Hollywood Earnings Season Trends: Direct-to-Consumer, Cord-Cutting and More

Bob Iger, Reed Hastings, David Zaslov and Bob Bakish - Split - Getty - H 2017
Getty Images

Also: A debate about TV advertising trends.

With second-quarter earnings season for Hollywood conglomerates and pay TV giants in the history books, investors and Wall Street analysts have been looking through the latest results and CEO comments to gauge the outlook for the entertainment sector. 

And according to many, things are looking difficult as pay TV subscriber losses and ratings challenges are among the dark clouds casting a shadow over investors' confidence.

"It was another tough quarter from a stock perspective, as several of the media companies [posted] disappointing results or outlooks," Jefferies analyst John Janedis said in his earnings season review. "Investor sentiment across the group remains negative." He added: "The negativity around second-quarter earnings was worse than we anticipated."

With cord-cutting accelerating, industry giants, such as CBS Corp., which unveiled plans to launch its CBS All Access streaming service internationally, and Walt Disney, which announced future digital ESPN and Disney movie services, are reacting with more direct-to-consumer initiatives and in some cases, such as Discovery Communications, which has agreed to acquire Scripps Networks Interactive, with deals. 

Here are three key take-aways from the latest quarterly entertainment industry earnings parade:

Cord-cutting accelerates, but some see positive signs

Pay TV subscriber losses hurt industry players because big portions of their profits come from their cable networks business. Lower subscriber numbers mean an impact on affiliate fee revenue. And after a worse-than-expected first quarter of 2017, cord-cutting gained further steam in the latest period.

Craig Moffett and Michael Nathanson, analysts at MoffettNathanson, estimated a whopping 941,000 subscribers cut the cord during the second quarter, up from 809,000 in the year-ago period. "The rate of pay TV subscriber erosion worsened, rising sequentially from 2.5?percent last quarter to 2.7?percent in the second quarter, the fastest rate of decline on record," the analysts wrote recently in a report.

Virtual pay TV services, such as DirecTV Now, Dish's Sling and services from the likes of PlayStation, Hulu and YouTube, have also competed with traditional pay TV providers, but partially offset the subscribers losses in a potentially positive for entertainment companies. They signed up about 469,000 subscribers, the analysts estimated, which would have left total pay TV sub losses for the second quarter below the comparable figure for 2016.

Credit Suisse analyst Omar Sheikh in a forecast suggested that "subscriber losses [are] likely to get worse in the second half." He argued: "With new marketing for Hulu and YouTube TV likely around the start of the new NFL season, we expect both new services to grow materially in the second half and recapture more customers dissatisfied with the expanded basic bundle. However, they will, of course, also likely cause some incremental losses to traditional [pay TV operators]."

Sheikh concluded that "a reasonable assumption" would be that traditional pay TV operators' subscribers decline 3 percent-3.5 percent year-over-year in the back half of 2017, while the virtual pay TV services' recapture rate improves to 55 percent-60 percent from an estimated 45 percent in the second quarter. He added: "On this basis, total video subscribers will be declining at a faster rate of 1.9 percent by the fourth quarter," compared with 1.1 percent in the second.

But Morgan Stanley analyst Benjamin Swinburne focused on the positive side of subscriber gains for virtual pay TV services and streaming providers. "Over-the-top subscriber trends continued to surprise to the upside in the second quarter, with Netflix reporting a record second quarter, CBS All Access and Showtime expected to cross 4 million subs by year-end 2017, and Starz and WWE OTT reaching about 2 million and over 1.5 million," he wrote.

And Nathanson wrote in a report this week: "Over the past few years, the media industry has moved from denial of a structural problem towards acceptance that consumer behavior has irreversibly changed. Along with that acceptance, there is a Plan B emerging that seeks to usurp traditional, heavy and linearly based distribution models with slimmer, smarter OTT systems."

Direct-to-consumer initiatives come into focus

Entertainment companies are rolling out direct-to-consumer streaming services amid the pay TV subscriber trends. But analysts say that could further fuel the pay TV subscriber exodus and unwinding of the pay TV bundle, raising questions about the financial impact on cable network owners.

