Media and Entertainment Primer

Although media & entertainment has historically been its own sector, albeit within the Technology, Media & Telecommunications (TMT) bucket, M&E has shifted away from being attached to telecommunications and increasingly melded in with technology as distribution channels shift from physical to digital.

Major global media & entertainment firms include:

• Netflix
• Amazon
• Disney
• Comcast
• Time Warner
• Electronic Arts
• Sony
• Nintendo
• Tencent
• Blizzard Entertainment
• Epic Games

The Digitalisation of Television

Television has seamlessly transitioned from cable to online services, with cable subscribers dropping off every year, commonly cited in earnings presentations as “cord-cutting” – although many cable companies are also internet providers, so they are protected from declines in this sense, as consumers demand faster internet to stream shows off platforms such as Netflix.

Traditional studios themselves are now directly being challenged by divisions of the new Internet oligopoly, with every HBO (Game of Thrones) facing competition from Amazon Studios or Netflix (House of Cards). Amazon and Facebook have far deeper pockets than traditional media players and there may be more major shifts in viewership trends as Amazon bids unprecedented money on NFL games.

For television, revenues have historically been through advertising and subscription fees to premium channels. Subscription fees have shifted to internet and platforms such as Netflix, but conventional advertising has dwindled. Other than for sports and other live events, it is difficult for advertisers to know that they are reaching the same market as before with 30 second spots during commercial breaks, especially with fast-forward capabilities for most digital boxes for planned programming.

The Digitalisation of Movies

Cinema stocks, which fall under the consumer & retail umbrella, have not fared well over the years – moving pictures have gone from the weekly family event for all genres (Gone with the Wind, The Sound of Music) to Summer Action Blockbuster only, as movies are only seen as “worth it” on the big screen if they are saturated with expensive special effects and with ample star power (Marvel Studios – owned by Disney).

Adjusted for inflation, box office revenues have been declining as fewer people flock to theatres. Sales post-theatrical run have also changed materially – no one purchases or rents DVDs, or the short-lived successor Blu-ray, as movies can be streamed immediately off Netflix and competitors. In developed markets, theatres have tried to change their business model by upselling food and luxury viewing experiences or letting customers view unlimited movies for the day per ticket purchase.

Where movie revenue is growing is the developing world, as the Chinese box office numbers jump up every year – more a function of growing incomes and urbanization. A nascent domestic blockbuster market is forming there now, with recent successes such as Wolf Warrior 2.

Digitalisation of News

Newsprint has suffered immensely from the advent of digital news. Regional newspapers are seeing dwindling readership and are shuttering or merging. Even before global news being a click away on the BBC or CNN, broadsheets were being switched to tabloid form for quick and convenient intake of the news diet.

Now, with a wealth of customizable news options online, the only newspapers and magazines left standing will be global marquee titles (Financial Times, New York Times, Wall Street Journal, The Times, Daily Telegraph, South China Morning Post) and pretentious items (The Economist, The New Yorker, GQ, Vogue) – both of which are also leveraging their brands to increase their online presence and vice versa, as a print subscription usually is bundled with complimentary digital access.

Smarter companies have evolved, and there is now a bifurcation of news and content business models that succeed online – mass market and premium. Mass market news sources such as the BBC have enormous traffic that can yield substantial revenue from advertising alone, with the addition of smart targeting due to the sheer volume of data they collect. Premium content from leading sources such as the Financial Times may be exclusive via the use of a paywall, which basically is today’s version of yesterday’s print subscription.

Investing in Video Game Stocks

Important distinction: when analysts discuss gaming stocks, they are referring to gambling companies – Casinos generally fall under real estate and hospitality.

The Digitalization of Video Games

Previously, people purchased hardware for video games (consoles) such as the Sony PlayStation or Microsoft XBOX or any of their successor iterations. Games could be single-player or multi-player, but absent a large physical tangle of wires, multi-player was largely limited to 4 people.

Console games have traditionally been the jurisdiction of a majority male and relatively hardcore crowd as gamers would have to purchase an expensive piece of hardware – which was still a loss leader – and gaming software on disks or cartridges that could only be played via the requisite console. Handheld gaming was via portable devices such as the Nintendo Game Boy.

This has changed rapidly over time, from console connectivity to the internet (playing Halo online) to software purchases made over the internet instead of purchasing a physical disk. An even larger trend is the switch from a purchase model to a “freemium” model – with the download of popular games being free, but downloadable content add-ons and enhancements for anything from in-game costumes and textures (skins) to virtual currencies (gold) being purchased separately.

The freemium model has been enthusiastically adopted in China, which is culturally averse to purchasing expensive ticket items with low marginal cost (consoles and physical games) with domestic incumbents such as Tencent succeeding with organically developed games such as Honor of Kings (with over 200 million players) and companies via acquisition (Riot Games).

This has led to gaming becoming far more mainstream as evidenced by a large and growing gaming community that is far more diverse across gender and age. Major successes in this space include titles such as League of Legends and Overwatch. Handheld gaming has almost been entirely eradicated due to the multifaceted capabilities of the smartphone – today Google Android is the dominant “console” (through software), with companies such as Activision Blizzard flourishing under the new paradigm with mobile friendly games such as Hearthstone: Heroes of Warcraft.

From a revenue perspective, the freemium works much better than the past. Previously, video game companies would have to sell consoles at retail outlets such as Gamestop, Electronics Boutique (EB Games), and big box merchandisers such as Target and Walmart. In addition to logistics costs and planning, this meant selling at a discount to the final sales price so the vendor would get their required return. The physical packaging and manufacture of disks also required cash outlays.

