What the Bear Market Means for the Media Sector

on Strictly Business. More with him in just a moment. We're back with veteran media analyst Navin Sarma for a conversation we held on May as a virtual part of the program from the Monaco Streaming Film Festival. I think to the first time I interviewed you back in ten and the discussion was pegged to looming fears of a recession, fears that I should point out proved unfounded. Then now here we are, more than three years later, for a

very similar conversation, though under very different circumstances. So how does where we stand now in terms of these recessionary fears differ from where things stood economically last we talked about this sure, and as you point out, and we talked about a recession, it didn't happen. We got a

pandemic instead. UM. So I went back and I looked through my notes on you know what we thought was baked into a potential um economic recession in twent and I've got to say that that this time around, things are far more complicated. UM. When we think of scenarios which could result in an economic down turn our recession, there's multiple overhangs this time, any of which can ultimately push the economy into a recession. I'm going to go through a list. I'm probably gonna miss a couple, but

here it goes high inflation. We haven't seen that forty years or forty years, certainly since I've been working. UM, But but that's certainly a concern. We've got high interest rates, we haven't seen that since, certainly before the Great Procession in two thousand and eight. We've got supply chain issues, um, which is impacting the ability to get product of consumers. We've got high energy costs in this country, but certainly in Europe much more of an issue. We have labor constraints.

The workforce hasn't come back after the pandemic, and so many businesses are so short of labor that's resulting in high labor costs. And then we've got geopolitical risks. We have a war in Europe as well, and so all of those things are are complicating the ability to assess what could drive an economic downturn, what could result in an economic downturn, and then what could the impact be on companies? H Yeah, sure, so, UM, actually go ahead if you want to. Sure, so let's verst that's the fun.

We haven't seen any evidence current habits or at least you know, at the moment of a recession. We had, Yes, last last quarter we had negative GDP growth, but you you need, you know, two quarters for recession. So recession technically is a contract created by by economis and politicians. But ultimately, when we think about consumer spending and we think about the media sector, we're really thinking about how consumers feel about spending. Because consumer spending represents two thirds

of the US GDP UM. If consumers feel stressed and stretch and they choose to cut back on spending, that ultimately UM will impact the media and entertainment sector. Even if there isn't a recession. UM I think one of the things that we have to consider is is consumers change behavior, sometimes permanently due to stresses. We certainly saw that during the Great Recession, and we certainly saw that

during the pandemic. In the case of the pandemic, we saw an acceleration in secular trends, um, which you know, you and I've talked a lot um about these trends. You know, whether it's cord cutting, it's the move to streaming, it's the shift of advertising from you know, traditional um, you know, media to digital. All of those things accelerated during the pandemic. Um. If we get another economic downturn, we certainly think that that could re accelerate those trends again.

And you know, and we can talk about what that means for for Hollywood longer term. Sure, I mean, I just think of all the things that could be at risk here, advertising right off the bat. To me, that that seems to always go hand in hand that when there's some sort of economic downturn, that's the first thing that companies cut. Correct. So advertising actually, interestingly enough, is

a lagging indicator of economic activity. It happens about six months you start to see you know, um, advertising decline really six months into a recession um and so it's actually a lagging indicator and then attempts to take some time to recover at post a recovery. Now, at the moment, we're not seeing any any impact or any evidence of and spending declines UM though there are certainly is expectations that it will decline if the current economic path continues. Okay,

and there's also I mean, take your pick. Cord cutting is something that we've got to keep an eye on. Theatrical tendons, which certainly has already been facing its challenges, and what to me is sort of the grand daddy of them all here is streaming. Where could the timing possibly be worse given there's such a focus now on churn and retaining customers in a brutally competitive environment. Yep,

So let's let's tackle each one of those. So cord cutting, yes, um, you know, even prior to discussions of a recession, we had SMP expected card cutting to re accelerate, so it was about four and a half percent if you include the virtual operators, UM one, we think it's going to re accelerate to over six and even worse than that. And then if you layer in you know, an accounting procession stress, consumers are more than likely to drop their linear TV services at a much faster rate. UM. You know.

