Big Media Is Now Wide Awake

Netflix forever changed the game – twice... One iconic business struggled to catch up... 'Big Media' is now wide awake... The next dramatic shift coming to this industry... Why the future looks bleak for the market's most established player...

Editor's note: Digest editor Justin Brill is out of the office for two weeks. So we're featuring a series of essays from some of Stansberry Research's top analysts...

This week, we've already heard from Extreme Value analyst Mike Barrett on why you should pay attention to millennials' concerns and Extreme Value editor Dan Ferris on a "recipe for disaster" that's playing out in the credit markets. Today, Stansberry's Big Trade editor Bill McGilton talks about the rise of an online-streaming giant – and its coming downfall...

The way we watch television and movies forever changed 12 years ago...

In 2007, Netflix (NFLX) launched its online video-streaming service. Hulu unveiled its competing service later that year, and it launched for the American public in March 2008.

Today, these two industry leaders – as well as newer arrivals like Amazon Prime Video, Sling TV, and others – are known as over-the-top ("OTT") media services. They provide programming "on top" of the Internet... without the need for a cable or satellite connection.

Before long, folks saw the advantages of these OTT services...

They were easier to use and more convenient than traditional cable or satellite TV.

People no longer needed to wait hours for a technician to give them access to content. They didn't need to sit through blocks of commercials while watching the shows. And subscribers could view the content as long as they could use the Internet. OTT services reached a new level of convenience with the rise of tablets and smartphones starting around 2010.

Plus, OTT services were much cheaper than traditional "pay TV" services. (Nowadays, pay-TV service averages more than $100 per month... but you can get Netflix for just $9 to $16.)

That's because companies that offer OTT services – like Netflix – don't have the same infrastructure costs needed to operate a cable or satellite network. So they can compete with these pay-TV providers at a fraction of the costs and pass the savings on to customers.

As a result, customers started abandoning pay-TV providers in droves for OTT services...

This movement – known as "cutting the cord" – gained steam in the years that followed. From 2012 through 2018, media-research firm Leichtman Research estimates that pay TV lost 10 million subscribers. Leichtman also notes that this trend is accelerating... Last year, the company said almost twice the number of folks left pay TV compared with 2017.

In today's Digest, I (Bill McGilton) will cover the rising popularity of OTT services, detail how the "Big Media" companies have finally woken up, and explain the next dramatic change coming to this industry. Let's start with what Netflix did to kick this shift into another gear...

Six years ago, Netflix took its streaming service to the next level...

It went beyond the realm of reruns.

On February 1, 2013, the company premiered its first original program – the politics-focused drama House of Cards. More important, Netflix did it in a way that had never been done before... Knowing OTT subscribers love to consume the content when it's convenient for them, the company released all 13 episodes of House of Cards at the same time.

The move proved to be a huge success...

More than 2 million Netflix subscribers watched the first season of House of Cards in the first 30 days. It became the first online-only series to receive major Emmy nominations.

House of Cards' success helped Netflix again change the media industry forever... It proved Netflix could create its own high-quality original content, which became a new way to drive subscriptions. Since then, Netflix and other OTT providers have followed this blueprint...

Over the years, Netflix's original series have included Orange Is the New Black, Stranger Things, Daredevil, and more. Others have introduced original programming, too – from The Handmaid's Tale on Hulu to The Marvelous Mrs. Maisel on Amazon Prime Video, and more.

As a result, more people than ever are turning to OTT services...

Last year, according to market-research company eMarketer, there were 170 million OTT subscribers in the U.S. And by 2022, that number is expected to climb to 198 million people – or around 58% of the U.S. population. Take a look at this chart...

Even though you can see that eMarketer believes the rapid growth in the OTT market will slow down in the next few years, this new way of watching TV and movies is here to stay. The majority of the U.S. population has already shifted its viewing habits to these services.

As this shift picked up speed in recent years, one iconic American business scrambled to catch up...

