Media, Gaming, And Telecom Companies, Unplugged

Put That In Your Pipe

Glitzy awards shows, extraterrestrial satellite arrays, packed-out concert arenas: telecoms and media are unquestionably two of the sexiest industries in the world… not that Finimize is biased or anything.

While they may seem wildly different, investors tend to treat telecoms firms like your cable provider and media companies like movie studios as one $5 trillion-strong sector. (“Technology” is sometimes lumped in there too, though it’s now grown so big that many tend to treat it as its own beast.) The analogy used to justify this link-up is that telecoms firms build pipes – laying the infrastructure for communication – which media companies then fill with content for people to consume. Of course, nobody likes paying for pipes unless they’ve got something running through them – and so it’s no surprise that pipe owners and pipe fillers are often one and the same firm. In telecoms and media, Comcast owns NBCUniversal; AT&T owns WarnerMedia; and Verizon owns, er, AOL and Yahoo!...

But all those different business lines can make media and telecoms a formidable sector to wrap your head around. Happily, Finimize is here to help. In this Pack, we’ll walk you through the most important bits of the industry, explaining how they work and how to value company stocks. We’ll also look at the biggest factors shaking things up in the future, ranging from streaming wars to esports. First up: is 5G really good news for telecoms?

The takeaway: Media and telecoms firms often share common owners, which is why investors tend to lump them into one gigantic but complicated sector.

How Telecoms Works

Telecoms firms (or telcos to their friends) build the infrastructure that connects peoples’ devices to their beloved content. They’re often broken down into two further subsectors: the infrastructure firms that manufacture the chips, towers, and cables that carry a connection and the service providers that let you access that equipment. American Tower, for example, owns the cell towers that make network connections – and it gets paid rental fees by the likes of Verizon, who then in turn collect subscriptions from end-users like you.

An infrastructure company’s business model is fairly simple: build technology and then sell or rent it to others. Service providers, meanwhile, historically made money by hawking regular cable, internet, or cellphone subscription products – but after a bruising decade of rising infrastructure costs and falling subscription prices, they’re increasingly looking elsewhere to eke out extra revenue. Firms such as Safaricom, Kenya’s most valuable company, have experimented with mobile payments: its M-Pesa unit makes it over $1 billion a year. Others, regarding the rise of advertising giants Facebook and Google with envious eyes, have invested in their own advertising platforms. Singapore’s Singtel has spent over $1 billion buying “adtech” firms in the hope of selling its enormous bank of user data to companies seeking to better target customers.

But infrastructure firms and service providers alike are now on the cusp of a major technological change: 5G. Speedy fifth-generation mobile internet networks are already available, and are expected to become much more widespread in the next few years. That’s going to be hugely expensive: investment bank Morgan Stanley forecasts $872 billion of investment over the next decade, almost twice what was spent on 4G. This is partly because 5G signals, which can’t travel as far, require more antennae than 4G – which may lead to an expansion in shared “virtual networks” like Walmart’s Straight Talk or the UK’s Giffgaff. It could also lead to consolidation in the industry: industry giants T-Mobile and Sprint have been trying to merge for two years.

Still, for those firms left standing, 5G could prove to be much more lucrative than 4G. Executives wax lyrical about the promise of the “internet of things” (IOT): a world where almost every device connects to the internet via a 5G network. That includes doorbells, self-driving cars, medical devices, factory equipment, even fridges – and could mean millions more devices using a lot more data, as well as plenty of profits for the firms furnishing those connections. 5G may also replace wired networks in some places, with factories particularly keen on the idea. According to Morgan Stanley, 5G may generate $156 billion in revenue for telco service providers.

Infrastructure firms stand to do even better, as they can capture the service providers’ need to upgrade without worrying about whether consumers and companies will be willing to pay for them. Chinese giant Huawei is the market leader in 5G technology, though it faces security-related roadblocks to expansion in the US, and companies like American Tower should also see increased revenue. Indeed, those service providers who own their own antennae networks are starting to “spin them off” into separate firms in an attempt to raise cash to fund 5G development – as well as satisfy investors who’d rather bet on just towers. Those sales should also help firms like AT&T and Vodafone get a handle on their debt – which, as we’ll see next, is a key concern…

The takeaway: Telcos either sell infrastructure or services, and in the face of high 5G costs they’re now looking to eke out extra revenue from new lines of business.