On the streaming side, Yeah, churn chef Ley is an issue, and it's something that we've been spending a lot of time focusing on because, um, all of the all of the streaming services have have shown an ability to grow grow subscribers. What they haven't shown the ability to do at the moment is to retain those subscribers. And so your favorite show ends, you watch a movie, and then you cut the core, you cut your streaming service, and

then you come back after six months or so. And so what we've seen in a number of the streaming services is the subscriber based turns over once or twice a year. Um. What happens when you go into a recession and consumers look at how much they're spending on the streaming services, They're spending a lot of money, and they decide they're going to cut back on the number of services or they're not going to stick around as long as they previously did. And so that could re

accelerate churn. And and that's got you implications for you know, operating metrics, cash flow metrics, um, and really the financial performances for the media companies. Well, certainly there's other factors to talk about, and we'll get to theatrical and a cent in a second, but let's dick with streaming for a second. It's where all the eyeballs are right now in terms of the marketplace and what Netflix has gone

through recently. Such a dramatic, dramatic turn of events we saw coming out of last quarter, and so I wanted to get your take. Uh, is it as bad as it looks right now for Netflix? Or perhaps the market is perhaps ra acting a little too strongly? What do you think? Well, so, I mean there's there's the growth aspect, which is is certainly a concern. Um. I think you know a lot of the concerns that that came out in the quarterly earnings were ones that the market had

been focusing on and asking questions of Netflix. However, um, given the growth that they had had previously, they it wasn't a concern certainly for the equity markets. And that's and that's you know, password sharing, which as as um if you look at the results, they're essentially at you know, if you include Pastor, Chary Summer, un thanky billion household penetrated in the United States and Canada. That's basically a

fully penetrated mature market. UM and so UM. You know that the question that that has been asked of them is and this kind of addresses UM. This will impact a lot of the media companies in the next couple of years as well. As you start to get mature and as you start to see growth start to slow, what do you do as a result of that? Do you which would be the easiest thing? Would you would do? Increase content spending, Push more content in front of consumers.

That will energize UM that that will energize subscriber growth going forward. However, there's a price to that. If you are going to be spending more money, you're gonna push out your break even points. You could go cash flow negative in a way. That's a bit of undisciplined spending for the sake of growth. And as we saw with with Netflix and its earnings, the market currently doesn't like that, and so UM and so undisciplined spending to just grow

isn't the solution. You have to come up with other alternatives to try to re energize growth, or certainly to try to to try to reduce chart. And and that's something that I think a lot of the companies are working on and we'll see over the next couple of quarters. I think companies experimenting on ways to try to reduce chart. And what do you think about the competitive set surrounding Netflix?

It feels like once a week I I see a survey of some kind addressing just how many services the average US home or global home needs is at four? Is at six? Is? It's whatever? Um? What do you think? So? I mean, certainly the number of services that people are signing up for UM. I mean I I can't how many I have. I think I have eight? Um, that's unsustainable, especially if consumers are feeling stressed, they're going to cut back on the number of services. And is three is

it too? It hard to tell. I mean we're so early on in terms of the evolution of these services, UM that I think I think the jury still lot on how many of these services people will sign up for. I think you're gonna get a lot of experimentation over the next year or two. In terms of business models. You know we're seeing Netflix, say you know, they'll they may introduce UM an advertising UM service. Disney is talked

about doing an advertising service. That's certainly uh, you know, could could benefit those companies because offering a lower price point might get them to stay longer with those services. Um. You may see bundling be different. You may see um, you know, bundling of all of the services. So I think you're gonna see a lot of experimentation over the next couple of years and trying to draw conclusions from

what companies are experiencing today. UM. I think in the next couple of year, months and years, we're gonna have to have, you know, a different set of conversations about what that means for the streaming service. What do you think about the hand Warner Brothers Discovery is playing with, especially as it relates to what you brought up with bundling, because here they are with HBO, Max Discovery, Rest in Peace, CNN plus Uh, how does it all come together, do

you think for this company in the streaming space? Yeah, Look, I think one of the things that that kind of got lost over the last couple of years, especially with Warner Media being embedded with it, the larger A T and T family was how powerful a company, um Warner Media is with its its legacy of you know, of content going all the way back to the beginning of of the film and TV industry. And so there's a

lot of content there. And oh, by the way, they have Warner Brothers, which is one of the premier studios in the world, and their ability to generate a lot of content, uh, you know, a lot of which they used to sell the third parties. Now a lot of that would go towards UM the you know, the HBO Max streaming service. So I wouldn't just count their ability to be one of the long term survivors in the streaming awards. Got it. I want to get back to what we raised earlier with regards to the state of

the theatrical business. We're having this conversation the weekend that Top Gun returns to theaters. Very high expectations there. Uh. I think even best case scenario for Top Gun, for the entire movie business, it's never that total box office, whether global or domestic, is just never going to get back what it used to be, in part because the pandemic,

