Let's try to separate a sprawling sector into a couple of manageable parts.
The media industry can be confusing because media businesses come in several flavors:
- Some focus on creating content for you, the consumer, to enjoy. Let's call these guys the "producers." Examples of this business model would include Walt Disney (NYSE: DIS ) and Time Warner (NYSE: TWX ) .
- Others work on finding new and innovative distribution channels for those productions -- or sometimes on exploiting established distribution channels. These are the "distributors." Comcast and Time Warner Cable fall into this category, as do less-traditional media wranglers Sirius XM Radio (Nasdaq: SIRI ) and Netflix (Nasdaq: NFLX ) .
- And then you have a few picks-and-shovels plays that create and improve the technology that makes all of this stuff possible. I'm going with "enablers" for this category, which includes IMAX (NYSE: IMAX ) and RealD (NYSE: RLD ) .
Of course, a few giants of the industry straddle two or more of these categories. Time Warner's many faces certainly fit this bill, as does mini-conglomerate News Corp. and any content producer that also owns TV stations. But I think these categories provide a useful framework for how to think about the companies that make up the media world. So let's have a closer look at these groups in the light of some strategically chosen questions.
Define the sectors
Welcome to the land of gray areas. The distributors, as presented here, focus on distribution of content that other companies produce by physical hook or by digital crook. Regal Entertainment Group and Cinemark would feel at home here, too.
The producers bucket includes pure entertainment experience providers. The jump to cruise lines, hotel chains, and casinos isn't very long from there. This includes titans of the old-world approach to media distribution, where there's a physical object for every piece of consumable media content. I hope that everyone in this sector is at least trying to make it in the new digital reality.
Here's what it boils down to:
- Distributors: Inventive media distribution services, usually Internet-friendly and ready to change with the shifting landscape. Companies in this category that lack an online plan better have a very well-defined niche to dominate with impunity, or else get ready for the great gig in the sky.
- Producers: High-quality content comes first, then everything else falls into place. The sooner a company from this list realizes this, the better it will do in the next 10 to 15 years.
- Enablers: They often control the tools that connect distributors to producers. Many of these could be buyout bait for members of both of the larger subsectors.
What metrics matter most?
This is where a shrewd investor needs to pay attention. The metrics and expectations that fit one category of entertainment stocks simply don't matter to the others. Here's how I'd define the signs of success or impending doom:
- Distributors care about subscriber counts and growth, size and quality of media library (I know, nebulous stuff), and a combination of balance sheet and cash flows strong enough to survive inevitable rough patches. Given a sound strategy, nothing besides these details really matters in any universal way. No, not even the specific technologies used.
- Producers represent a more traditional model: you want high return on invested capital, revenue growth, and stable or rising margins. If available, it's very useful to see financial returns from individual, major pieces of content such as a high-budget movie or a new theme park. Especially for integrated entertainers like Disney, a big hit can pay dividends for years or decades as the company builds cash-cow machines around new characters.
- The enablers fall in the middle ground here. Growth is important, but we're typically talking about capital-intensive business models that require a steady flow of cash and decent returns on capital in order to make sense.
What's the least understood thing about each sector?
Distributors are often misunderstood -- particularly the new wave of digital experts. Remember the "nothing else matters" thing from above? Many critics of companies in this sector try to apply financial models meant for completely different operating structures and fail to see the value of sustained subscriber/customer growth. This is why some old-schoolers sell Netflix short or steer clear of Sirius where forward-thinking investors see sustainable business models instead.
The producers are standing at a crossroads with huge opportunities and risks ahead. Some of these companies will die rather than adapt, and the winners may eat some of the losers. The stakes are much higher than most people suspect -- and traditional publishers are actually more resilient than you'd think. Digital alternatives are luring movie/music/multimedia consumers much faster than they're stealing newspaper subscribers or bookworms. Amazon.com's (Nasdaq: AMZN ) e-book success notwithstanding, the market for printed infotainment will never quite die and the (admittedly drastic) decline will take many years.
Finally, the enablers often fly entirely under the radar. For example, Kung Fu Panda 2 tripped and fell at the box office, but IMAX still made a mint on big-screen presentations of the bumbling bear. This is a very different route into Hollywood.
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