First, as the pay-TV industry bled subscribers, wireless telecom AT&T (T) became the biggest player in the space with its $67 billion deal for DirectTV in 2015. AT&T thought the move would give its current pay-TV services an edge. But its timing couldn't have been worse... Since the merger, AT&T has lost more than 1.5 million DirecTV subscribers.

So then, in 2018, AT&T spent $85 billion to purchase industry giant Time Warner – owner of HBO, Turner, CNN, the Warner Bros. Entertainment movie studio, and other Time Warner content like the Harry Potter films. It plans to launch its own OTT service with WarnerMedia-exclusive content, luring cord-cutters onto its platform and shoring up its hemorrhaging pay-TV segment.

AT&T got caught on the wrong side of the OTT market. And it has been spending a fortune trying to make up for it... including buying a library and studio for original content. With $197 billion in total debt, it's now the most indebted non-financial company in the U.S.

It took a long time for most Big Media companies – like AT&T – to wake up and appreciate that the future of media distribution is through OTT services like Netflix.

But now, Big Media is wide awake. And the competition will soon intensify in a big way.

Several new OTT platforms will enter the market over the next couple of years...

In the fall, consumer-electronics giant Apple (AAPL) will launch an OTT service called "Apple TV+." It will feature exclusive, original content from beloved talent like Oprah Winfrey, Steven Spielberg, Reese Witherspoon, Jennifer Aniston, and more.

And as I said earlier, AT&T plans to launch its WarnerMedia OTT by the end of the year – incorporating exclusive content from its acquisition of Time Warner.

Pay-TV juggernaut Comcast's (CMCSA) media subsidiary, NBCUniversal, plans to launch its own OTT in 2020. It will be supported by advertising and feature TV shows and movies from NBCUniversal's existing library, original content, and third-party programs.

And CBS (CBS) is discussing a merger with Viacom (VIAB). CBS needs Viacom's movie and TV library to boost the offerings of its OTT service, CBS All Access. Plus, it needs Viacom's Paramount Pictures film studio so it can produce more original shows.

Existing OTT services are stepping up their offerings, too... For example, Amazon (AMZN) plans to spend $6 billion annually on original content for its Prime Video service.

But one new entrant to the OTT market will blow all the others away...

This company owns the largest and most iconic collection of movie and TV content on the planet. And by the end of this year, it will launch its own OTT service.

Regular readers know I'm talking about entertainment giant Disney (DIS). In early November, the company plans to debut its OTT service called "Disney+."

At the start, Disney+ will only offer around one-fifth the number of TV shows and one-eighth the number of movies that Netflix does today. But more important, the Disney+ offerings will include some of the most popular TV shows and movies ever made...

Subscribers will get instant access to all the Pixar animated movies, most Marvel films, 30 seasons of Simpsons episodes, old Disney movies like Bambi and Snow White, more recent Disney movies like Moana and Frozen, 5,000 episodes of Disney Channel shows, and a lot more. Disney also plans to attract subscribers by developing exclusive TV series based on the Marvel and Star Wars franchises that will only be available on Disney+.

At the same time, it's in the process of pulling all its existing content off Netflix. So if you want to stream a Disney product, you will need to sign up for Disney's OTT service.

A Disney+ commercial-free high-definition ("HD") plan will cost $7 a month, or $70 if you pay for an annual subscription. That's less than half the price of Netflix's premium HD plan.

Disney expects to enroll 60 million to 90 million subscribers around the world by the end of 2024.

And more important, Disney's plan for OTT media distribution goes much further...

You see, back in May, Disney reached a deal with Comcast to take over full operational control of Netflix's next biggest competitor... Hulu. And under the agreement, Disney can buy Comcast's remaining 33% stake in Hulu in January 2024.

Hulu is known more for TV-show reruns than movies. But as I mentioned earlier, their service also produces its own original content. And subscribers can also take advantage of a "live TV" option. Hulu currently has around 28 million subscribers.

Disney expects to focus more on content for families and children with Disney+, while Hulu will be more adult-oriented. But the company also plans to bundle Disney+, Hulu, and its sports programming from ESPN+ into various packages for subscribers.