That is why Disney's newly unveiled direct-to-consumer push, which will mean the end of its movie output deal with Netflix, drew mixed reactions. "We still have so many questions," Wells Fargo analyst Marci Ryvicker titled her report, for example. "From the conversations that we have had with investors, the lack of info gave off the impression that this is a very reactionary move, which is uncharacteristic of Disney, and could very well signal that the pay-TV ecosystem is weaker than the market already feared," she said. "Unfortunately there are too many unanswerable questions. How does this impact Disney's upcoming affiliate renewals? ... How will peers and partners react?"

FBR & Co. analyst Barton Crockett offered: "In a world in which CEO Bob Iger is openly talking about a surge in consumer engagement with app-based entertainment, this move seems necessary for Disney; but it also seems destined to further accelerate the inevitable consumer transition to a patchwork of discrete online services — and away from the traditional bundle that is so richly lucrative for Disney."

He added: "Disney is not giving much guidance yet on the direct push, but we see a measure of earnings per share pressure as the investments ramp up."

Swinburne lauded Disney, though, for a nuanced approach that will see it offer new digital services while also continuing to work within the traditional pay TV business. "This nuance highlights the industry's complex but critical pivot to capturing the booming demand for OTT services while protecting its legacy earnings base," he said. 

Meanwhile, CBS, which has been building its direct-to-consumer business and expertise for a while, got positive reviews for continuing to diversify its revenue sources and taking CBS All Access around the world. "CBS showed continued evidence that it is evolving away from the primary reliance on advertising revenues," wrote Nathanson. "The company’s playbook is now a blend of affiliate growth through retransmission fees and reverse compensation plus their own OTT platforms, content sales and dependable ad growth from ownership of key sports rights. Despite a very rough sea for many media stocks in 2017, this narrative has produced a relatively stable CBS [stock] price."

Direct-to-consumer questions also came up on other earnings calls, such as that of 21st Century Fox, as Guggenheim Securities analyst Michael Morris highlighted in his report. "The company was quick to say that while they feel confident in their position in the changing pay TV business, they remain open to expanding consumer access to their programming and did not rule out a direct-to-consumer initiative in the future," he wrote.

Analysts debate TV advertising outlook

So how healthy is the TV advertising outlook for entertainment industry giants? Wall Street observers have shared different takes on the issue.

In his report titled "Third-quarter outlook muted," Janedis reduced his cable networks year-over-year ad growth estimates to 0.5 percent from 3.0 percent, but highlighted that was better than the second-quarter decline.

Sheikh said second-quarter advertising was "mixed," while the current quarter's trends were "improving." He explained: "Industry data suggests U.S. cable advertising growth deteriorated in the second quarter, to -4 percent from -1 percent in the first quarter. Broadcast advertising, by contrast, strengthened to 4 percent in the second quarter from 2.4 percent in the first quarter."

Swinburne highlighted that "incremental softness in advertising and marketing services, from large advertisers (agencies) to small (out-of-home) conflicts with generally solid U.S. economic data" and asked: Is this slowdown cyclical or secular?" His answer: "Perhaps some of both." 

Looking at ad trends ahead, Sheikh said: "Company guidance on the third quarter was generally positive, with most indicating that advertising would grow in the quarter. Only Time Warner and Viacom provided guidance that ad revenues would decline (low single digits)."

Highlighting that the advertising upfront selling season reportedly brought ad rate increases in the mid-single digit range for some companies and the high-single digit range for others, with Fox's cable networks even getting a low double-digit boost, the analyst concluded: "Unless ratings deteriorate materially, this should provide a tailwind to ad revenues from September."

All in all, there was a lot to digest for Wall Street this earnings season. "It was an eventful media [earnings] season," Bernstein analyst Todd Juenger wrote on Wednesday. One of his big take-aways from the latest reports and calls: "Fundamental revenue drivers are getting worse. Sub losses accelerated, audience losses accelerated, advertising demand is fading."

He added: "The market is quickly dividing the remaining media stocks into 'winners' (Fox, CBS, and eventually Disney; we would include Lionsgate) and 'losers' (Discovery, AMC Networks, Viacom). We believe the risk here is greatest at the supposed 'winners.' We see them more as 'less bad' than 'absolutely good.' For Fox, we are highly skeptical of the Sky deal. For CBS, we believe an acquisition premium is being priced into the stock, which is risky given the ownership/control."