On Friday, June 24, FTSE Russell conducted its annual index rebalancing. Many communication services companies migrated from the Russell 1000 Growth Index to the Russell 1000 Value Index. Components of the sector, including streaming services, entertainment, media, cable, telecommunications and social media companies, have come under pressure in the first part of 2022. But why? And amid the falling stock prices, are there still places to find value in the sector if you know where to look?
The dwindling predictability polka
After losing 200,000 subscribers in the first quarter of 2022, Netflix, the company that revolutionized streaming, warned that it could hemorrhage a whopping two million viewers in the second quarter. Its stock price cratered, taking much of the streaming industry with it. The stock has yet to meaningfully recover and has since been added to the Russell 1000 Value Index, while its weighting in the Russell 1000 Growth Index has been reduced. In some ways, Netflix may be the victim of its own success. With so many households already signed up for the service, it becomes harder to add new ones. Competition is getting increasingly intense. As more and more streaming services companies compete for a finite number of subscribers, organizations have had to find new ways to capture and maintain customer relationships. This shift in how media organizations run their businesses affects company fundamentals and has investors taking a hard look at the players in this evolving industry. The criteria for a “good investment opportunity” have changed along with the landscape.
The coveted content calypso
Several years ago, when people thought of direct-to-consumer (DTC) streaming services, content aggregators Hulu and Netflix came to mind. Recently there has been an influx of competitors into the space, and many media companies like NBCUniversal, Paramount Global (formerly ViacomCBS) and Discovery Networks, created DTC services that offer shows from their own studios. Major technology companies like Apple and Amazon are pouring money into their own services, further expanding the competitive landscape.
Subscription fees are a key component of these companies’ revenues, and fickle consumer behavior has reduced the predictability of these inflows. Consumers can sign up and later cancel without penalty and will often subscribe briefly to watch a show they want to see, then cancel and move to a different service. This pattern has caused media companies to invest heavily in original content to attract subscribers, as desirable content has become a primary driver of subscriber numbers. These content costs are the biggest expense many media organizations incur. In our opinion, a drawback to this subscriber-focused model is the steep depreciation in the value of these assets after the initial viewing window.
The blood from a stone swing
Further dampening the appeal of subscriber-driven business models is that the hours of content being developed annually have increased, but there is no commensurate uptick in the number of hours consumers spend watching or share of household income devoted to paying for programming. As markets become more saturated, companies will incur more costs to expand into emerging and frontier markets, likely developing new content specifically tailored to consumers in these markets, as this is one of a few ways to expand the subscriber base. This dynamic has made us cautious about investing in most streaming services companies. While an array of business models can be considered candidates for investment if the stock price falls far enough, we’ve found media companies that go beyond the subscriber-driven business model which we feel offer compelling investment opportunities given the current valuations.
In an environment where warring content platforms fight over an increasingly saturated consumer base, our preferred way to invest in content creators is to do so without being completely tied to subscriber numbers as the determining factor of a company’s value. We think media companies with multiple divisions aside from content creation provide a good diversification of income sources and risks.
A situation where a company’s DTC relationship with consumers is part of a larger ecosystem and can reinforce their relationship with its characters and other creations could lead to the streaming service’s position as a valuable augmentation to the total business, as opposed to being the total business. In addition, companies with strong franchises and ways to monetize viewers’ relationships with characters through theme-park rides and merchandise long after a series or movie airs, provides a more resilient asset base with less depreciation after the initial content viewing window. That dynamic creates more value for the company—and ultimately for shareholders.
As young industries mature and consolidate and older industries pivot, an intimate understanding of the environment in which they operate becomes increasingly important. Among streaming and media companies, we believe stock picking is crucial to avoid the allure of high-flying names with limited long-term business potential. We prefer a more diversified business model.
If the cost of content production remains as high as it is today, we believe not all the current streaming contenders can remain in operation or as standalone businesses. In the meantime, DTC service providers will continue to battle each other for eyeballs in the streaming wars. While they do, we will continue to seek out companies with more to offer than a rotating subscriber base.
WHAT ARE THE RISKS?
All investments involve risks, including the possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments. Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.
IMPORTANT LEGAL INFORMATION
This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. This material may not be reproduced, distributed or published without prior written permission from Franklin Templeton.
The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as at publication date and may change without notice. The underlying assumptions and these views are subject to change based on market and other conditions and may differ from other portfolio managers or of the firm as a whole. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market. There is no assurance that any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets will be realised. The value of investments and the income from them can go down as well as up and you may not get back the full amount that you invested. Past performance is not necessarily indicative nor a guarantee of future performance. All investments involve risks, including possible loss of principal.
Any research and analysis contained in this material has been procured by Franklin Templeton for its own purposes and may be acted upon in that connection and, as such, is provided to you incidentally. Data from third party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. Although information has been obtained from sources that Franklin Templeton believes to be reliable, no guarantee can be given as to its accuracy and such information may be incomplete or condensed and may be subject to change at any time without notice. The mention of any individual securities should neither constitute nor be construed as a recommendation to purchase, hold or sell any securities, and the information provided regarding such individual securities (if any) is not a sufficient basis upon which to make an investment decision. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user.
Products, services and information may not be available in all jurisdictions and are offered outside the U.S. by other FT affiliates and/or their distributors as local laws and regulation permits. Please consult your own financial professional or Franklin Templeton institutional contact for further information on availability of products and services in your jurisdiction.
Issued in the U.S. by Franklin Distributors, LLC, One Franklin Parkway, San Mateo, California 94403-1906, (800) DIAL BEN/342-5236, franklintempleton.com – Franklin Distributors, LLC, member FINRA/SIPC, is the principal distributor of Franklin Templeton U.S. registered products, which are not FDIC insured; may lose value; and are not bank guaranteed and are available only in jurisdictions where an offer or solicitation of such products is permitted under applicable laws and regulation.