Beyond Bulls & Bears


Communications breakdown: The great subscriber shuffle

In the first of a two-part series on the communications services sector, Mandana Hormozi of Franklin Mutual Series breaks down the streaming wars and uncovers hidden opportunities she sees within the rubble.

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.


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