Developed markets such as North America are becoming largely saturated, while growth in international markets is becoming increasingly competitive. Long-term forecasts for subscribers, EBITDA and operating margins have been revised downwards and companies are more focused on profitability than ever.
While most streaming services have ad-supported tiers, the two largest platforms Netflix and Disney+ are launching ad-supported tiers. Disney+’s ad tier will launch in December, while Netflix’s ad tier is expected in Q1 2023. The success of their AVOD strategy is important evidence for the future of streaming. Key questions to answer include ad loads, cost per thousand impressions (CPMs), and whether the strategy is driving revenue and revenue. If the ad tiers cannibalize the higher ARPU subscriber base and shrink revenues, the streaming industry’s outlook will look much bleaker. However, recent reports suggest that Netflix believes their ad CPMs can hit the $80 range, which is equivalent to the premium NFL broadcast reach. Disney stated in its recent earnings call that the Disney+ ad tier attracted leading CPMs during the recent preliminary negotiations.
Netflix, which is down 60% YTD, is being watched the most due to the slowdown in subscriber growth. Investments in content have been decoupled from subscriber growth as highly anticipated quarters continue to face negative net gains. Netflix’s strategy to once again accelerate subscriber and margin growth is to launch an ad-supported tier, crack down on password sharing, and invest in video games to increase subscriber engagement. The ad-supported level and revenue sharing with accounts is expected to launch in the first quarter of 2023. We remain Bellwether on the stock and await additional information on their strategy before becoming more optimistic about their growth catalysts.
Disney reset their long-term subscriber guidelines for streaming in the recent revenue call, breaking the core of Disney+ from Disney+ Hotstar and lowering the midpoint of core subscriber expectations by 10 million. We consider the move necessary given the loss of digital IPL rights in India. However, we note that the new guidance is still a high bar to reach, given the trends we’re seeing in the streaming industry. Disney’s ad-tier strategy includes a 38% price increase for the ad-free premium tier, which should help boost the domestic ARPU that has fallen in recent quarters. Disney is also heavily exposed to the theme park business, which could face challenges in a weaker consumer spending environment. Disney’s reset streaming expectations and better theme park performance are offset by a likely weaker consumer spending environment and a 20x consensus FY 24 EPS multiple, limiting upside in our view. We continue to review Bellwether.
Warner Bros. Discovery is in the midst of a major transition since the merger was completed. Management will combine HBO Max and Discovery+ into one streaming service, which will launch in the summer of 2023. The company is also pulling back on its streaming aspirations and will focus on its linear and theater business as well. While the newly combined company has impressive size and distribution, we are wary of becoming bullish on the stock during this difficult transition period in an increasingly difficult macro environment.
Elsewhere in the entertainment landscape, Take Two Interactive remains the most preferred due to its strong pipeline and relatively cheap valuation compared to peers and the historical average. Video game engagement is declining from the heightened pandemic environment, but user numbers and engagement are stabilizing significantly higher than in 2019. We view the gaming industry as having strong growth potential and we view Take-Two as our top pick within the space. Take-Two acquired Zynga during the quarter and provided updated financial guidance. We view the new guide as a cleanup event, shifting focus to the company’s robust pipeline of games. A pipeline with a follow-up to GTA towards the end of FY 2024. Take-Two is trading below its competitors and its historical average is at a two-year P/E ratio, which we believe offers an attractive entry point.
Contact your financial advisor for a copy of the full report, “US Communication Services: the Big Picture in Pictures,” which shares four other key points from the communications industry’s earnings season.
Main contributors: Kevin Dennean and Reid Gilligan
This content is a product of the UBS Chief Investment Office.
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