I think will shrink the theatrical business. Whether we're talking about just the footprint of the exhibition business, or just more to the point, the kinds of movies that are viable in theaters, which you know, Marvel a handful of horror movies and and and and that's about it as far as I see it. How do you see the prospects for theatrical Yeah, it's it's very interesting. Um. I've been I mean anecdotically, I've been to the theater seven or eight times since the pandemic ended, and or I

guess since the theaters reopened. I've yet to be in a theater that is crowded. Um. I think. I think one of the challenges at the moment is that there's significant parts of the population that are are a bit uncomfortable going back into the theater. Certainly, um. You know, young adults and teenagers and you know twenty five year old are comfortable going back, and so they're they're the ones who are who are flocking to the theaters to

watch all those um um those superhero movies. Children. On the other hand, parents are a bit uncomfortable taking them there and so they've been slower to come back, as are are are older adults. You know, the ones who would go and see comedies and dramas and things like that. I think those will relaxed as people get more comfortable with the idea that UM that you know they're vaccinated and that they aren't going to get sick by going

to movie theaters. But I do agree with your basic premise, which is I think longer term, the box office is going to struggle to come back to pre COVID pre pandemic levels UM. The number of movies being released into theaters has declined. It's unlikely to come back to the levels that you previous saw. Dramas and comedies they worked much better on a streaming service, or at least that's what the studios seem to think, and so putting them into theaters UM is going to be a bit of

a challenge. I don't think we're going to go back to the you know, the days where you had day and date releases, or that studios would would take higher profile movies and put them directly into their streaming services. I think the studios have learned a lesson over the last year or so that that putting a a a movie through a theatrical release UM benefits the long term. UM. The long the long term value of that particular film. Um, you have better discovery, you have franchise building. All of

those things are clear. And so yes, we've gone from ninety days to potentially forty five days for for a release window. But I don't think, um, but I don't think that you are going to have you know, the fear that everyone has, which is or many people have, which is that the theatrical window completely disappears. Having said that, now we have an opportunity for a lot of companies, and Netflix is of the world, the app the Apples and the Amazons, to put more movies into the theaters. Um,

there's a lot of screens that are available. They can take advantage of that. We'll we'll see what happens. We'll be back with Navin Sarma after this. We're back with Navin Sarma, Senior director of SMP Global Ratings. What you were saying with regard to the pandemic overhang on the theatrical business, I'm wondering how you see other out of home media businesses faring. Whether we're talking about theme parks, concerts, Broadway, uh, all of which have took taken some serious lumps in

the past few years. But also have shown a lot of resilience. UM. Longer term, how are you feeling about those out of home businesses. Experiential is the word that all the media companies are out throwing around. So consumers don't just want to sit on there, you know, in their chairs and and have stuff happen in front of them. They want to get out there and experience it, whether it's concerts or going to theme parks or going to sporting events. I think that's where we think consumers are

going to really push the media sector. Um. We've kind of seen that already, right, UM. You know, the theme parks have been have done incredibly well. They may not necessarily back to occupancy, but they are. They are crowded, and people are signing up and going to those steam parks. UM. Concerts and especially the concert venues are doing quite well. And we've seen a number of um of concerts get announced for next year. So next year I think will

be a big year for for concerts. But I do think people want to go out and actually interact with the people, um, you know, an experience events rather than just sit at home. Sure. UM, although and I think to some degree that's being driven by the fact that people because it was suppressed over the past two years and sort of exploding now. I do wonder though, uh, you know, if the pandemic continues to persist, continues to linger, whether it's going to have a more deleterious effect than

than we might be envisioning here. I don't know. I think at this point, Um, I think the majority of the population is in effect moved on and you know, and told our politicians, yeah, we might get sick, but we think it's something that we can live with. So I don't see, and we're certainly not anticipating our resurgence of the pandemic leading to any kind of a shutdown in the you know, in the in the in the

in the in the economy. I also wanted to ask you about M and A and the and deal making, which, you know, going back to our recession conversation, I think is only going to get more difficult, which runs contrary to the narrative that's been prevailing the past few years that we're gonna seem more and more consolidation. Um, how are you feeling about how the state of M and A is playing out? Yeah? So so at the moment,

I mean it's interesting. So for the last ten years or so, actually since the really the Great Recession, interest rights have been incredib really low. UM. The Fed cut interest rates, you know, right at the beginning of them, of the Great pro Session, and they kept it very low. And they they you know, they kept right through the

pandemic to really stimulate economic growth. And that had some side effects or effects and impacted the It made money very cheap for deal making an M and A. And so we saw a lot of deal making over the last number of years, UM financed by by cheap money. What you're and you know, but what you're seeing today, however, is that the cost of capital, especially over the last couple of weeks, is the Fed has ratchet up interest rates UM. The cost of capital has gone up considerably,

and that definitely has hurt dealmaking. And M and A. We've we've heard anecdotal stories of deals getting to the finish line but dying because of expensive financing. Now, having said that, if we go into an economic downturn, UM and the Fed decides that they do need to um you know, cut interest rates to try to once against stimulated and on my growth, you certainly could see deal making them and a pick up and and look that that tends to happen towards the end of ose session.

