Media:Updating Our Latest Thoughts on Subs,Advertising,Box Office,M&A,and Valuation

Despite solid Q2results announced over the summer, large-cap entertainmentstocks remain out of favor, largely underperforming the market down -8% YTDand down -5% since the end of earnings season (mid-August) versus the S&P+5% and -2% for the same periods, respectively. Below we highlight key themesand concerns we believe are plaguing the group and how we see these overhangsimpacting stocks over the next few months. We also take an updated look atvaluation given trough multiples for some of these stocks, which we believe couldprovide a great entry point to some high-quality content plays longer term.

    Waiting for the shoe to drop. Since the notorious Disney earnings call inAugust 2015, when CEO Bob Iger highlighted an acceleration in subscriberdeclines, there has been a heightened awareness of the ongoing reduction in payTV households. Subsequent to then, trends have worsened (see Figures 1and 2,below), most notably in Q2’16when sub declines were well ahead of the prioryearperiod. Combined with the impact of cord shaving, we estimate cablenetworks in general are now losing between -1.5% and -2.5% of subs on a y/ybasis, a range consistent with recent management commentary from severalcompanies. Investors at this point appear naturally focused on whether increasedcord cutting will lead to further acceleration in ecosystem losses. Exacerbatingthis trend, most media company CEOs are now highlighting their inclusion orinternal development of OTT/streaming services versus a more conservativetone in prior years. The interplay between these new services, ongoing shifts inviewership habits, and increased awareness by consumers of cord-cuttingopportunities (Walmart now includes a cord cutting calculator on its website)are creating uncertainty around the long-term financial outlook for mediacompanies, clearly impacting valuation. While the overhang on stocks from alack of visibility is unlikely to disappear any time soon (and indeed sub declinesmay get worse before they get better), we are not as negative as valuationssuggest noting the following: 1) when factoring in the cost of broadband, thecurrent or proposed vMVPD services provide less value to the customer thanadvertised; 2) a proliferation in OTT bundles (DTV Now expected in Q4andHulu in early 2017) provide an opportunity for networks to reach the estimated13.3m broadband-only households (SNL estimate for end of 2015), partlyoffsetting the impact of cord cutting; and 3) TV Everywhere offerings continueto progress (we highlighted in our July report on The Converged TelevisionOffering), with increased episode stacking, authentication rights for networkapps, and better customer interfaces, which is improving consumer perceptionsof price/value for the traditional bundle.