There has been no shortage of headlines recently about declining TV audiences, cord-cutting and so-called “skinny” TV packages – with many focused on Disney. The Walt Disney Co. is a significant holding in a number of Trimark funds and we spend a great deal of time thinking about the competitive moat around its Media Networks business as certain trends become more prevalent.
While it is clear to us that the industry is changing because some TV viewers are consuming TV content outside of the traditional bundle, we believe that media companies with in-demand content and a flexible approach to monetizing it will remain well-positioned to compound shareholder value. In this blog post – my first – I will summarize some of the current industry dynamics and frame our views around Disney’s competitive moat.
The changing TV ecosystem
The trend of shrinking “traditional” TV viewership (i.e., cable or satellite subscription) has been underway for over five years. The number of U.S. households with a pay TV subscription peaked in 2009 at just over 100 million, and since then about 5% have “cut the cord.”1 This can be explained by a variety of factors:
- Delayed household formation among millennials
- The rising costs of pay TV packages relative to consumer incomes
- Increased availability of alternatives for accessing media online
Multiple studies have shown that the majority of cord-cutters are younger consumers who access TV content through other sources. However, two interesting facts are worth noting:
- The average number of hours per day that Americans spend watching traditional TV has increased since 20092
- Younger consumers are watching more video content on smartphones, computers and smart TV devices than ever before3
The young consumers at the center of the cord-cutting phenomenon are not giving up TV altogether, but shifting their viewing to other platforms and devices. As this group becomes a more meaningful demographic, it’s likely that demand for traditional TV bundles will continue to decline. In response, the industry has created several different ways of accessing TV content, including:
- TV bundles that only feature popular channels at a cheaper price point
- Over-the-top (OTT) streaming solutions that charge viewers a monthly subscription fee
- Pay-as-you go services from popular TV networks selling content directly to consumers
Can Disney sustain its competitive moat?
As long-term investors, we constantly think about the risks of potential disruption to company business models and try to assess the impact on our portfolio holdings. Given the outlook for ongoing changes, what makes us positive about Disney’s ability to navigate potential disruption to the TV ecosystem? The answer: business model flexibility.
Traditional TV bundles are designed to attract customers using high-demand content while also encouraging sampling of lesser-known channels that are “subsidized” by popular networks. In contrast, skinny TV bundles mostly do away with sampling and focus on targeting specific tastes. As these packages proliferate, the most-watched networks should become vital to attracting new subscribers. Most of Disney’s TV network assets fall into these “must-have” categories, such as broadcast programming (ABC), live sports (ESPN and SEC Network) and children’s content (Disney Channel).
Disney’s access to this content is secured by:
- Multi-year programming rights with leading sports organizations
- Ownership of TV and film studios that produce original content
- A patent-protected intellectual property library
Disney controls five of the top 20 TV channels based on prime time viewership, more than any other media company.4 Distributors that choose to exclude Disney’s programming risk making their bundle unappealing to a large group of potential customers. We continue to see a strong case for Disney’s content to be at the core of future TV bundles, however skinny, and its channels have found their way into the majority of skinny bundles on the market to date.
What about Netflix?
As OTT viewership rises, Disney’s moat remains firmly intact. The company’s shrewd capital allocation decisions have included investments in content assets like Pixar, Marvel, and Lucasfilm – bringing a plethora of movie rights that can be sold to a variety of streaming services.
The OTT business model is built around subscriber growth, and attracting subscribers means offering a wide selection of popular options. This “fight for content” plays out very well for Disney because its intellectual property consists of precisely the type of content demanded by OTT providers. In particular, Disney has a deep library of popular children’s programming, movies and scripted original series, which should allow the company to negotiate attractive deals with video streaming services. Recent deals the company signed with Netflix include streaming rights for new movie releases as well as older catalog titles like Daredevil that were generating little profit, but will now be repurposed into Netflix mini-series and movies. If successful, this model should allow Disney to generate revenues from similar properties deep within its library.
Reaching viewers directly
The recent launch of DisneyLife, a dedicated subscription streaming service in the U.K., is further proof of the company’s flexible strategies. This service provides content directly to consumers, without a distributor or streaming service. In addition to strengthening the Disney brand through direct engagement, we think the company will gain access to data about customer viewing habits that will be helpful in future content creation. It is early days for this model, but sitting at the head of the OTT table allows Disney to figure out the optimal content mix for various platforms in a given market in order to maximize profitability.
By adapting Disney’s business model to include new distribution channels, we believe CEO Robert Iger has the right strategic vision to keep Disney’s content relevant and available to consumers in whatever ways they choose to access it.
How are we positioned?
Disney is a significant holding in Trimark Fund, Trimark Global Fundamental Equity Fund and Trimark Global Dividend Class. Our investment philosophy focuses on owning high-quality businesses that are trading at a discount to their intrinsic value. As outlined above, Disney has wide competitive moats that we believe will allow it to succeed in an evolving TV ecosystem. In adherence to the Trimark discipline, we are continuing to monitor the valuation of this high-quality company relative to our estimated intrinsic value.
If you have any questions about our positioning around Disney, please leave a comment below and I will make every effort to respond in a timely manner.
1 Source: Leichtman Research Group, August 2015.
2Source: U.S. Bureau of Labor Statistics Time Use Survey, 2014.
3 Source: Nielsen Total Audience Report, 2Q 2015.
4 Source: Nielsen 2014 18-49 Primetime Ratings.
Note: The company listed above is for illustrative purposes only and is not intended as specific investment advice.