Companies have underperforming assets um that they'd like to shed. You have companies that are that are underperforming because of an economic recession, that are unable to meet their financial commitments. You get bankruptcies, especially increasing after we come out of a recession. You get for sales. So I think you could you could see a return to that, but a lot of that would depend on what happens to interest

rates going forward. And I'm thinking that what's going on in Washington will certainly come into bear here in terms of the potential for regulation. There seems to be an increasing focus on antitrust. Uh. Do you think that's going to weigh on the deal making as well? I think it's a good it's a good point. I think it a weigh on the the desire of some companies to

actually do deals. Clearly, the regular there's in Washington. The politicians of Washington are very focused on the tech industry um, and so we could see them step in and and potentially um, you know, prevent or try to prevent deals

happening that involved the tech companies. Uh, you know, we saw some comments from the FTC about Amazon's acquisition of MGM, and in the grand scheme of things, MGM is a you know, is tiny compared to Amazon, and yet that raised a number of concerns in Washington over that deal. So it kind of depends on who's getting involved in

those transactions. I think with media companies, if you saw, you know, further consolidation in certain sectors, you know, if there's a consolidation of movie studios, that might raise some some regulatory issues. UM. Certainly, if cable companies decide that they're going to try to merge, um, that could raise some issues. But I do think the especially you know, the people who have the money today, it's the tech companies. They may be limited what they can do given the

height and focus on on their businesses. Staying on tech for a second, you know, it's an interesting time because we've looked at these businesses as too big to fail for so long. But here we are coming off a week where you know, we saw Evan Spiegel ats Snap a revised guidance which sent the stocks for anyone in digital advertising plummeting. We're seeing meta take a huge hit coming out of their previous quarter. Are we finally kind

of as we saw with Netflix. Are we finally seeing companies that seem too big to fail, too successful to stumble? Are we perhaps moving into a new era of understanding just how incredible these companies are. I think what's interesting is is the discussion I was at a conference for for the last couple of days. In fact, I was at the conference where Snap spoke, and the question that everyone was asking was is this a Snap platform question issue?

M Are they just losing share to the platforms like TikTok or is this a you know, the forerunner of um of an advertising decline or pressure on advertising? So when you when you when you look at digital advertising on tech and social media platforms, they may be more vulnerable in an economic downturn because so much of that advertising is skewed towards small and mid sized businesses UM

and then they certainly get hurt in a recession. In addition, when you think about the ad funnel, advertisers allocate bottom of the funnel transactional ad dollars to digital platforms, and these these may be more vulnerable. These dollars may be more vulnerable if consumers cut back on spending. Um, you know, and so, and when you look at top of the funnel brand advertising, they may that may see less decline depending on the session scenario, which may actually benefit television.

So um, so, you know, what we're seeing with the tech companies might be specific to Snap or it might be you know, our forerunner of of you know, pressure on digital advertising intercession. Um, You're you're mentioning s spending made me think of a different area of spending that I'm curious about, which is content spend, which you know has risen astronomically in recent years, primarily because of the

competitive streaming marketplace. And I have to wonder, you know, certainly, as we've seen you know, Disney recently announcing that they're gonna shave a billion dollars off an initial spending projection they gave earlier in the year, We've seen David's as Love and Warner Discovery more than one say hey, you know, we're not going to get crazy here. Are we on the verge of of a broader base pullback in content spend? And what would that mean? Yeah, that's the hundred billion

dollar questions exactly exactly. I think at the moment in Hollywood. The message that um that we're hearing, as you point out, is that all of the companies are going to be disciplined in spending to growth subscribers. It's not that they're going to cut back on spending, it's that they're going to control the growth of spending. UM yeah, to you know, to to to be more disciplined and and and and look for you know, and and grow what they would call,

you know, financially responsible subscribers. So I don't think, I think, I don't think the fears of them cutting spending are are accurate. I think I think what what we should be asking the media companies is is you know, how much are they going to increase spending this year to next year and then the following year and then the

following year. I think that that where that is where we're going to see the discipline, um and and and look at the end of the day, what that results in is that they may they get through financial stability, you know, break even on their services faster. And and that's what the current um, you know, equity markets are rewarding for. I think one of the concerns that we've

raised as a result of that is okay. So let's say we get to the end of this year and subscriber growth is weaker than the companies that anticipated chun might be higher because of the economic recession. What do

the media companies do. Do they back off this pledge to be disciplined in their spending and spend a lot more to try to re energize growth, or do they like what Netflix has done, which is, you know, look at their spending and say that the growth of spending will go in line with the revenue growth, and so be more and remain and continue to remain discipline and how they spend on content. I can't imagine that we're going to see an increased, you know, ratcheting up of spending.

