Analysts Warn of Possible Downside of Digital Boon for Entertainment Giants

While such Hollywood conglomerates as CBS and Viacom beat earnings expectations due to deals with the likes of Netflix, BTIG's Richard Greenfield warns that the "love affair with digital licensing may not play out as anticipated."

NEW YORK - Digital distribution deals for library content with the likes of Netflix, Hulu and boosted CBS Corp.'s, Viacom's and Comcast-controlled NBCUniversal's latest quarterly financials, which they reported this week.

Wall Street analysts agreed that a good part of the upside earnings surprises particularly of the two Sumner Redstone-controlled entertainment giants was due to digital revenue and profit. But some of them also wondered whether there will be a risk and long-term downside to the boon in the quarter.

"Digital drives the upside," Credit Suisse analyst Spencer Wang said about Viacom's Friday results.

BTIG's Richard Greenfield estimated the entertainment giant's quarterly revenue boost from content deals with Netflix and Hulu at around $70 million. And Wang said: "The upside in the quarter was driven by high-margin digital revenues, for example deals with Netflix and Hulu, which accounted for 10 cents per share, or around 80 percent, of the variance with our earnings per share estimate."

Similarly, Barclays Capital's Anthony DiClemente highlighted that CBS reported "a very strong second-quarter in part driven by incremental revenue from its digital media deal with Netflix."

"Of the media companies that have reported this week, Viacom, CBS and Comcast handily beat expectations in part due to the high-margin flow-through of new deals with Netflix and/or Hulu," Nomura analyst Michael Nathanson summarized in a report late Friday. "Two other companies – Discovery and Time Warner – have resisted these “big” jumps into the online water and did not produce the same sized domestic surprise."

DiClemente added that Time Warner has the largest TV library with over 50,000 episodes and could be next to do deals. "Given the deals that CBS and NBC have struck with Netflix and Amazon, we anticipate TW would tee off a similar deal shortly," he said. "Management indicated ongoing discussions with all of the digital outlets."

Greenfield cautioned though that industry CEOs shouldn't be blinded and argued that too much availability of TV content online could ultimately affect TV viewership.

The title of his comments late in the week: "Media’s Online Gold Rush or Catch-22? Who Are The Losers? We Cannot Believe Everybody Wins."

"As the U.S. multichannel video market matures and home entertainment revenues fall, media companies have a new best-friend, called digital licensing," he said. After skepticism about digital distribution just a few years ago, when former NBCUni CEO Jeff Zucker spoke of digital pennies for analog dollars, it now feels "as if everyone in Hollywood’s new favorite drug is called “digital” and it appears to be quite addictive."

Greenfield's conclusion: "We would love to think that digital is all incremental - viewing and profit-wise, but our gut says the market/press love affair with digital licensing may not play out as anticipated. Just a matter of when that becomes clear and who gets hurt first/most."

Nathanson similarly highlighted that Wall Street loved the digital boon reported by Viacom, CBS and Comcast/NBCUni. "These digital dollars helped drive 2012 earnings revisions higher," he said.

Just like Greenfield's, his warning contained a mention of a potential negative effect of online availability of content on TV viewing. But he also included a reference to the music industry.

"The swing amongst analysts from fearing digital deals to welcoming them as sources of upside surprise reminds us of a time in our previous lifetime," Nathanson wrote. "From 1998 to 2004, we had the glorious chance to cover the global music industry -the first consumer media industry that was being affected by the emergence of the Internet."

Nathanson recalled that back then most on Wall Street had negative views on music companies as the CD market matured and piracy took its toll. When Steve Jobs and Apple the iPod and iTunes, "for a brief period, the parabolic growth of digital music downloads combined with a short term “improving” decline in CD sales (due to folks converting their favorite CD to their iPods) actually produced a temporary positive
inflection in U.S. music sales," he explained.

But music fundamentals continued to suffer. Nathanson continued: "Record stores went out of business as it was hard to compete with 99 cents downloads delivered electronically versus $14 albums. Music companies suffered due to that self-inflicted deflationary act." Meanwhile, Apple saw its stock price grow from $8 to over $350, he added.

"The current content licensing deals make a ton of sense as lower valued shows are now being sold to a greater number of buyers," Nathanson concluded before sharing some advice with Hollywood conglomerates: "Our hope remains for media execs to continue to be vigilant and broker future deals that will efficiently monetize library content, rather than follow an ideal that all digital deals are good."

He even outlined the likeliest near-term risk - viewers changing their TV behavior, which could be "adversely affecting networks that don’t offer live, exclusive or premium content."


Twitter: @georgszalai