Media economics - Evolution vs Revolution -- RBC Capital Markets

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Over-the-Top (OTT) content offerings remain the biggest topic of discussion amongst Media investors, with Hulu and YouTube likely to enter the Pay TV distribution foray sooner rather than later. More than ever consumers will be able to move around the ecosystem so contemplating what OTT products will emerge and how the sub base evolves become a critical aspect of Media stock valuation. At 15x NTM P/E Media stocks still trade at a discount to Consumer Discretionary (18x) and the S&P500 (17x), with uncertainty around the Pay TV universe likely a major contributor to the discount.

See the future: RBC's Evolving Subscriber Model

We don't claim to know what Hulu, YouTube or any other digital MVPD will ultimately come up with, exactly. So what we've done instead is create what we consider to be a powerful, proprietary model that allows us take the current consensus outlook of 1-2% annual subscriber declines in multichannel Pay TV - the basis for most long-term forecasts - and compare that to a world whereby large numbers of traditional subscribers migrate to digitally distributed platforms and skinnier traditional + OTT bundles. We're able to build out scenarios across a broad range of variables including Multichannel net adds/losses, skinny bundle trends, subscriber growth at OTT and customizable OTT tiers with different Media nets and bespoke assumptions on per-sub monetization (Affiliate Fee and Ad). The output of RBC's Evolving Subscriber Model is domestic revenue growth by Media company, so for each Media stock it can be flexed under unique scenarios around OTT and the overall ecosystem.

Media economics - Evolution vs Revolution

In setting up our ecosystem scenarios we started with 3 tiers of OTT options that we think will emerge. We have the skinny 'Limited Edition' bundle at $30-$35/mo, but we think this will be tough to create and content will be limited/incomplete. A much more robust 'Best of Cable' content offering prices out at $50-$60/mo and we think this will garner far more OTT subs. An 'All Cable' offering is >$75/mo. We've tiered networks based on how we see negotiating leverage with CBS, DIS, FOXA and TWX in the best positions. Our scenarios then encompass some pretty big inflections in subscribers. After laying out a Base Case (Scenario #1) we then model in a big increase in skinny bundle penetration(Scenario #2) and then a massive loss of traditional subs at 5mm p.a. going to OTT tiers (Scenario #3).

Media may have terminal growth!

Scenarios #2 and #3 encompass some pretty massive shifts to the ecosystem. But for CBS, DIS, FOXA and TWX the change in revenue CAGR vs the Base Case is negligible (CBS, DIS, FOXA) or modest (TWX, but from a high base) with these stocks still seeing MSD/HSD revenue CAGR. There is more material revenue growth pressure at DISCA, SNI and VIAB, and these are starting from lower bases of LSD/MSD growth, suggesting some bifurcation of fortunes in Media from OTT. Overall though, our Scenarios still imply positive terminal growth for Media stock revenue.

FOXA and TWX are our preferred names

We think the results are particularly important for FOXA and TWX with >50% of OIBDA from cable nets and lowly 12.5x CY17 P/E valuations. If investors begin to agree that the changing ecosystem will still mean growth at FOXA and TWX we think they can rerate. CBS and DIS show well in our Model too, but we think this is already well known for CBS (to their credit), whereas DIS is probably binary to exactly how ESPN is worked into OTT tiers (a point of contention). DISCA, SNI and VIAB show less well and this could mean lower relative valuations vs peers, ceteris paribus.

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