And if anything, what we may see that will bring down spending is with regard to the streaming business, somebody's going to step away from the table. Somebody is going to say this is getting too rich for my blood. Doesn't necessarily mean they you know, I think there's a

few scenarios there. Number one, we can see someone pull out and revert to the Sony model of hey, we're an arm supplier, everyone could buy our content, or we're going to see perhaps a consolidation among players, and there's been plenty of speculation about Paramount and maybe a spun off NBC Universal UM. As I mentioned those companies, I'm particularly curious about Paramount and what you think about the hand that they're playing. Uh, you know what, what would

you be advising Sherry Redstone in this marketplace? Yeah, it's a it's a good question. And I think I think one of the things that we do forget when we look at the US media companies and we size up Paramount versus Disney and and and Warner UM And and Warner Brothers. Discovery, Disney, and Warner Brothers are massive companies and massive global companies. UM far bigger than everybody else. Paramount is actually a global media company as well, and

they've got tremendous scale. And so I think one of the one of the one of the things we forget about is is what is our comparison to if we're just looking at US companies. Yes, Paramount has a scale problem. If you look at Paramount versus the global media companies and you throw on I t V, you throw at the Bertles amount of a vending Paramount is a very, very large diversified media company with with operations all over

the world. They've got a big Latin American operation, and so I wouldn't discount their ability to be one of the winners. Having said that, they certainly have more limited financial resources than a Disney or or a Discovery UM, and so they have to be a bit more careful in what they do, especially internationally, what content they the Greenland,

and also what markets they operated. So the approach that they've taken so far, which is they'll settle or license some of their content UM and then in markets where they don't think they can get a good return, they'll partner, like what they are doing with UM with NBC in Europe. I think that's a good financial model. I think that that works as long as you remain discipline again once in you're spending UM, and also in your expectations for

what growth it will be overseas. I think Comcast UH is a bit similar in terms of that international scale through Sky. Comcast, though, is a very different company because they're in the pipes business, and I'm curious what you think about that business. We talked a little about cord cutting, but it's more than that. When you think about how Comcast is really almost more a broad band company now and they're in mobile. So how do you feel about

the broadband bis this and where Comcast stands there? Yeah, and I'll say this about Comcasts as well as for companies like Amazon and Apple. They've got businesses that are far stronger than the media businesses that they own. UM, and those are the businesses that they want to defend.

And so maybe not as much for Comcast because NBC is a as your point at a global media company, but media essences can be a retention tool for for some of these companies to you offer the media at you know, you you offer a media media video film TV to your your subscribers, whether it's an Amazon or it's an Apple, and you essentially give it to them for free and say, if you sign up for our services, you can get this as an add on. And so

you can use media as a retention to them. We can talk a bit about you know what that means for media in general. Comcast doesn't. Comcast has a similar type of strategy, maybe not necessarily as there Conian is what I just laid out, UM, but they are more than willing to use media and they do this within their their comcast broadband footprint. They offer Peacock for free to consumers, and that's an attempt to keep customers on

their platform. Well, let's talk about that media as retention tool strategy more broadly, because it's interesting when you look at Amazon and Apple, media is really just a rounding error, even though they are going to be spending huge amounts of money, uh, compared to everything going on in media,

So in is weird counterintuitive ways. It almost like, well, the best way to approach the media business is not really to be focused on it, which sounds insane and it and it is because if especially if you're you know, if you're a media company and you've got returns that you're trying to achieve on content, and some of your competitors don't really care about the returns because they're looking at their subscriber numbers. It's a hard thing to compete against.

How much are you willing to pay? There may be discipline on the side of the traditional media companies in terms of what they're willing to pay for a certain piece of content, but that kind of goes out the window when you're looking at some of these other companies and so it makes it makes it an unbalanced playing field for the traditional media companies. Yeah, but it is a playing field that I'm enjoying watching immensely. And I know you are too, uh, Navina, appreciate you sharing your

insights today. Always good to talk to you. Great talking to you to as well. Thank you. This has been another episode of Strictly Business. Tune in next week for another helping of scintillating conversation with media movers and shakers, and please make sure you subscribe to the podcast to hear future episodes. Also, leave a review in Apple Podcast let us know how we're doing.