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Warner Bros. Discovery’s HBO Max vs. Viaplay
Modest Growth vs. Massive Expansion Efforts in The Global Video Industry
Streaming was never going to be a very good business, at least not relative to what came before for the owners of the world’s major media properties.
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That Was Then
Consider the case of HBO. Prior to the launch of HBO Max in 2020, HBO generated approximately $7 billion in revenue ($6 billion from subscription revenues earned primarily via their cable and satellite operating distributors) with more than $2 billion in EBITDA. Content spending was around $2.4 billion and the service had approximately 35 million domestic subscribers, where the bulk of revenue was generated.
At the end of 2019, AT&T – the then-owner of Warner Media, HBO’s parent company – presented a plan to create HBO Max. To start, the initiative required $5 billion of investment. From there, the aim was to create a unit that in 2025 would have had $5 billion in incremental domestic revenue, $4 billion in incremental domestic customer acquisition and programming costs and 75-90 million subscribers. Overall, this would have led to a business that was intended to generate at least $12 billion in revenue and more than $3 billion in EBITDA. In early 2021, an updated plan was presented which conveyed an intention to get to $15 billion in revenue by 2025 with only breakeven results, but 120 million total subscribers (including 25% through AT&T services).
Either of these approaches appeared potentially realistic. Therefore it should have been well-understood that the economics of unbundled one-to-one-based direct-to-consumer businesses are not as good as those with mass distribution and forced bundles using intermediaries. The latter model drove the cable industry quite successfully for more than forty years, but everyone knew that its best days were in the past.
At the time, the investor community was primarily focused on subscriber counts when they focused on streaming video services because of a perception that it would help “traditional” media companies mirror Netflix’ growth and then realize Netflix-like valuations on a per-subscriber basis, at least for the streaming parts of their businesses.
Profitability from streaming wasn’t much of an issue of focus for many investors although others – myself included – could acknowledge the profit erosion and recognize that if the death of the old model was inevitable, why bother trying to prop it up? And besides, absolute profits could be higher in a streaming world if a provider pursued the global opportunities in front of them. DTC-based video businesses would only require one investment in infrastructure and could benefit from scaled content investment, especially with media properties that can play globally. Marketing and customer acquisition efforts were another aspect of streaming that would clearly benefit from scale because of the advantages that come from experience and scaled insights.
This Is Now
Now firmly under control of Warner Bros. Discovery (WBD), current aspirations for HBO Max appear to fall somewhere in between the two targets set out by AT&T. Including its Discovery+ and other streaming offerings, WBD now has set a target of 130 million subscribers across all of its services for 2025 (this compares with its present figure of approximately 90 million unique subs today, of which more than 70 million are HBO subs, including around 45-50 million in the US). The company’s profitability goal calls for $1 billion in EBITDA at that time.
If HBO Max can add another 20 million subscribers in the US, it would approximately match Netflix’ current totals. However, Netflix’ content budget last year was $14 billion in terms of amortized expenses and $17 billion in cash outlays, or around $6-7 billion for the US alone if we assume an allocation that is proportional to its domestic revenues. Figures such as this matter if you have the view that there should be some relationship between spending on content and subscriptions (not to mention relative volumes of viewing).
The entirety of WBD’s spending on content across all of its businesses is only slightly bigger than what Netflix spends at a global level, and most of that content will never make it to HBO Max. Disclosures for the company’s DTC segment convey total costs of revenues of $8 billion in 2022, so presumably content spending allocated to this division is closer to $6-7 billion as a global level today. If we further assume that the majority of spending is related to domestic HBO Max, then perhaps they are around $2 billion behind Netflix in the US.
Can HBO Max catch up? It’s a realistic goal. If one assumes a simplified 10% annual ARPU increase (capturing revenues from subscriptions as well as advertising) along with the company’s stated subscriber goals we would see $6 billion in new revenue for the segment. Should every incremental dollar of revenue drop to the EBITDA line and if other costs can be (unrealistically) held constant, the division would have $4 billion in EBITDA. Given the company’s $1 billion EBITDA goal, this leaves $3 billion more to spend on the business around the world relative to 2022 activities. Perhaps marketing costs can be reduced a bit, but it’s hard to fathom doing so by much because of the constant churn associated with streaming services, even if water-cooler content is only available on a weekly basis. A $9-10 billion total global content budget for DTC services could then allow HBO Max to effectively match Netflix’ current levels of $6-7 billion although this wouldn’t leave very much for the rest of the world. With different assumptions around ARPU increases or perhaps a superior ability to generate subscribers with less content, one can imagine that its goals are plausible.
However, even if WBD did increase its spending to match Netflix’ levels, the company has also taken actions that add to risks around this objective, and almost certainly limits upside relative to the strategies pursued prior to Discovery’s acquisition of the business.
Consider the following:
· Some significant content has been removed from HBO Max while other content formerly on the platform is no longer exclusively available on HBO Max and will also be available on its linear TV networks in the US. By contrast, most content on many other SVOD services including Netflix remains exclusive to those services
· WBD has scaled back the commissioning of original productions in Europe while other streaming services have continued to increase them
· In major European markets, HBO Max was constrained at launch because of pre-existing content licensing arrangements, especially with Comcast’s Sky in the UK, Germany and Italy. Recent choices will entrench those constraints: WBD’s management has conveyed that it intends to renew that arrangement, and has expanded its relationship by licensing content in other European markets to Sky’s JV with Paramount, Sky Showtime. In France, WBD has licensed content to Amazon.
