First, AT&T unveiled its long-awaited over-the-top steaming service -- DirecTV Now. With a low $35 per month promotional rate for a package boasting over 100 popular channels, this is an attractive offering for many subscribers. Not to be outdone, Netflix rolled out offline viewing, a feature that has been in high demand among customers, especially since a major competitor made it available in 2015.
On this episode of Industry Focus: Consumer Goods, we discuss the new services, the waves they might make in the industry, and how important they will end up being to shareholders of both companies.
A full transcript follows the video.
This podcast was recorded on Dec. 13, 2016.
Vincent Shen: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. I'm your host, Vincent Shen, and it is Friday, December 2nd. With me in studio today is Fool.com contributor Dan Kline. We're taking advantage of your visit, Dan, to Fool headquarters this week, so we're pre-recording this episode, which you will hear on Tuesday, December 13th. Dan, it's always great to have you on the show. How are you?
Dan Kline: I'm doing great. You treated me to lunch today, which is, if anyone thinks we're a little less energetic than usual ...
Shen: We had a very heavy meal of Bonchon wings. My first time I had them was in New York, but they have since made their way, have several locations around Alexandria, Virginia here, also in D.C. great wings.
Kline: I will say, we're not getting paid for this, and they didn't send us free wings. If you don't have one where you live, get on a plane today.
Shen: (laughs) Our main topic for the show today is the new over the top streaming service from AT&T called DirecTV Now. That launched at the end of November. We're going to break down the offering itself, but then we're going to take a broader look at some of the competing services, and the likelihood that they end up driving any kind of meaningful top and bottom line gains at their respective parent companies.
But before we do that, I want to touch on another related story. That is the announcement from Netflix and their decision to finally allow offline viewing to their subscribers. The company broke this news on the same day as the DirecTV Now launch, probably stealing a little bit of their thunder. But if you are a Netflix user or follow the company in general, you probably know that management has been fighting this move for a long time. Amazon first upped the ante in September of 2015, they introduced the offline viewing to Prime video users. I think Sean and I talked about that on the show last year around that time. At the time, chief product officer at Netflix, Neil Hunt, he tried to ward off critics by arguing that adding options and complexity to the service would result in confusion or inaction from users. So, instead of just letting viewers download the content while they were traveling or somewhere without a good internet connection, the company tried to find other alternatives, like special servers that they could put on an airplane or train, for example, that could carry the entire Netflix library. Or, they tried to figure out better video technology that would reduce the file size and the data needs of videos. But basically, lo and behold, the simplest option prevails, right?
Kline: Yeah. I mean, that's a tad inefficient. (laughs)
Kline: I don't think we need to bring all of Netflix with us everytime we fly. That seems a little bit reaching. And the reality is, his point about complexity is correct. Good luck on Amazon figuring out how to download things. It's not super simple. The Amazon interface is light years behind the Netflix interface. That's true whether you're renting something on Amazon, or you're actually watching it through Prime -- figuring out how it is, where it goes --
Shen: I will absolutely agree with you. Recently, I tried to watch something on my mobile phone for the first time through the Amazon Prime video library, and it required two additional app downloads. It was very surprising for a company that, in the past, has generally been so good at making shopping or using their services as easy as possible.
Kline: I think the Amazon video experience is generally lousy. I'm a subscriber and a Prime number, I'm a Netflix member. And I think what Netflix has done is removed the last barrier to any person who had resistance to a $9.99 price tag, because the people who don't get Netflix are the people who are still spending money renting movies, or going to Redbox. Look, I'm a parent, and before I would take my 12 year-old son on a plane ride, I would pay for a season of The Simpsons, or a couple of movies he wants to watch, and I would rent them or buy them so he could watch them offline. We're a Netflix subscriber. I am never again going to have to do that. So, if I ever have to make the decision of, "Is Netflix worth my $9.99, or should I drop it for a month or two because I'm not watching anything?" it's a no-brainer, because we were spending money elsewhere that now just goes into the Netflix bundle. I don't see why anyone wouldn't get Netflix now.
Shen: Yeah. In the beginning, I didn't think this was that significant or that big of a game-changer. But something to keep in mind is, they're rolling this feature out worldwide. The fact that, I think Netflix is now approaching about 90 million subscribers worldwide, and a growing portion of that 90 million is international, and you have some markets where maybe the internet is costlier and not as reliable -- this is maybe going to convince some fence-sitters that "Hey, if I can find a good connection or a cheaper connection, download it, and watch it at my leisure offline, that makes it that much more compelling."
