War on TV Part III: Reductio “Ad” Absurdum
As we have written in “War on TV” parts I and II, the next generation of consumer electronics will make it much, much easier for viewers to find and watch increasingly compelling “over-the-top” programs, a development that could accelerate the audience migration to streaming media. As this irreversible shift plays out, its biggest near term effect will be on advertising, the source of more than 60% of TV network revenues. Ratings, particularly in prime time and amongst the most valuable demographics, are falling. Increasing DVR use, particularly for the most popular programs, and “multi-tasking” are reducing the effectiveness of TV ads, while new metrics show the targeting and assured reach advantages of streaming video. The ad community continues to prioritize TV, but growing on-line video ad spending coupled with weak 2013-14 “up-front” ad sales could forebode future pain of potentially “newspaper-like” proportions for the networks. Even a modest downward turn would seriously threaten the multi-channel model, eroding networks’ ability to fund popular programming and raising the stakes of future fee negotiations with system operators. We are concerned for fall quarter ad revenue shortfalls for media companies, particularly given their current valuations. Cable MSOs and traditional ad agencies are at longer term risk. On-line streamers, e.g. NFLX, AMZN and GOOG, independent studios, e.g. DWA and LGF, and digital agencies, e.g. VCLK, will be beneficiaries.
Advertising is the lifeblood of channelized TV. US TV ad revenues were $64.5B in 2012, up 6.4% YoY on election and Olympic advertising, not quite double the fees paid by multi-channel operators. Despite the rise of digital media, TV has grown as a percentage of total ad spending over the past decade to 40%. In contrast, newspaper advertising collapsed, while print is under pressure.
TV audience is deteriorating. TV households, total multi-channel service subscribers, and overall viewing hours have declined since 2010, with particular weakness in ad friendly demographics. Primetime ratings have been bloody – in the 2012-13 season, average audiences were down 3.7% for CBS, 5.7% for NBC, 9.7% for ABC and a stunning 22% for Fox. The quality of that audience for advertisers has also diminished, with DVR use on the rise, especially for the highest rated primetime shows, and building evidence of “multitasking” drawing attention from commercials. Given that Nielsen, the dominant ratings service, employs an antiquated and, likely, biased measurement methodology, we fear actual TV audience engagement may be worse than suggested. Meanwhile, all measurements of streaming internet video show 40-50% annual growth.
TV ad spending at the brink. Magna Global projects 2013 TV ad sales down 2.8% against a tough compare, with broadcast nets taking a 6.8% hit. Upfront sales for the fall season have been poor, with relatively few takers willing to pay the high single digit price increases asked by the networks in the wake of the disappearing primetime audience. Talks are still underway, but total commitments are likely to be $800M to $1B lower than a year ago, with the specter that further ratings disappointments could result in substantial make-goods and a poor spot market, thus adding to the networks’ ad woes.
On-line video ads poised to take advantage. On-line video advertising has grown from $1B in 2009 to $3B+ in 2012, and is projected at $4.5B for 2013, ~7% of projected TV ad spending. This growth is driven by an increasing appreciation for the precise targeting and tracking, flexible formats, assured reach, and interactivity offered by digital video, compared with the heterogenous audience, fixed format, growing ad skipping and inattentiveness offered by TV. One recent survey reported that 58% of marketers thought that digital video ads outperformed TV, and another reported that nearly 75% of marketing professionals plan to increase their spending on streaming video in the next year.
Newspaper advertising déjà vu? TV bulls point to the recent stability of TV ad spending, but print media offers a chilling analog. Newspaper readership started falling in the late ‘90’s, yet ad revenue, adjusted for the 2001 recession, grew well into 2006, only to be cut in half by 2010, as on-line search and display ads flourished. With the decline of TV viewership, the rapidly growing on-line audience and the emergence of reputable metrics for assessing the effectiveness of streaming video ads, the stage may be set for another jarring adjustment in advertising budget priorities. We note that there is growing dissatisfaction with the accuracy of TV ratings. Nielsen reps build personal relationships with rating households, which are compensated to accept the company’s monitoring equipment, potentially spurring atypical behavior. Moreover, the methodology does not distinguish between ambient and active viewing, and likely overestimates the number of household members engaged with the TV.
A rock and a hard place for TV networks. Advertising accounts for 90% of broadcast network sales. Programming makes up 80% of the total costs. If TV ad spending were to fall at a 3% CAGR, while programming costs continued the recent 4% annual growth trajectory, the results would be dire, squeezing the current 9% operating margins to nothing in less than 2 years. Cable networks, with 55% of sales from MSO fees, are much more insulated, but would still see their robust 42% operating margins clipped by 3-4%/yr. With typical video bills now exceeding 2% of average after tax household income, nets may also find it much harder to raise MSO affiliate fees, which have grown 8%/yr. in recent years. “Other” revenue, largely fees for selling content to on-line, DVD and syndication, is nearly 10% of projected 2013 sales for broadcast nets (just 3% for cable) and growing at a 30%+ pace. Weakness in advertising, resistance on fees, and rising programming costs could leave on-line as the most viable profit lever, albeit with the risk of hastening the decline in TV advertising.
Media stocks at risk for 4Q13. High valuations for TV network owners leave considerable downside, should our concerns for a weak advertising market in the fall play out. Cable, satellite and ad agency stocks have less immediate exposure, but are at long term risk as the channelized TV model erodes. On-line video players, e.g. NFLX, AMZN, GOOG, and others, are in a strong position, as are independent content producers, such as DWA and LGF, who are gaining a new channel in which to sell their programs, and digital ad agencies, like VCLK. The next and final piece in this series will examine broadband and the economics of distribution.
For our full research notes, please visit our published research site.