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“Linear Pain, Few Will Gain.” Not only the title of Wells Fargo analyst Steven Cahall’s Tuesday report made for a bleak warning for Hollywood. So did his takes on cord-cutting, the focus on building out streaming businesses and more.
“We think the linear business model that has underpinned media is set to decline rapidly,” Cahall warned in the report. “Pivots to direct-to-consumer (DTC) are dilutive to margins and earnings. We’ve laid out long-term company financial outlooks through the transitions and see a lot of hard choices ahead for many media names, including paring back investments, not renewing sports and/or consolidation.”
In 2023, media stocks’ non-sports content value on streaming will reach around $31 billion, exceeding that on linear, “with their streaming content value +10 times since 2019,” he estimated. “With sports shifting over too, and Netflix and Apple and Amazon adding to streaming content, the foundations of the bundle are crumbling. It is/was a great business, and its decline is going to hurt media stocks.”
Argued Cahall: “The over-monetization cracks are clear: on advertising, average revenue per user (ARPU) for cable/broadcast primetime viewers has gone from $54/$57 per month in 2007 to $113/$104 per month today. New AVOD from Netflix, Disney and Innovid will slowly but surely cannibalize linear ads. The base bundle is now around $80 per month (+7-8 percent over a decade) and could hardly be called skinny, so we see this revenue going ex-growth too.” And he now forecasts cord-cutting to reduce the industry count to around 50 million bundle subscribers by 2027.
What does all this mean for financials? “Streaming margins are still being proven, and it’s overly optimistic to assume that they can approximate linear anytime soon,” Cahall wrote. Across the media sector that he covers, “we think linear network earnings before interest, taxes, depreciation and amortization (EBITDA) margins are above 30 percent this year and will be below 10 percent by 2032, with linear EBITDA across the sector going from $33 billion this year to $20 billion in 2027 and $8 billion by 2032E,” the analyst estimated. “Streaming EBITDA is -$9 billion today and will only be around $8 billion in 2027. Of the group, only Disney will have more EBITDA in about five years.”
All this led Cahall to conclude that “fundamentals are strongest for Disney and Fox,” reduce stock price targets for other sector stocks and downgrade his rating on Paramount Global from “overweight” to “equal weight,” cutting his price target from $40 to $19.
“We’ve been bulls on Paramount’s content and streaming execution. While those aspects have trended well – and credit due to management – it increasingly feels like a myopic view on the stock,” the analyst explained. “We’re increasingly worried about the linear ecosystem across media, and this strips away visibility into what we were playing for as bulls: a trough in earnings with streaming driving growth on the other side.”
Cahall also summarized Paramount’s challenges this way: “harder choices ahead.” Among others, the company “might have to choose if streaming is the right home for its more expensive sports rights like the NFL,” he explained. “Raising prices on streaming would be a sign that the business is more attractive/sustainable, but that threatens churn. Finally, consolidation is a logical consideration, but no actions have been undertaken.”
Meanwhile, Cahall cut his price target on “equal weight”-rated Warner Bros. Discovery, which has the “most linear EBITDA,” from $19 to $16, “primarily due to WBD’s high leverage and uncertain earnings outlook, which is not unique to media companies.”
The Wells Fargo analyst on Tuesday also reduced his stock price target for “underweight”-rated AMC Networks from $27 to $10 PT from $27 to $10, “reflecting a challenging road ahead,” and that of “overweight”-rated Lionsgate from $15 to $12, due to a lower valuation for Starz, while highlighting: “a spin-off of its studio assets should drive strong interests from strategic and financial buyers.”
Cahall continues to rate Comcast “underweight,” but has cut his price target from $36 to $30 “on our tougher linear outlook.” While he diagnosed “downside pressure” for NBCUniversal EBITDA, he noted the company’s bigger financial contribution from its core cable systems and beyond. “This strong base of non-media earnings likely will give Comcast lots of looks at peers looking to partner or consolidate, and/or that are looking to unload expensive sports rights,” the analyst argued.
Meanwhile, Cahall lauded “overweight”-rated Fox, on which he has a $43 price target, for having the “best balance sheet” and “options to monetize sports.” He pointed out though: “Since Fox is mostly a pure play linear company, the natural thinking would suggest we should be more negative since it has lots of sports rights that are outpacing revenue growth. But, we think the unused arrow in the quiver is that Fox has optionality.”
For example, “currently, its sports rights are not in the digital ecosystem, and we think it has options to sub-license digital rights, such as the World Cup, MLB, college football and the NFL NFC package to streamers. It’s likely balancing options between sports betting monetization, linear deals (retrans, reverse comp) and streaming sub-licensing, with the outcome being more durable earnings, in our view.”
Cahall’s top pick is Disney, calling the stock “our preferred media name,” with an “overweight” rating and $145 price target. Noting that it is the company that is “furthest along” the streaming transition with “most DTC scale),” he emphasized: “Disney is the best positioned traditional media company to make the DTC pivot due to its proactive management of linear declines.”
He also predicted that it could take ESPN “to a fully à la carte service sooner versus later, fomenting more cord cutting, and we don’t think Disney is really over-earning in the bundle as sports are low-margin and will monetize more directly in streaming.”
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