With a freemium model, there is no physical footprint and the marginal cost of an additional sale is nothing. However, maintenance for servers and paying staff to update content is a constant cost – albeit less expensive than the extensive new capital expenditures required to start a new game.

Major companies to watch in this space are Activision Blizzard, Tencent, and Electronic Arts.

Video Game Stocks Business Model – Freemium and Mobile Gaming

Digital revenues have been steadily rising for gaming companies. As alluded to above, video games have increasingly become more mainstream via the freemium-based model and mobile gaming.

The freemium model gets maximum traffic to games due to the low initial commitment – games are free to download and can be played under a variety of computer or mobile settings. Once the game’s addictive properties keep a certain amount of players, or the game develops critical mass where peers are pressured to play, customers may end up paying more than they would have if they purchased a single copy of a game in a conventional manner – sometimes up to thousands of dollars.

For both PC and online freemium games, analysts track traffic and revenues closely – similar metrics to internet stocks. Investors want to see rising average revenue per user (ARPU), daily and monthly average users (DAUs and MAUs) and a healthy pipeline of expansion packs or additional content.

The video game industry is tireless in putting out new upgrades and downloadable content such as skins or unlockable characters. There are usually ways to earn all of the game’s core content via play time, but many opt for shortcuts through buying “gold” or “credits”. The best examples of these games are Hearthstone: Heroes of Warcraft by Activision Blizzard and League of Legends by Tencent (via subsidiary Riot Games). ARPU for freemium PC games is often much higher than mobile games, but with lower volumes. The quality of design is often higher for PC games.

The mobile game industry has even more mainstream gamers across a much wider demographic pool – including stay-at-home moms and the elderly. While certain people would never pick up the latest iteration of Counter-Strike, easily accessible games such as Candy Crush and Zynga Texas Hold ‘Em Poker have amassed unprecedented player bases (although both have declined materially from peak). Whenever a new hot game comes out, they can be downloaded in seconds via the App Store. ARPU is much lower in terms of purchases, but there will be in-game advertisements and sponsorships that generate large cash flows as advertisers are willing to pay for the massive traffic.

E-Sports and Non-Gaming Revenue Streams: League of Legends, DotA 2 and Hearthstone

Certain E-sports are now more popular than North American major league physical sports by viewership and League of Legends now has their own celebrity e-athletes on multimillion dollar contracts with lucrative endorsement opportunities.

Given that the firms that make the games own the intellectual property, they can form leagues for these e-sports and will gain revenue from streaming games and for broadcast rights for large events. They will be able to collect entry fees and admission for viewing e-sport competitions across various regional, national and international levels.

As we see gaming fandom growing with fan conferences and “cosplay”, where children and grown men dress up as their favorite video game characters, there are monetization opportunities through licensing toys and television shows.

Video Game Stock Indicators – The Games Pipeline and NPD Data

For video game revenues, hotly anticipated new releases such as Destiny 2 or Overwatch result in a very large amount of revenues from day one, which steadily declines with sales resurrecting around expansions. New releases will stem structural declines in the product life cycle.

Similar to cinema stocks, video game stock investors will look at the next Madden installment like the upcoming Avengers movie. If sales exceed expectations, share prices rise and vice versa. Like all other stocks, video game stocks can get overhyped and experience a pullback in value once expectations are tempered. ATVI underwent such an experience after the first Destiny release, although the stock has tripled since its correction then.

Equity analysts also closely follow NPD group data as predictors for sales. NPD monitors customer purchases across various stores and a poor numbers release may drive share prices lower.

Digitalisation of Music

The music industry has followed a business model of streaming royalties through radio play and for use in television and advertising as well as the physical sale of CDs. Artists supplement their earnings by going on tours, usually coinciding with the release of a new album.

The music industry has spent ample resources fighting piracy yielding mixed results, as copied music on disks became a minor problem versus large scale downloads on peer-to-peer networks (Napster). iTunes was an early compromise for the music industry, but most people remained reluctant to purchase music.

The landscape has now changed with Scandinavian startups such as Spotify and Soundcloud eradicating the old regime and revealing that most listeners are willing to pay a nominal fee for convenience and flexibility – while data analytics can recommend smart playlists that are bespoke to the user. Even with a $10 fee a month, the average spend per listener has jumped up and customers are very happy with the product. Despite large valuations in their seed rounds, these music apps are still in their infancy and are experiencing large cash burn.

New Streaming Media and Online Galleries

Viewing habits have changed, as attention spans shorten and consumers look for content that tailors to their particular tastes. Google’s YouTube is the dominant streaming (“tube site”) platform for this as consumers look to be entertained (YouTube personalities, video game streaming, music videos) or educated (news, DIY videos) – with various YouTube celebrities making substantial sums of money and partnering with Google to create more content.

In a shorter format, videos are also available on Facebook’s Instagram – or tastefully curated (or less tastefully curated) photos. Instagram has become incredibly successful for Millennials and has given rise to the profession of Instagram model, where unconventional, physically fit and facially gifted online celebrities can amass hundreds of thousands to millions of followers and earn a fixed fee per endorsement or percentage of sales via coupon codes peddled on their posts.

Although the technological innovation began in America, the business model has evolved in China. Platforms such as Youku Tudou are owned by Alibaba, so the stores that internet celebrities sell items through are on Alibaba platforms such as Tmall, allowing for profits to flow back to the company.

Companies to watch in this space are Facebook (Instagram), Snapchat, Google (Youtube), Alibaba and Tencent.

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