Valuing Telecoms Stocks

Telcos love debt. They’ve traditionally funded much of their expansion by borrowing, and that’s largely been for tax purposes. High levels of debt mean high interest payments – lowering profit and therefore taxes due. And because telcos have stable, recurring revenues, along with lots of valuable physical assets, lenders are only too happy to offer them credit.

This desire for debt means that investors’ priority isn’t really telco profits, which are calculated after tax and interest payments. Instead, they tend to look at the amount of cash the company makes (“free cash flow to the firm”) less capital expenditure (or capex – the amount the firm spends on infrastructure and so on). It’s these figures which the telcos try to optimize, and from which the hefty dividends they pay out to shareholders emerge.

That said, telecoms capital expenditure is “lumpy”: it comes (like, appropriately enough, a 5G signal) in waves, rather than remaining steady each year. And because not all telcos spend on infrastructure at the same time, looking at free cash flow minus capex can make it hard to compare one telco to another. So alternatively, investors might look at “earnings before interest, taxes, depreciation, and amortization” (or EBITDA) as a proxy for a firm’s profitability. By excluding many of those lumpy costs, EBITDA can help you weigh up the relative merits of rival firms.

Specifically, investors like to look at EBITDA “multiples” when comparing stocks. Looking at enterprise value to EBITDA, an investor can see that Sprint’s stock trades at 5.1x, compared to Verizon’s 7.8x. That may suggest that Sprint is undervalued – or that Verizon, with a more diversified business, has better growth prospects. As a rule of thumb, telco service providers trade at much lower average multiples than telco infrastructure firms – 7.9x compared to 13.4x. That’s because the equipment firms tend to be higher-margin businesses.

Investors also look at the dividends telco stocks pay: the sector offers an average “dividend yield” (the annual payout each share provides as a percentage of its price) of 4.53% in the sector, compared to the 1.68% of the broader US stock market. So an investor focused on generating income might note that AT&T’s 5.3% yield is higher than Verizon’s 4% and buy AT&T accordingly.

But if you’re buying AT&T, you’re not just buying a phone business… you’re also buying a TV channel. Or rather, a Not TV channel…

The takeaway*:* High interest payments mean that profit isn’t a particularly helpful metric for analyzing telcos – with investors using EBITDA multiples to compare stocks instead.

Television Chocolate

The average American adult spends over 4 hours a day watching TV. And that translates to an awful lot of money for the companies producing those programs: the television networks. In the US, there are two main kinds. Of the free networks, the “Big Four” are NBC (owned by Comcast), ABC (owned by Disney), CBS (owned by ViacomCBS), and Fox (owned by… Fox), with The CW (owned jointly by ViacomCBS and AT&T) in fifth place. These make money either by selling advertising or by selling their shows to “affiliates”. Affiliates comprise those TV stations – like Los Angeles’ KTLA – which pay “reverse retransmission fees” to networks in exchange for carrying their content.

These affiliate stations join the second type of TV network – featuring premium channels like Showtime and Starz – in making their money from both advertising and subscriptions which are often bundled together into cable packages. The ultimate value chain is therefore pretty complicated. The viewer pays their cable provider – the cable provider pays the TV stations – and some of those stations then pay the parent network whose content they use.

The big challenge facing all parties is “cord-cutting”: people are increasingly canceling their cable subscriptions and instead choosing to cherry-pick the content they actually want. This trend is affecting different players in different ways – but many networks are now looking to go direct-to-consumer, launching streaming platforms that a user can sign up for with no need for cable (like HBO Now, CBS All Access, and NBC’s Peacock).

That trend could eventually lead to these being the only places you can watch the networks’ content. That’ll lead to lower advertising and affiliate revenue for the producers – but also more subscription revenue. The affiliate owners, meanwhile – companies like KTLA parent Nexstar – may find themselves without a product to sell. And other potential losers include the likes of Disney-owned ESPN: a default network in cable bundles now, but unlikely to get the same number of viewers paying for it as a standalone.

83 million people currently pay $9 a month for ESPN – but 56% of them would cancel if they could. ESPN would need to convince all the remaining 44% to pay it $20 a month to maintain revenue post-unbundling: yet only 6% of people said they would pay that much. So ESPN’s subscriber cash is likely to fall, while the fees for sports broadcasting rights will stay the same or climb, thanks to increased competition from streaming giants – more on which later.