Kline: And the reality is, the internet is not that reliable. If you remember, last week, we were going to tape one of these shows, and I was remote in an office with a high-speed, wired internet connection, and we could not get Skype to connect in order to give us a good signal.
Shen: Sure, fair enough.
Kline: How many times have you been watching Netflix in your living room, where randomly it stops, and you have to restart --
Shen: Or let it buffer, yeah.
Kline: Yeah. So, even at home sometimes, we have a family home in the woods in New Hampshire, and the internet connection is satellite internet, it's awful. I would much rather wait an hour to download a movie and then watch it that night than have to deal with the buffering and the stops and the audio not being right, or whatever is going on. This is just a smart move. And I understand, the reason they resisted it was pirating. I can now download a series of House of Cards and hand you my laptop and you can watch it. But guess what? I could give you my Netflix password, too.
Shen: Yeah. So, big takeaway, maybe it helps some of those fence-sitters that I mentioned, in areas where the internet connection isn't as reliable. But all in all, I think it's just the stickiness of that Netflix product that they're offering. And ultimately, I think if they're able to keep those subscribers loyal, we saw some churn when they increased their rates earlier this year, but make it as compelling as possible, with their content, but also with the usability of that content, maybe in the future, if there's another price increase, people are more willing to stomach that.
Kline: This is a valuable give-back. You have to listen to your customers, and people clearly wanted this, for all the reasons we've listed. So, when they go to $12.99 or $11.99 in a year or two, at least they can say, "Hey, we gave you what you asked for."
Shen: Yep. A few details I do want to add, in terms of, anybody who didn't know about this or wants to look into it is, you need the newest version of the Netflix app to do so. And the library isn't comprehensive. It's growing, they'll be adding more content to it, in terms of what you can download and view offline. It includes most of their original series.
Kline: It's a question of rights. You're going to see this, when we talk about the OTT services, some of these rights scenarios weren't ever considered when they made these deals. So, as these movie deals come up, and TV deals, they're going to start asking for the right to let people download it offline. It's not a technology issue.
Shen: Yep. And one big example of content that is currently not included in this feature is Disney content. They signed that really big, expensive deal that gave them some of that exclusivity.
Kline: And Disney might be a holdout, because they're one of the last few places that actually still sells DVDs. So, if you're Disney, you may not want Netflix to be allowed to have your content offline, because it might cost you a $19.99 sale. It's the one thing, as a parent, you can justify, because a little kid is going to watch Cars 300 times in a row, and you're getting your money's worth. So, not everything is coming to this service. But as an adult, as a father, it's still a very valuable offering.
Shen: So, out with one streaming service, in comes another. DirecTV Now is currently available for free trial. Why don't you give me some basics, Dan? How much is it, and what are customers getting?
Kline: DirecTV Now is your latest alternative to cable. It's live streaming cable channels. And the promo offer is a $35 a month package, which, in theory, AT&T is taking a bath on, though, let's assume they've negotiated some good deals there, for at least a short time. You get about 100 cable channels, including, in some markets, local channels, but that's very limited, like, if you live in New York, you might get NBC, but you can only watch certain programs on demand. But in general, you're getting the top cable companies like TBS, TNT. It's very similar to Dish Sling, or Sony PlayStation Vue, where you don't have cable, you want to watch some live TV, you want some sports, and you're going to pay and you're going to get a streaming-only cable service.
Shen: Yep. I should add, there's four tiers to the service --
Kline: Which are made a little bit irrelevant by the promo offer right now.
Shen: Yeah. They have cute names. The first tier is $35 a month, it's called Live a Little. The next one's $50, Just Right. And then the promo one is Go Big which is usually $60, but the current promotional rate is $35.
Kline: And they say they're going to honor that forever. Now, forever, for AT&T, is not trustworthy. Just like they're going to grandfather your unlimited plan forever, and then slowly make it terrible for you. But, in the short term, it's probably the cheapest per-channel deal. Dish Sling is at about 22 channels for $20, it varies a little bit how many channels.
Shen: And you can stack on additional, right?
Kline: You can add stuff. So, it's probably $35 for 100 channels. And 20 of those channels aren't stupid ones you don't watch. Most of them are good channels.
