Invesco: The Streaming Wars

With the recent launch of streaming services from Apple and Disney and expected launches from AT&T and Comcast in the first half of next year, “The Streaming Wars” are heating up. Calling them wars is a bit of an overstatement, at least at this point. Streaming platforms are fighting for your leisure time and wallet but, for now, the differing strategies, combined with the industry’s structural tailwinds, should allow growth for all. More streaming platforms will accelerate the transition of video consumption from traditional linear TV towards internet based streaming services, driving demand for faster internet speeds and larger data allowance to the benefit of telecom and cable infrastructure owners.  The biggest losers from the transition are likely to be the traditional cable/satellite channels whose negotiating position will be weakened by an acceleration of subscriber losses from legacy multichannel pay-TV bundles.

 

The most prominent name in this sector is undoubtedly Netflix. Netflix has 158 million subscribers and is still growing rapidly, with almost 7 million subscribers added last quarter (0.5m in US, 6.3m international) and more than 7 million expected next quarter despite the increase in competition since the launch of Apple TV+ and Disney+ in November. Netflix has been so successful because they provide a compelling service with a broad and extensive range of quality content in exchange for a relatively low monthly price, compared to traditional pay-TV bundles, of just $12.99 per month.

Netflix uses its scale advantage from its enormous subscriber base to spend $15bn per year on entertainment content, more than any other media company in the world, to ensure they attract new and retain existing subscribers.  Netflix wisely decided a few years ago to produce more content in-house instead of licensing rights from production companies, giving them more control over the content and more exclusives. Following the early success of productions like House of Cards and Orange Is the New Black, Netflix has continued with this strategy, delivering more hit shows like The Crown, Stranger Things, Narcos and 13 Reasons Why.  This shift in strategy towards original programming puts a strain on cash flow, as in-house production has to be funded upfront, well before the show starts to benefit the income statement.  Whilst this transition is ongoing Netflix has seen increasing cash burn, but this is expected to trough in 2019 with annual improvements thereafter.

The need for capital to finance production of content means that Netflix has become a regular bond issuer in the last couple of years and has become a bigger part of the HY market. We’ve owned Netflix bonds since they first issued EUR denominated bonds in 2017, over which time we’ve seen credit rating upgrades.  Their 2027 EUR 3.625% issue is trading around 105 but still offers a yield to maturity of around 2.8%, compared to 2.5% for the wider Euro market of BB-rated bonds, and a higher spread than Netflix’s equivalent USD bonds.

 

Netflix now faces more competition from rival streaming platforms than ever before, so as a bondholder it is important to consider whether it can maintain its global dominance in this increasingly competitive market.

 

The first competitor to consider is Amazon’s established streaming platform Prime Video, which has grown alongside Netflix over the last decade.  Amazon’s proposition is slightly different from Netflix’s. Prime Video is included with an Amazon Prime subscription which, along with a number of other perks, provides free shipping on Amazon’s website. There are more than 100 million Amazon Prime subscribers, of which around 40 million use Prime Video. Amazon’s content library isn’t as compelling as Netflix’s, as they only spend about half as much on content per year; however it serves a different purpose, which is to keep customers engaged with Amazon.

 

Two new entrants to the streaming market are Disney and Apple. But, given the scale and the loyalty of Netflix’s and Amazon’s customers, we think it will be difficult for these new entrants to permanently poach them. I would argue that Disney and Apple agree, as both their streaming platforms are launching at very low price points, designed to position them as complementary services rather than replacements.

 

Disney launched Disney+ at just $6.99 per month, much cheaper than Netflix’s $12.99, and it will be given free to 17m households who are customers of Verizon’s unlimited phone plan or any new fibre / 5G broadband customers. Disney is using the strength of its brand and simultaneously building a content library that makes it an almost essential purchase for families. The Disney+ library consists of nearly the entire back catalogue of Star Wars movies and related series, Marvel movies and series, Pixar movies, old Disney movies, 30 seasons of The Simpsons, Disney Channel shows and 35 original movies. It is targeting 90 million subscribers by 2024 and is off to a strong start, having signed up more than 10 million in the first two days. Disney’s focus on family content is another sign it is not aiming to replace Netflix for most households but rather positioning it as an additional service for families.

Apple launched Apple TV+ cheaply too, at just $4.99 per month but essentially free for much of its target market, as they provide a complementary 12 month subscription to customers who purchase a new iPhone, iPad, Mac or Apple TV device. Apple sold 279 million iPhones, iPads and Macs in 2018 which gives them a huge potential customer base to sign up. Given the free offer, it seems the service is as much about driving iOS adoption and upgrading of Apple hardware as it is about driving a new revenue stream, which makes the service more analogous to Amazon’s Prime Video.

From a content perspective Apple doesn’t appear to be trying to be a replacement for Netflix, as they are focussing on 100% original content, with a budget of just $1bn in year 1 and a commitment to spend $6bn over the next few years. Whilst original content will drive new subscribers, it is important to have a broad and extensive library of content to maintain subscriptions, and it seems most users will struggle to satisfy all their needs with Apple TV+ alone.

Perhaps the biggest threat to Netflix’s domestic business will come from AT&T’s HBO Max, which is due to launch in May 2020 at $14.99 per month. AT&T is targeting 50 million domestic subscribers and 25-40 million international subscribers by the end of 2025 by offering a broad and compelling library of content and cross-selling into AT&T’s extensive customer base. The service includes HBO hit shows such as Game of Thrones, Big Little Lies, Silicon Valley, The Wire and West World in addition to Turner and Warner Brothers content and recently acquired rights to South Park, Rick and Morty, Doctor Who and Friends.

HBO has had a standalone streaming service, which includes just their HBO content for $14.99 per month, since 2015 and has amassed close to 10 million subscribers. These will be pushed into their new HBO Max service. While HBO Max may impact Netflix’s domestic ambitions, constraining subscriber growth and price increases, HBO Max’s international ambitions are relatively modest, which should allow Netflix to continue to deliver strong subscriber growth outside the US.

Finally, Comcast’s Peacock service will launch in April 2020. Subscribers will have the option of an ad-supported service with no subscription charge or an ad-free subscription service.  Little is known about the quality of the content library but, based on the information available, it doesn’t appear Peacock will provide a content library to rival Netflix for most households.

We expect Netflix to continue to benefit from their first mover advantage in the streaming market, and although the arrival of rival services will cause some short-term headwinds, we believe that over the medium-term Netflix will continue to be successful.  The launch of new streaming services from Apple, Disney, AT&T and Comcast, combined with increasing content spend by Netflix and Amazon, will accelerate subscriber losses for the legacy multichannel pay-TV bundles. This trend will impact traditional cable/satellite TV channels that lack the scale to create their own streaming service, particularly those producing general entertainment content. AMC Networks, Discovery and Viacom are perhaps most exposed, and we do not own bonds from these issuers.  Whether Netflix is successful or not, it is clear there is a shift from the consumption of video content via traditional linear TV towards internet-based streaming services.  This shift will drive demand for faster internet speeds and larger data allowance to the benefit of fixed and mobile telecom operators and cable infrastructure owners. We have large bond holdings across a range of these names.

Investment risks
The value of investments and any income will fluctuate (this may partly be the result of exchange-rate fluctuations) and investors may not get back the full amount invested.

Important information
All data is as at 30/11/2019 and sourced from Invesco unless otherwise stated.

 

Where individuals or the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals and are subject to change without notice. This document is marketing material and is not intended as a recommendation to invest in any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication. The information provided is for illustrative purposes only, it should not be relied upon as recommendations to buy or sell securities.