Investors, then, aren’t too keen on ESPN. But that’s not true of all TV networks – so press on to see how they value them.

The takeaway: TV networks make money from advertising, subscriptions, and affiliate retransmission fees. Cord-cutting could hurt all of them, particularly affiliates and underwatched channels.

Valuing TV Networks

A good place to start when valuing a TV network is to look at revenue per subscriber. You can break that down further, seeing how much it makes from a direct subscriber versus an affiliate one, for example. The average network receives a retransmission fee of around $2.10 per affiliate station subscriber per month – but those numbers don’t always correlate with viewership. For example, CBS earns about the same per subscriber as drama specialist AMC, even though its programming gets many more viewers – perhaps suggesting CBS could boost its profits by selling to people directly.

That’s an assumption based on what the company could do, though. To directly compare network stocks as they are, investors look at EBITDA multiples. ViacomCBS, at the time of writing, trades at about 6.5x its earnings, compared to 16x for Fox – either indicating that ViacomCBS is significantly undervalued or that Fox has greater growth prospects. Affiliate stable Nexstar, however, trades at 8x its earnings – and given what we discussed last session about its future prospects, that might make CBS seem appetizing.

The really tricky thing when comparing network stocks, is finding adequate comparisons. Thanks to conglomeratization there are few companies today that represent a simple bet on a TV network: ABC and NBC both make up just a small portion of their parent companies’ revenues. And even with those that are closer to “pure-play” investments – like ViacomCBS and Fox – you’re investing in other things too (ViacomCBS owns a book publisher, while Fox, for some reason, owns a loan marketplace).

It’s also hard to compare the TV networks themselves. CBS’s value is underpinned by long-running procedurals, while Fox’s relies on its controversial but popular news output. While both are TV shows, they have very different revenue drivers. Still, as the TV industry shifts to a direct-to-consumer model, you might argue that entertainment is worth more than current affairs: you’re probably more likely to pay for 456 old Law & Order episodes than 456 old news broadcasts. And then there are the new ways that TV channels will have to monetize their content in the brave new world of streaming…

The takeaway: Investors look at EBITDA multiples to compare TV networks’ stocks, but finding suitable comparisons can be tricky.

Streaming Wars

Netflix, Disney+, Hulu, Amazon Prime Video, HBO Max, Apple TV+, CBS All Access, Peacock… it’s fair to say the streaming market is heating up. As viewers cut cable subscriptions and stop visiting movie theaters, they’re turning to online video libraries instead. Investors, meanwhile, just want to settle down in front of something good – easier said than done, because success looks completely different depending on the platform.

The current leader is Netflix, which kickstarted a revolution when it launched online video in 2007. That first-mover advantage helped it build a massive, stable revenue base of 158 million subscribers. And that, in turn, allowed Netflix to borrow billions, which it spends building a library of exclusive original content in the hope of keeping you glued to the platform.

Times have changed, however. Netflix is no longer the only player in town – and some think its once-innovative business model could prove to be a distinct disadvantage. Netflix is a pretty simple media company, really: it makes content and then sells it. The drivers of that are correspondingly simple: profit is a function of how many subscribers it has, how much it charges them, and how much it spends on getting content out.

The other streaming players work differently, however. Amazon openly admits that its goal with Prime Video is simply to keep you subscribed to Prime so you spend more shopping – Prime subscribers spend an average $800 more on Amazon each year than regular e-shoppers do. Disney, meanwhile, is selling its streaming services at a cut-price rate, in part because it can later monetize that by upselling users cruises, theme park tickets, and merchandise. And Apple, for its part, hopes that star-studded shows will entice you to buy a bundled subscription that includes its much more profitable iCloud services – and perhaps a new iPhone every year.

Others are betting big on advertising. Hulu offers a cheaper subscription than Netflix but attempts to make up the difference with ad revenue. And NBC’s hoping its new (free!) Peacock service will allow it to make more from traditional TV ads: it’s investing heavily in technology that will let it run synchronized ad campaigns across both TV and streaming, hoping to charge a premium for more targeted tat-touting.

