- Data suggest that conventional network television is on the decline.
- Some have migrated to ad-friendly practices, but I don’t anticipate this to cause an inflection point in declining TV usage.
- As such, I urge investors to view Netflix as the best in class media investment, despite un-compelling profitability metrics.
Netflix (NASDAQ:NFLX) continues to grow rapidly. This marks the shift from linear broadcast television to on-demand streaming. And while it’s difficult to gain a pulse for the entire TV industry, data is continuing to show that usage of TV is declining across all day parts. This doesn’t necessarily negate the existence of multi-channel video program distributors, but it’s worth noting that content will continue to shift towards multi-platform alternatives like Netflix where subscription revenue becomes a higher percentage of the mix with advertising becoming a smaller component.
It's worth mentioning that Netflix does advertise, but instead of showing pre-roll or in-stream advertising, Netflix utilizes product placements as a more user friendly solution. Hence, you’ll hear really funky lines written to emphasize certain brands, or you’ll see certain movie characters drink certain brands of soda or use certain vehicle brands over others.
Broadcast television networks are starting to recognize trends in millennial behavior, and to retain television subscribers, the networks are starting to reduce advertising. Recently, Turner Network Television otherwise known as TNT announced that they were going to reduce ad load by more than 50% to retain viewership.
According to AdWeek:
To that end, Reilly said the network has "just begun negotiations" to add eight to 10 minutes of additional program time per hour on the new dramas premiering this year. "This is an opportunity we're putting out to the industry to embrace change and move the needle," he said. "We're going to reduce the ad load in those hours by over 50 percent." It echoes a recent announcement from Turner's truTV, which also plans to drop up to nine minutes of ads each hour this fall.
Of course, it’s worth mentioning that TNT is desperate to recover its audience metrics and shift advertising to more desirable ad formats that are better targeted. I’m anticipating that there will be further social integration in partnership with Facebook's (NASDAQ:FB) television integration post the acquisition of LiveRail and partnership with Nielsen. TNT’s reduction hasn’t been put into effect, but I anticipate that this massive shift in reducing advertising within linear broadcast is in its early stages.
It’s also worth noting that according to UBS analysis TNT’s total commercial minutes across all day parts on Time Warner (NYSE:TWX) declined by 13% Y/Y in Q4’15 and 5% Y/Y in the month of January. Now, it’s worth noting that the reduction in commercial viewing across Nielsen’s C3 metrics when pertaining to TNT isn’t due to the reduction in advertising, but rather the drop off in viewership among television subscribers. TNT only began negotiation of lowering its ad load, so commercial viewing isn’t being affected by strategic efforts to reduce advertising, and at this point, TNT risks losing subscription revenue if it continues to clutter its channel with ads.
The last bastion of hope for broadcast television networks is sports broadcasting. However many of the content providers like the NFL, NHL, MLB, and NBA have already shifted to OTT applications, and it’s not yet clear whether television networks can successfully shift to on-demand content while retaining licensing rights for sports. As such, investors have to be selective in the media space, and should avoid the vast majority of broadcast television networks for the time being.
It’s not yet clear if CBS (NYSE:CBS), ESPN (Walt Disney (NYSE:DIS)), NBC (Comcast -A (NASDAQ:CMCSA)), Twenty-First Century Fox (NASDAQ:FOXA) can successfully transition to over the top, and while it’s worth mentioning that the firms have impressive programming budgets, the television packages have lost millennials/generation Y.
According to UBS analysis:
Primetime TUT (total use of television) results, which include all use of the TV screen, shows more modest declines than the PUT (person using TV) data as consumers increasingly use their TV sets for streaming video and video games. P2+ (persons aged 2 or more) Primetime TUT was -1.9% and -2.3% among aged 18-49 (vs.-3.7% PUT). This implies that these demos increased their non-traditional TV usage by 11% and 15%, respectively. Every age group increased its non-traditional TV use Y/Y and people aged 12-24 now spend 31% of prime using their TV for things other than watching TV. – Doug Mitchelson
I don’t anticipate broadcast television networks to recover, or mitigate declining audience metrics as conventional revenue drivers like pricing, ad load, and international distribution have been fully leveraged. It’s not that these companies will completely disappear, but it’s worth noting that many of the businesses that I have cited are operating broken growth models with the exception of Walt Disney and Comcast. Comcast provides diversified revenue through its marketing of internet and TV bundles and in a world absent of TV, Comcast can charge more for data streaming costs for web-based television. In the case of Walt Disney, it’s worth mentioning that its theme park, movie studio, and merchandise business provide enough diversification to mitigate the secular shift away from programmable television content.
However, the big winner is Netflix (NASDAQ:NFLX) followed by Alphabet Inc-C (NASDAQ:GOOG) as both companies are better positioned to monetize online viewers as opposed to conventional broadcast television. I don’t anticipate Netflix to miss on its outlook, and anticipate revenue to materially accelerate due to its rapid roll out internationally, and incremental opportunities to leverage scale to lower marketing/content costs on a per unit of revenue basis. Netflix’s content budget is comparable to some of the larger networks, which reduces the competitive risk factors for owning the name, and its appeal among the younger demographics creates longer-term residuals that can be modeled into a terminal growth assumption further out into the future.
I don’t anticipate the shift to online to be cataclysmic, but rather gradual. As the UBS data illustrates the shift to non-traditional TV across all demographics implies that Netflix is winning the later adopters, which implies that Internet TV is starting to reach a mass market consumption model within the United States. While Netflix is not currently profitable, the company’s inherent value comes from the intangible aspects of its business model.
I anticipate Netflix's revenue growth to sustain at a 25% CAGR due to rapid TAM expansion and subscription pricing increases. I anticipate long-term net profit margins to stabilize at 10%, and the valuation to resemble that of other mature media names over the long run.
To help quantify the valuation, I arrive at an end of five-year valuation of $86.76 billion at 21.76x net income and then discount that valuation using the firm’s weighted average cost of capital, which is currently 8.72%. Therefore, I’m assigning a price target of $133.42, which makes it a compelling opportunity at these lower levels. Furthermore, I reiterate my high conviction buy recommendation for Netflix stock, as I have found find very little data to support the notion that Netflix’s business carries the implied risks asserted by other analysts. It's simply best in class in the TV space.