Morningstar Magazine - October/November 2016 - 82

Investors Cutting the Cord Forget set-top boxes. Innovation and upstart companies are changing the way viewers consume television programming and feature films. S E C TO R R A P Rob Wherry There used to be a saying in the media world that "content is king." In other words, if you produced the televisions shows and feature films viewers wanted, you had competitive advantages over other companies in the sector. Does that expression still hold? That's debatable, as the media sector has seen its fair share of innovations that have changed how millions of Americans consume programming. Indeed, no longer do households eat dinner and then watch the news and a hit show that comes on during prime time. Rather, consumers are more likely to binge watch an entire season of a favorite show in one weekend or watch a hit movie on their cellphones or tablets. Then, add in companies such as Netflix NFLX and Amazon.com AMZN, which not only have allowed consumers to get around the traditional broadcast television model but are also developing original content. With the media sector picture changing focus constantly, we sat down with Neil Macker, who covers the industry for Morningstar. He was interviewed in August, and his answers have been edited for length and clarity. Rob Wherry: Can you start by giving us your read on the media sector? 82 Morningstar October/November 2016 Neil Macker covers media companies for Morningstar. His coverage list includes Fox, CBS, Disney, and Discovery Communications. Macker: When it comes to the TV ecosystem, the challenges for media companies are the "cord-cutters," "cord-shavers," and the "cord-neverers." These are the people who are no longer entering into the pay-TV ecosystem or they are exiting or cutting back the amount they are spending in that area. It is something that the mainstream media has been talking a lot about. So, with the first white paper we did in December, the idea was to take a look at that and to say: "What is happening in that space and what are the interesting things these companies are trying to do to combat that?" If we look at the pay-television market-there are around 93 million pay-TV subscribers in the United States. That number has come down slowly over time, and pay-TV penetration, depending on how you look at it, is around the low 80%'s. That is down from a high of around 90% four or five years ago. The question for the companies I cover are: Are these people that are coming out of the ecosystem permanently out of the ecosystem and is there any way to draw them back in? There is some popular reasoning for why viewership is declining. One is lower household formations. Millennials are staying home with their parents and not forming new households. That explains some of the drop. Part of the drop is also based on affordability. If you look at what the pay-TV bundle costs nowadays, it is $70 to $90 a month compared with the content costs of the bundle, which are around $45. That is the amount a media company charges the pay-TV distributors per month on a per subscriber basis. That differential is going to the distributors. One of the things I looked at was what is a way of drawing that profit out and how can media networks move the price of the bundle down or capture more of that bundle itself? One interesting development is the emergence of new linear over-the-top pay-TV distributors. The first ones I've seen with this are Sling, which is offered by Dish DISH, and PlayStation Vue, which is offered by Sony SNE. Sling came out and said there are certain channels that people want to have and we are going to try to provide a subset of those channels. So, for $20 a month, Sling gives consumers access to those channels. Sony went at it a different way. It is recreating the pay-TV bundle and moving it onto this new platform, which is a PlayStation platform. It has signed up all the major cable channels, and in some markets, it has lined up local broadcasters as well. So, for $40 a month, you can get a very robust package of cable channels plus your local broadcasters. Now, the question over the long term is, does that value proposition hold up against just buying Netflix or Hulu or pirating it from other places? One of the ways we see piracy is not the traditional way, which is simply people going on to the Internet and downloading a show. The other part of piracy is, for lack of a better phrase, "soft piracy"-where millennials have gone out and formed their own households, but they are using somebody else's password. You are still getting the channels you want, you just aren't paying for them. Can you go into a little more detail by what you mean by cord-cutters, cord-shavers, and cord-neverers? Macker: Cutting the cord means a consumer no longer has pay-TV. They have decided the cost is no longer worth it. They may be replacing pay TV with Netflix, Hulu, or Amazon Prime. http://www.Amazon.com

Table of Contents for the Digital Edition of Morningstar Magazine - October/November 2016