In other words, streaming is a “loss-leader” for many of Netflix’s competitors: it exists to lure users in who can then be monetized in other ways. For them, profits are a function of how many subscribers they have, how much they’re charged, how much content costs, and how much they can make from subscribers in other areas. Those extra revenue streams mean they can charge less for subscriptions or invest more in content and still, potentially, make the same profit. That presents a major problem for Netflix, which might find itself outspent or undercut by its revenue-mixing rivals.

These different business models also mean investors have to value streaming products differently. For Netflix, it’s fair to focus on cash flow and profit (our Pack How Netflix Works goes into more detail here). But with the others, streaming can only be understood in the context of the wider company. It’s early days for all these platforms, so financial reporting is murky – but the best metric to keep an eye on is probably “average revenue per user”, or ARPU. When calculated comprehensively, that should include the revenue generated from adverts and related product sales. It’s perhaps impossible to fully figure out how effective a streaming business is here – you’ll never know if you would have gone to Disney World even if you weren’t a Disney+ subscriber. But ARPU goes some way towards estimating this 🐭

There’s a lot of money at stake. Combined global revenue from streaming subscriptions alone is likely worth around$40 billion already, and that’s forecast to grow. Still, compared to the$150 billion video games industry, it’s small fry…

The takeaway: Many new streaming services use content as a loss-leader to sell other products. That could pose a threat to Netflix, which relies solely on its content business.

Video Games

Avengers: Endgame, the highest-grossing movie of all time, made $2.8 billion. Grand Theft Auto V, the highest-grossing video game of all time, made _$6 billion. In fact, it’s themost financially successful media title ever. What’s more, _GTA V cost a lot less to produce: $265 million versus Avengers’ $365 million budget. Video games, despite being perennially under-discussed in mainstream finance circles, is a stunningly good business.

But as with every other media branch, it’s also undergoing rapid change. The business is shifting away from its one-time-purchase model in favor of free-to-play and subscription options. Fortnite, a pioneer of the former, made $2.4 billion in 2018 and $1.8 billion in 2019 – mostly from in-game cosmetic upgrades. So-called “microtransactions” have been a boon for the entire industry: GTA V continues to make money selling digital goods online. That could be about to peak, however, with countries like China cracking down on addictive games that seek to exploit players.

This might only drive more people towards games’ other new business model: subscriptions. Apple’s Arcade offering, which gives access to a bunch of iPhone games for one price, is one smartphone example, while Xbox Game Pass and PlayStation Now are similar products for big-budget console titles – both vying to be the “Netflix for games”. And with the imminent rollout of “cloud gaming”, which streams video games from powerful servers, players will soon be able to use such services even without an expensive games console. In theory, you’ll be able to play any game from any device – meaning your smartphone will have the power of a PlayStation.

That poses both opportunities and threats to different parts of the industry. The big console manufacturers – Sony, Nintendo, and Microsoft – currently make $19 billion a year from selling hardware, plus another $9 billion in publisher fees from studios who want to release their titles on their platforms. The hardware revenue could evaporate, while increased competition from tech giants like Google – muscling in with its Stadia – could drive down publisher fees too. Still, subscription revenue could make up for that: $10 every month adds up to a lot more than $399 once every six years. And platform owners are willing to buddy up with Big Tech in order to make sure they bank that money: Sony’s already agreed to host its cloud services on Microsoft’s Azure platform.

Game publishers, meanwhile, may not mind whether traditional console makers or new tech firms end up capturing the nascent market. Investment bank Morgan Stanley estimates that cloud will increase the number of gamers by 10% – meaning publishers’ profits could be $11 billion higher by 2025.

New business models offer more stability, too. Right now game profits are quite “lumpy” – spiking on a new console or hit title. Recurring revenue, whether it be from regular microtransactions or subscriptions, is much more appealing to investors who are then less reliant on any one success.

That might also be why investors are increasingly keen on esports. Bringing in around $1 billion in 2019, the accompanying media rights, ticket sales, and advertising offer a persistent revenue stream. Leading esport team Cloud9 is currently valued at $400 million, with venture capitalists betting that future growth in the market will further boost the team’s $29 million annual revenue. If viewership increases, then league owners – often the game publishers – will win out too: in January 2020, Activision Blizzard’s Overwatch league and Call of Duty league agreed a multi-year streaming deal with Google’s YouTube.

