Fracking, the technique to ex-tract oil and gas from rocks, has made the U.S. the world’s largest producer of natural gas, as well as an oil powerhouse that, according to The New York Times, is “ready to eclipse both Saudi Arabia and Russia.”
Yet, wrote the Times, fracking’s biggest skeptics are on Wall Street. Why? Because the industry’s financial foundation is unstable. Fracking is not generating enough cash to cover expenses. The 60 biggest fracking firms had negative cash flows of $9 billion per quarter.
Let’s now move to streaming media, where just one firm, Netflix, has become a worldwide powerhouse, that, according to some predictions, is ready to eclipse traditional TV companies. Despite a reported $9 billion debt (some say $11 billion), Wall Street continues to value the stock higher than traditional media companies, when linear media actually generates higher profits. The question is: Why?
Last May, for just a short while, Netflix even surpassed Disney and Comcast in market cap. Surely, Netflix has taken over the wallets of investors and the hearts of the production community of agents, actors, and lawyers, all of whom love the influx of money that Wall Street has brought into the industry via Netflix, which has a commitment to spending some $8 billion in original content.
The studios, too, have gotten into the game, and although they don’t like to produce for Netflix (since studios don’t get back-end rights), they enjoy the income, which serves only to help amortize the studios’ fixed costs.
Nonetheless, the production community is not investing in Netflix. “I love their money,” said a Hollywood veteran, “but I don’t have Netflix stock and I am not planning to buy it.”
Experts now warn that with debt-to-equity levels three times larger than those held by Disney, and nearly twice as high as those held by Comcast, Netflix will need to ensure its consumer base (currently set at 130 million subscribers worldwide) keeps growing in order to accrue the cash intake necessary to service its debt. Last April, Netflix went to the bond market to raise $1.9 billion (its fifth bond issue in three years).
On Wall Street, as of last August, the three largest U.S. companies in the entertainment industry were: Disney (with a market cap of $166.83 billion), Comcast, (with a market cap of $161.78 billion), and Netflix (with a market cap of $146.49 billion). The list excludes companies where entertainment is just one aspect of their businesses, such as Apple, Alphabet (which controls Google and YouTube), and Amazon.
Even relatively small linear TV companies like CBS (which Wall Street values at a market cap of $20.6 billion) posted an operating income of $2.42 billion and net earnings of $1.31 billion in 2017. That’s something that Netflix has never been able to achieve.
Perhaps that’s because the linear TV model has multiple revenue sources — advertising, retrans fees, per sub fees, affiliate fees, domestic and international content licensing sales, and subscription services. SVoD has only one: subscription. Granted, this could soon change since Netflix is planning to run unskippable ads between episodes. So far, just a few U.S. and U.K subscribers have seen the tests.
With all their revenue streams (broadcast, cable, on demand, content sales), linear channels are the ones making money.
Stated U.S. entertainment business consultant Russ J. Kagan: “CBS, under Les Moonves [who recently departed as CEO] and his senior management team, [grew] revenues and built a base for future continued revenue growth [and] value. They have moved away and changed from dependence on traditional advertising revenue from the linear CBS/CW Networks and greatly enhanced the value of CBS by growing their cable and satellite subscriber fees, content sales, Showtime, and newly owned OTT platforms (like CBS All Access). CBS also achieved this without making large and costly mergers or acquisitions. The team seized and executed every opportunity for organic growth and expansion that was available globally,” concluded Kagan.
In addition to a huge debt, no profits to show and negative cash flow, Netflix will soon reach maturity (growth will only come from untapped, but difficult markets, such as India and China). Today, Netflix reaches 75 percent of U.S. streaming TV viewers. The company also faces reduced growth and more competition from direct-to-consumer platforms such as Hulu (basically a Fox and Disney OTT operation), and Amazon Prime Video (which is profitable).
Netflix also has a conflict with the film industry. Recently, the Paris, France-based International Confederation of Art Cinema opposed Netflix participating at the Venice Film Festival, citing Thierry Frémaux, director of the Cannes Film Festival, who excluded films without a theatrical release (typical of Netflix’s movies) from his competition.
On top of all that, U.S. studios are increasingly pulling content from Netflix in order to focus on their own streaming services.
But still, all these drawbacks don’t seem to discourage Wall Street investors. And drawbacks are not just confined to Netflix. Professor Jay R. Ritter of the University of Florida told The New York Times that “of the 15 technology companies that have gone public so far in 2018, only three had positive earnings per share in the preceding year.”
The Times’ article pointed out that Spotify, the popular music streaming service based in Sweden, continues to add millions of users, but lost $1.5 billion last year.
According to the article, “the buzziest money-loser of the year is MoviePass, which has upended the film industry by essentially giving away millions of free movie tickets.”
Similarly, in The New York Times Book Review, former Wall Street Journal journalist Roger Lowenstein wrote about “the gilt-edged and magical status that society [i.e., Wall Street] confers on Silicon Valley” in his review of Bad Blood. The book, by John Carreyrou, is about the frauds perpetrated by the founder of a company who conned investors with a technology that did not exist and had a paper valuation of $9 billion.
Baffled by this seemingly misguided holy grail of “growth over profits” mentality, VideoAge sought out answers from the same professor, Jay R. Ritter.
Why, VideoAge asked Ritter, does Wall Street value the digital SVoD services, which lose money, over linear channels, which actually make money?
Ritter answered, “Traditional broadcast is in decline, although not as steep a decline as for newspapers and magazines. Instead, technology is permitting people to view what they want to see, when they want. The lower costs that digital service on demand have now (compared to the past) resulted in its growth. So, Wall Street is looking ahead and valuing companies that are in decline at low valuations, and giving high valuations to companies that are benefiting from newer technologies. Traditional broadcast, including radio and newspapers, have depended on an advertising model that is inefficient compared to the targeted advertising that Facebook and Google can provide,” he said.
VideoAge further asked Ritter if competition from other SVoD services will make the prospects for Netflix and the like less rosy?
Ritter answered: “There is a case to be made that the market is overvaluing Netflix and Amazon.com, as well as other fast-growing companies, such as Tesla. It is possible to overpay for growth, as the market did in early 2000 for Cisco Systems, Sun Microsystems, AOL, and other tech companies. Only time will tell whether the market is overpaying for growth today.”
Kagan summarized it all in a digestible sound byte: “Wall Street assigns zero factor for future growth to linear television, plus they don’t get value for their profit. The Street sees linear as finite, i.e., limited by cable and satellite growth, while for legacy companies, cable and satellite are seen as anchors. In the case of Warner Bros., [acquiring company] AT&T will first tackle WB’s HBO, which already reaches 58 percent of the 92 million U.S. cable and satellite subscribers. AT&T will push for more and will partner with other Telcos internationally.”
(By Dom Serafini)