For better or worse, all of this conveys that it is unlikely HBO Max will become a global platform comparable to Netflix, Amazon Prime Video or Disney+, although it could still be a sizable business in the US at minimum.
What Are the Implications for WBD?
From there, whether or not the entirety of WBD would be well-positioned to grow further might be a better question to focus on. If we can imagine how the industry looks in 2025, it’s not hard to imagine that streaming services will be more mature in the US than they are now. Perhaps they will still be able to collectively grow by high single or low double digits with a significant total addressable market left to capture (as half of US households would still be paying more than $100 per month for traditional pay TV). So that business will probably be ok.
But how about the rest of the world, and Europe in particular where the market will remain relatively large and content developed for a US audience will still resonate well? Unlike Netflix, Amazon, Disney, Comcast, Paramount and Apple, WBD’s exposure to streaming-related revenues would primarily relate to the traditional business of licensing content. That could still be a good source of growth, assuming the company is capable of securing relevant talent and producing hit programming, although it might be essential for WBD to be every streamer’s “second-favorite” supplier of content after each service’s in-house production units, much as Warner’s TV content production business was in the US for many years when it was part of Time Warner.
One can argue that the actions taken by WBD to limit the near-term losses of new ventures and reinforce older and more profitable historical business models could be a favorable choice for purposes of maximizing near-term cashflow, especially if these choices better position the company to compete in the long-run. One could also make assumptions that its choices will superior capital returns with lower risk overall. More practically, given the amount of debt WBD required to close the transaction with AT&T and the real risks to many revenue streams which are largely outside of the company’s control (i.e. the possibility that TV advertising is going into a period of secular decline and the reality that ongoing cord-cutting will lead to core cable network subscriber losses which can’t be offset by higher affiliate fees per subscriber), a shorter-term focus is understandable and potentially necessary. However, I would argue that WBD’s overall approach has the effect of limiting long-term growth potential vs. strategies which more aggressively lean into a DTC-driven world of streaming video.
Contrasting Strategies: Viaplay vs. WBD
For an interesting contrast to WBD’s approach, I like to look at Sweden-based Viaplay, which is regularly in my mind when I think about companies who pursue significant expansion efforts. Little known outside of its home region where it was previously Nordic Entertainment Group, and before that a division of Modern Times Group, the company’s roots are as one of the largest TV and radio broadcasters in Scandinavia. After launching a streaming service for its home markets in 2011, then spinning out of Modern Times Group in 2019, by late 2020 the company articulated a vision to become the ”European streaming champion.”
Arguably this wasn’t going to be hard to do by virtue of the limited efforts from others. Budget commitments made by much bigger broadcasters such as ITV, M6, TF1, P7S1 and RTL were barely amounting to tens of millions of euros per year in recent years, and were almost entirely focused on domestic markets. Ambitions haven’t become much more significant, and in some instances they have actually been diminished (i.e. the shutdown of the M6-TF1-led joint venture in France called Salto).
Nonetheless, the focus and investment in the streaming opportunity from Viaplay has been significant in relative terms. Prior to the pandemic, the business was growing at a mid-single digit level and producing profit margins of high single digit or low double digit levels, with cash from operations as a percentage of revenue at similar levels. By contrast, in 2022 the company incurred significant losses and cash outflows equivalent to 20% of total revenue (primarily because of negative working capital) in order to produce company-wide organic growth amounting to 20% for the full year. Now with 4.6 million Nordic subscribers and 2.7 million international subscribers (vs. 0 international subs at the beginning of 2021), the company is guiding towards 12 million international subscribers at the end of 2025. Organic revenue growth guidance calls for a 16-19% CAGR from 2020 to 2025, implicitly a similar amount for the 2023-2025 period as well, which would more than double the company’s total size between 2020 and 2025. Profit margins (EBIT) guidance calls for long-term 20% margins in the Nordic region and 25% elsewhere.
While direct comparisons between Viaplay and WBD are clearly going to be limited, I think it’s still worth highlighting the wildly different nature of ambition between these companies on a relative basis. After all, the two companies are primarily exposed to the professional video industry and both recognize the growing dominance of streaming DTC video services as well as the global nature of the industry.
However, one company is planning on doubling in size and the other implicitly aiming for single digit revenue gains. For sure, one could point to WBD’s size with $43 billion in pro forma revenues during 2022 and note that it’s harder to double a business of that size vs. one like Viaplay, where revenues were approximately $1.4 billion. On the other hand, consumers probably spend around $300 billion on video content annually around the world, and TV network owners generated approximately $155 billion last year, according to data from GroupM, which means that even with limited growth there’s a large market available. Moreover, video is clearly a scale-based business, where access to talent, experience with distributors, availability of relevant infrastructure and other factors mean that it’s likely easier to become bigger if you’re already big than it is for a small company to become significant.
One could argue that pursuing substantially greater scale could only occur by placing existing revenues and profits at greater risk, which might be true in the near-term, but I doubt it would be in the long-term. Further, even if aggressive action led to a bad outcome (such as reduced long-term profitability) for a large incumbent, it might still be better than alternatives where competitive upstarts with no legacy business in a given sector or country move more aggressively to take share and capture economic value. Fortunately for those upstarts, large incumbents won’t always make the right choices to maximize long-term outcomes, leaving significant opportunity for the smaller players in a given sector to invest, grow and realize heightened levels of profits for their own businesses instead.
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