries already are painfully aware.

Industry observers often have pinned hopes on the "long tail" to take some pressure off entertainment firms. The argument is that the tail allows even niche and nonblockbuster product to sell at least somewhat well online, making added money for content firms. "Pennies from the many can end up being more valuable than dollars from the few," Forrester Research analyst Josh Bernoff says.

But Anita Elberse, an associate professor at Harvard Business School, recently presented research in the Harvard Business Review that suggests the long tail is flatter than many have hoped, meaning that a blockbuster-focused strategy remains the main way to make money in the digital age. "A few winners will still go a long way -- probably even further than before," she wrote in her recommendations to content producers.

Elberse tells me she finds it difficult to predict whether and when overall digital revenue can make up for lost analog revenue, but she has hope for Hollywood.

"Film and TV content producers are better positioned than their counterparts in music were a few years ago," she says. "For one, they seem to have more control over the distribution channel, in particular in the television content area, where the networks' Web sites are important places to go for content."

For now, though, nobody would suggest that studios could make as much money in digital channels as in the analog world. Although digital distribution often is cheap, the basic theory of supply and demand puts pressure on digital prices.

"The value of entertainment comes from limited distribution," Bernoff says. "In digital, the distribution is broad and, sometimes, out of control -- as with file-sharing."

So industry folks must pray that DiClemente's projections will turn out to be way too pessimistic.

In the meantime, entertainment giants should give investors a better picture of their opportunities by breaking out more details about their digital business. So far, they don't tell us how much money they make from iTunes, VOD use and online advertising. Only CBS Corp. has signaled that it will start breaking out results for its CBS Interactive unit down the line.

A key reason surely is that much of this is considered competitive intelligence. But looking at how much sector stocks have been depressed in recent years, investors likely worry that there also is a bigger and scarier reason.

"The digital opportunity appears either too small or too distant to matter at present," Nathanson said in a report this year.

Maybe digital business is indeed still too small for most entertainment biggies to impress anyone. And maybe that's why DiClemente's report seemed so painful to many.
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