Shen: The full network list isn't available, at least that I could find, but a pretty good sampling of them are here. And as you mentioned, it includes most of the big networks. And like you mentioned, if you can get it, it includes three of the big --
Kline: No CBS.
Shen: No CBS. And then, the biggest package is Gotta Have It $70 a month. I'm trying to think if there was any other ... so, there's the promotional offer that's $35 ...
Kline: And there's a promo where you can get HBO and one of the other pay services for $5.
Shen: And some perks that come with the service are, the fact that you can cancel it at any time, there's no annual contract, no fees that way, and there's no waiting for a cable guy to come install it, no box, it will stream directly to your smart TV, your phone, your tablet, your PC, any devices you have like Apple TV, the Amazon Fire TV Stick. There's also a bunch of on-demand titles, too, right?
Kline: And they'll give you those devices. If you commit to three months, they'll give you an Apple TV. I will point out that Apple TV is $149, and 35 times three, I can't do that math live on their air ...
Shen: But it's less than $149.
Kline: It's $105. So, if you were thinking about an Apple TV, getting this for three months just to play with it while you're traveling is worth it, just to try it. But the reality is, they have built a me-too service. This is somewhere in-between what Dish and Sony are doing. Sony has a pretty traditional cable offering, in terms of its pricing and its package, whereas Dish is going for more Millennials -- "this is the best of the best, this is what you're going to watch." AT&T is somewhere in the middle. At that $70 price, it's not that cheap; at the $35 price, it's a good deal. The problem is, consumers have not shown that they actually want these services. I know you have the numbers, but the cable universe is about 94 million homes, even with the slow decline in cord cutting. Why don't you jump in with how many people are getting these?
Shen: You mentioned Sling and Playstation Vue as the main, what people would see as the competitors of this service. I want to mention, as a first foray into this world from AT&T and DirecTV, it's pretty competitive. I think it's actually, for what this world is, a pretty strong showing.
Kline: At the promo price, it's by far the best offering, because not only do you get $35 for 100 channels, you also can stream two streams, whereas the Dish offer is only one. Sony's is multiple, but it's much more money.
Shen: I think the bottom line, at least for customers, is that this is an attractive package. I think some people have been looking for that live TV competitor to your standard cable package. For some people, it will very much be cheaper if you can get in at that promotional rate, it becomes very compelling. After that rate expires, or once that promotion ends, I think it loses some of its luster, for sure.
In terms of the impact for the company, so if you're an AT&T investor, and you're looking at this like, "Is this a game changer for us?" I think, you have to keep in mind the scale of the business and what kind of impact this can have. I was really surprised. Even with Sony's Playstation Vue, the service has been out for how long, Dan, do you know?
Kline: Just a few months, not that long. Six months or so.
Shen: I think it has, just recently, in the past few months or so, crossed 100,000 subscribers.
Kline: And Sling is coming up on two years, I would say.
Shen: Yes, Sling came out in early 2015, so coming up on two years. That is also now approaching about one million subscribers. So, even the best case scenario, let's say that DirecTV Now can pick up one million subscribers to match Sling in the first six months, and every single one of those people adopts it at the $70 "go big" package.
Kline: And none of them drop DirecTV's regular package to get it.
Shen: Exactly. You're looking at $70 million incrementally, whereas in terms of these segments within AT&T, its cable TV business is a $20 billion business. So, it's important to think about where this really falls into things, and what you described as a me-too offering, that ultimately rings true.
Kline: We've talked about this: I'm super negative on this product. And I like Sling, I used Sling for a long time when I traveled, I played with it. But the reality is, they're going after you. They're going after younger potential cord cutters, or cord nevers, and saying, "Well, we're not going to get you for $110 a month for cable, maybe we'll get you for $20 or $30 or $40." And the problem is, the person who doesn't have cable is watching something else. He has Netflix, he's watching YouTube, he's watching Twitch video games. It's not someone who desperately misses cable.
Shen: I will say, right now my internet package gets paired with a pretty basic TV bundle. This is the kind of thing that would make me rethink that. If I can get in at $35, get way more value out of that, it does become attractive. AT&T specifically says, there are 20 million people not subscribed to any sort of paid TV service that they think this will appeal to. I think that's very optimistic.