It's clear that Disney will soon become a dominant player in the OTT market.

That's bad news for the industry's most established player – Netflix...

In the coming months, Netflix will have to deal with competition like never before.

As I've shown, the competition across the OTT market is about to increase dramatically. And of course, all these companies plan to ramp up their efforts to create exclusive, original TV shows for their OTT services – the blueprint that Netflix created with House of Cards.

While many people do subscribe to more than one OTT service, that comes with limits...

In April and May, Swiss investment bank UBS ran a survey to gauge how many OTT services people would be willing to pay for. The survey found that half were only willing to pay for one... 40% would pay for two or three... and only 10% would pay for four or more.

With all the newer and cheaper offerings entering this market in the near future, people are going to choose other OTT services over Netflix. And the incentive to go with the other services will only increase as more Big Media companies stop licensing their content to Netflix and distribute it directly through their own OTT services – like Disney+ is doing.

For instance, the most-watched show across all streaming services – former NBC sitcom The Office – won't be available on Netflix after next year. That's because NBCUniversal decided to pull it off Netflix and make it available exclusively on its own OTT platform.

And WarnerMedia is pulling the sitcom Friends off of Netflix, too. Friends is moving exclusively to WarnerMedia's HBO Max OTT service when it launches.

WarnerMedia made the move despite Netflix paying an incredible $100 million to license Friends in 2019. That's up from $30 million in 2018. Netflix was willing to pay more than three times the previous year's price because of Friends' huge draw among its subscribers.

Even so, WarnerMedia decided Friends' potential draw for its HBO Max OTT service outweighs the $100 million in licensing fees it was getting from Netflix.

Netflix needs to somehow make up for the loss of popular programs like this...

And its only choice is to develop more original content that can drive subscriptions. But that isn't easy... and it costs a lot. In 2020, Netflix plans to spend $18 billion developing its own content. And that's on top of the $15 billion the company has budgeted for this year. (My colleague Austin Root covered Netflix's "dirty little secret" in the Digest last November.)

It's a race to attract consumers with new Netflix originals as third-party content becomes harder to find and more expensive to license. There's no guarantee it will work...

Netflix is in a life-and-death race to grow its subscribers faster than its content spending.

Big Media is no longer just trying to make a few extra bucks by licensing its old content that would otherwise be collecting dust. It's attacking... And Netflix is in deep trouble.

Ultimately, Big Media no longer wants Netflix as its middleman. Moving forward, we can expect the OTT marketplace to be much more fragmented. And most consumers can't afford to buy all of these services. So they're going to have to make some tough choices.

No matter what they choose, one thing is clear: The future looks bleak for Netflix.

New 52-week highs (as of 7/16/19): First Majestic Silver (AG), Dollar General (DG), Western Asset Emerging Markets Debt Fund (EMD), Hershey (HSY), Ingersoll Rand (IR), Coca-Cola (KO), MarketAxess (MKTX), NovaGold Resources (NG), NVR (NVR), Procter & Gamble (PG), and W.R. Berkley (WRB).

In today's mailbag, one "rankled" reader shares her concerns about the "American Jubilee"... Do you have a question or comment for us? As always, send your e-mails to feedback@stansberryresearch.com.

"I'm 82, considered 'upper middle class,' I'd guess. My only long-term debt has been my mortgage or car payments, and they were paid off ahead of time. My monthly debts are paid in full – credit cards, utilities, etc. – always have been, even with putting six kids through college (they began saving early for that special event!).

"The idea of a Jubilee rankles me!! The frugal citizens, who were financially responsible, are being punished. I do see how the country benefits for one, BUT... it makes me want to go spend up a storm to get even!

"What benefit is there for responsible citizens? Does rewarding the reckless tell the world 'we'll save you from your own foolishness'? Hmmm... A wife and mom who believes in America's potential!" – Paid-up subscriber Christine B.

Regards,

Bill McGilton
Kiev, Ukraine
July 17, 2019