Quick Thoughts: DIS and VZ Sitting in a Tree …

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SEE LAST PAGE OF THIS REPORT Paul Sagawa / Tejas Raut Dessai

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October 24, 2019

Quick Thoughts: DIS and VZ Sitting in a Tree …

  • VZ will give 1 yr. of DIS+ to ~35M wireless subs on unlimited 4G plans and to new FiOS and 5G subs starting Nov 12. Rivals T (HBO), TMUS (NFLX) and S (Hulu) are already bundling free streaming media with new contracts. We are NOT optimistic for VZ’s 5G plans.
  • DIS jumpstarts the race to scale at the cost of a steep fee discount. Tentpole franchise strategy is winning theatrical race, will eventually drive to DIS+ long term success and synergy across all businesses. In near term, lost content licensing and deterioration of linear TV will be painful.
  • For NFLX, this doesn’t change much. We believe very few would cancel to take DIS+, particularly if it is free. Streaming wars narrative is significantly overhyped – biggest effect will be higher programming costs for a few years.

Disney and Verizon jointly announced a deal to give the carrier’s 4G wireless customers (unlimited plans only) and new residential customers (FiOS and fixed 5G) one year of free Disney+. This amounts to somewhere between 40-50 million US households plus the new adds between now and June 2020 (Exhibit 1). This is analogous to offers that Verizon’s wireless competitors already have in place: T-Mobile gives Netflix to all its post-paid wireless customers, AT&T gifts HBO (and may up the ante to include HBO Max when it launches), Sprint offers Hulu to new subs, and Apple has announced that one year of its fledgling Apple TV Plus will come with every major device purchase – iPhone, iPad or Mac. In this context, we’re not sure the Verizon/Disney deal is much of a game changer, but it could draw a few additional customers its way.

As an aside, many stories about the deal have emphasized how offering Disney+ enhances Verizon’s 5G service offering. We disagree. 4K video streams require 25Mbps. In most major markets, 4G LTE delivers more than 100Mbps in all but the most congested sites. Disney+ (or for that matter, Netflix) will perform just fine in almost all cases without 5G. Moreover, technical issues in sustaining connections using Verizon’s high frequency millimeter wave spectrum – signals are easily disrupted by physical obstacles, precipitation, even the user’s hand – and their very short useful distance (<1Km) leave us skeptical that the company’s 5G business strategy will be successful. T-Mobile’s build-out plan, once the merger with Sprint is complete, is far superior, offering broad coverage using long-distance 600MHz spectrum and capacity via Sprint’s ample mid-frequency 2.5GHz spectrum holdings. That service will be nearly ubiquitous with strong in-building support vs. Verizon’s spotty and potentially unreliable coverage.

Exh 1: A brief summary of content provider partnerships

Back to the streaming agreement, Disney would seem a bigger winner than Verizon here. In one fell swoop, Disney will pick up 40-50 million subs for the yet to be launched Plus service, albeit at a substantial discount to the $6.99/month list price (Exhibit 2). Presuming the flow of theatrical releases – starting with the summer blockbuster Avengers: End Game and working from there – and the franchise driven exclusives – The Mandalorian (Star Wars), High School Musical: The Musical: The Series, The Lady and the Tramp (live action), and others – capture significant engagement, turning a majority of Verizon free trials into paying subscriptions should be a lay-up. Hulu – already with 25 million subs and revenue from ads – and the new ESPN+ fill out Disney’s mini-bundle, giving the House of Mouse a very strong basis for competing in the streaming era.

Of course, there is an elephant in the room. While the streaming services gain their traction, the linear TV networks – ESPN and its family of channels, ABC, The Disney Channel, and others – will be losing it (Exhibit 3). Disney’s networks generate almost half of the company’s profits via ad sales and fees from Pay TV distributors. The aggressive shift in emphasis toward streaming is an acknowledgement of the future of video entertainment and the right move for the long run, but the pain in the near term as advertising revenues tank and fee renegotiations go badly will be considerable for investors. Analysts like to think bad news like that is already in the stock price, but given history, it is probably not ALL in there. The cavalry is coming, but those Verizon subs won’t be paying anything close to full freight until Christmas 2020.

The other narrative in the market is that the “streaming wars” will damage Netflix, which has ruled the roost for VSOD over the past decade. We are strongly in the camp of those questioning that conventional wisdom. Netflix has 160M subscribers, nearly 100M of those outside of the US, where Disney+, Hulu, Amazon Prime Video, Apple TV Plus, HBO Max, Peacock, CBS All-Access, and the other riff raff networks are not a competitive factor and won’t be for a long time, as the rights to most of the programming has been sold off to others (Exhibit 4). Netflix has generally paid up to have full international rights, including buying out back-end participation, for its “original” shows. This is proving prescient as the international market drives most of its growth.

Exh 2: Estimated Disney+ paid subs gained from VZ and organic, 2020E -2024E

Exh 3: Avg. Time Spent on Mobile Phones in the US passing TV, 2014 – 2021E

Exh 4: NFLX Quarterly Cumulative Subscriber Base Trend, 2Q12 – 3Q19

Those 160M subs (and growing) are also enormous leverage in bidding for new content. Even counting those discount Verizon subs, Disney+ will be less than a quarter the size of Netflix at launch. Those other networks? Smaller still. AT&T hopes that HBO Max can hit 50M subs within 5 years. Apple, which is giving a year of its Apple TV Plus service with every iPhone, iPad and Mac it sells, will have nominally more, but will have to convert those users to paid subs. For contrast, it has also given away a year of Apple Music with every one of the 200M+ iPhones it has sold every year for the past three years but has just 60M paying subscribers to show for it. Amazon won’t say how many of its Prime households actually watch the video service it provides for free with each membership, but third parties estimate roughly 35M households.

With the exception of Disney, which is going all in on delivering the might of its catalog and content franchises to its streaming products, none of the would-be warriors in the streaming business are likely to compete as a head-on rival to Netflix – they can’t or won’t spend the money to fill their services with even close to the same quantity of quality content. AT&T? Look at the balance sheet. Amazon? They are giving the service away for free with purchase. Apple? The same. Comcast? CBS-Viacom? Meanwhile, the average US Pay TV bill is $110/month. HBO is $15/month of that spending for the 35M households that subscribe. Netflix at $13.99 is an enormous bargain. No one is going to cancel that to free up the cash to pay for Disney+ – and thanks to Verizon, they won’t have to until this time next year. The real spending at risk from “streaming wars” are those cable set top box rental fees.

Exh 5: Despite growth slowdown, NFLX subscriber base could comfortably expand beyond 250M in next 4 years

The biggest downside to Netflix to this influx of would-be streamers is more bidders at the table for top content. Still, as the linear TV network death spiral accelerates, that will remove some bankroll from the auction. Disney will likely to be content reserving its own studio content for Disney+ and may not really bid up prices for output not in its control. Amazon and Apple will only buy so much – they are looking for a handful of prestige programs to help drive sales in their primary businesses, not to build a true rival to Netflix.

So, US sub numbers may be a bit soft for a year or so – taking 60M to 70M US households will be harder for Netflix than it will be for its new rivals to go from 0 to 10M (Exhibit 5). At the same time, running largely unopposed in international markets hungry for Hollywood content, there is a lot of room for growth outside the US. Netflix also has monetization drivers unused in its back pocket – a lower priced ad supported pricing tier, live programming including sports, etc. – that it can always lever to juice revenues if the subscription trajectory really slows. It’s been a tough year for Netflix investors, but we suspect, the best is yet to come.


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