Investing in the games industry is, fortunately, quite easy. Major publishers like EA, Activision, and Take-Two, and console manufacturer Nintendo* **are all publicly listed. The companies are less complex than TV networks and telecoms firms, so investors simply look at their stocks’ price-to-earnings multiples to compare them. At the time of writing, Activision trades at 24.5x its forecast earnings, compared to Take-Two’s 26.7x and EA’s 23x – perhaps suggesting that investors are less confident about EA’s growth potential, and excited for Take-Two’s GTA VI* .

You could also invest in a company where gaming is just part of the equation. Console manufacturers Sony and Microsoft obviously make money from more than just games. That’s also true of a potential esports bet: Amazon, which captures over 800 million hours of viewing a month via game streaming service Twitch.

The most dominant force in modern gaming, China’s Tencent, has huge stakes in many big publishers (including Fortnite developer Epic Games) alongside its massive social media business. But the problem with buying any of these stocks is that you’re not just betting on the gaming business’s growth, and it can be hard to tell how much gaming matters to their overall success. That’s true of all media conglomerates, in fact. So finally, we’ll break down just how to go about analyzing the big beasts.

The takeaway: Video gaming is a gigantic, lucrative industry that’s shifting to microtransactions, subscriptions and the cloud – and esports is attracting investors’ money too.

Success In Succession

The media and telecoms industries are dominated by a few gigantic conglomerates: Comcast, AT&T, Disney, and ViacomCBS are the biggest. These huge companies operate a diverse range of businesses, which makes it very difficult to value them. The best approach is a “sum of their parts” method, which involves breaking down the business into its core sectors and then applying multiples to each of those. We’ll explain with an example.️

Comcast’s key business lines are internet services, cable networks, broadcast TV, films, and its Universal theme parks. The image below shows how much profit each of those divisions made in 2018. We can then work out a suitable profit multiple for each segment by looking at those of the closest “pure-play” competitors – Charter Communications for cable, ViacomCBS for TV/film, and Six Flags for theme parks. Carrying those over to Comcast’s business units gives the company a total enterprise value of $332 billion – a lot more than the $270 billion its stock was trading for at the start of 2019.

That discrepancy can be partly accounted for by the discount investors typically apply to conglomerates. Their sheer scale leads to hefty operating costs – Comcast’s overall profit in 2018 was actually $2 billion lower than our graphic suggests, thanks largely to “Corporate and Other” expenses. And that scale also makes it harder for investors with a preference for just one sector to invest in: if you’re really enthusiastic about theme parks (investing, not attending) but hate cable and film, you’d probably rather invest in Six Flags than Comcast, even if you think Comcast’s theme parks are way better.

Pure-play companies like Netflix can command hefty premiums to their relative valuations. But media company bosses in search of scale and synergy hope that conglomeratization will ultimately help them succeed: Disney, for example, can only execute on its grand strategy by owning a wide range of businesses.

As an investor, you have to decide for yourself how much of a discount or premium to apply to a media company. You might think one firm looks overstretched, while another is pleasingly diversified. One of the best ways to analyze companies is to think holistically about the overall business: is it well positioned to do what it wants to do versus its competitors? If the answer’s yes, you might want to invest. If not… well, thankfully there’s a world of internet, video, and gaming content out there to occupy you instead.

In this Pack, you’ve learned:

🔷 Media and telecoms firms often share common owners, which is why investors tend to lump them into one gigantic but complicated sector.

🔷 Telcos either sell infrastructure or services, and in the face of high 5G costs they’re now looking to eke out extra revenue from new lines of business.

🔷 High interest payments mean that profit isn’t a particularly helpful metric for analyzing telcos – with investors using EBITDA multiples to compare stocks instead.

🔷 TV networks make money from advertising, subscriptions, and affiliate retransmission fees. Cord-cutting could hurt all of them, particularly affiliates and underwatched channels.

🔷 Investors look at EBITDA multiples to compare TV networks’ stocks, but finding suitable comparisons can be tricky.

🔷 Many new streaming services use content as a loss-leader to sell other products. That could pose a threat to Netflix, which relies solely on its content business.

🔷 Video gaming is a gigantic, lucrative industry that’s shifting to microtransactions, subscriptions and the cloud – and esports is attracting investors’ money too.

🔷 Valuing conglomerates is tricky, but one approach is to break them down into their constituent parts and then apply comparable multiples to each division. The whole is often worth less than the sum of its parts…