Kline: I was going to say, that includes the Amish, that includes the elderly. Every cable company is doing this. Comcast is working on a service. Everyone is going to have one. And maybe you will see the end of the cable box, and this type of delivery will just become the norm, so the 94 million will morph over into slightly less expensive packages with a little bit more choice. But, this idea that there's this huge untapped audience of people who, they won't pay $70 for cable, but they will pay $35. And the second they drop their cable subscription, their internet bill is going to go up $5 to $15, and then Comcast is going to put a data cap on them. And if they start watching a bunch of movies, and downloading 4K video, then they're going to pay overage charges. So, the reality is, these are products built for a theoretical future that nobody has proven is actually coming.
Shen: Alright, so, that is our pessimist view. I'm going to put on my optimist cap right now, because I do think there are a few things that we can keep in mind in terms of how this becomes attractive. For example, AT&T having this diversified suite of different businesses, including its wireless business, some people argue that this can be a loss leader because, guess what, AT&T have made it so that anything you watch, if you're signed up for DirecTV now, does not count against your data cap for your wireless service.
Kline: And AT&T's ability to bundle, because they're not going to invest more money in physical cable lines. They own DirecTV, which is a satellite product, and the biggest decliner in the cable business has been their wired cable business, because if you own DirecTV, which you can market nationwide, why would you spend money marketing locally? So, they can go to their phone customer and say, "Here's a promo, add DirecTV Now for $20 for the next three months, I'll give you a thousand channels," or whatever it is. They'll have a little bit of success with that, but there's a ways to go on the product. I think that's important to point out. I tested Dish, I did a story for fool.com on cutting the cord, and I lived with Sling and with Sony, and to say it's an unpleasant experience when it's your prime means of watching TV is putting it mildly. People, when they watch cable, flip around. They don't sit down like they do with Netflix and binge-watch. They don't always watch whole programs. Even if you're watching your favorite football team, during the commercials you might flip to a home improvement show, or whatever it is. Doing that on these services is painful. It's a little better on Sling than it is on Sony. From the demos I've seen of DirecTV Now, there's a lot lacking. You also can only pause for five to 10 seconds on most channels.
Shen: Yes, that's something to keep in mind. DirecTV Now, at the moment, at launch, it does not have a DVR capability built in, but that's supposed to be coming next year, as is supports for some additional ...
Kline: And, to be fair, the reality is, nobody really does. Sony has some limited DVR capability, better than others, but their price is higher. Sling is just this week testing some DVR. But the reality is, most of their deals with the cable companies preclude DVRs, pausing. There's some on-demand content. But generally, it's the type of on-demand content you could get with a Hulu subscription.
Shen: Looks like we're going back to our pessimist angle.
Kline: (laughs) But hey, good job, AT&T.
Shen: I do want to add some additional details on numbers I was able to find. I think it's kind of interesting, in terms of the profitability, what the contribution might be in terms of their margins. You mentioned the $35 promotional deal for the 100 channels is quite compelling. The fact is, it's not coming cheap. One analyst I have, they believe the gross margins for the various packages will range anywhere from 2% to 15%. This is, for AT&T overall, their operating margin is about 17%, so not even close. The fact of the matter is, SNL Kagan, they estimate that that $35 monthly bill, even for the lowest tier, which I think is where a lot of people will end up signing on for those core 60 or so channels, that barely covers the cost of the programming, based on their estimates. Then you factor in things like the back-end support, customer service, the infrastructure, and you're potentially looking at what is very much a loss leader.
Kline: I think there's one thing you can factor in there, I think we're about to see a bit of a come-to-Jesus. The cable companies have had all the leverage. ESPN has been able to say, "You can't get rid of ESPN. We want 10% more. We want to go from $5.80 to $6.25 to $6.45 per subscriber." Now, we're starting to see the cable companies say, "Wait a minute. We're going to offer a package without ESPN." Someone could go to one of these services and maybe not get certain higher-priced channels. There are going to be reductions in some of those costs. You are not going to, as a low-watch channel -- maybe VH1 Classic gets $0.02 per cable subscriber, and 80,000 people are watching it at the absolute best part of the day, they're either not going to exist because no one's going to pay them anything, or they're going to get lower fees. Even the big-ticket companies, ESPN ratings are down. So, you're going to see a trickle-down across the board. ESPN is either going to stay the same or take cuts, and they're going to spend less money on programming. So, you're going to see some of these college billion-dollar deals get lessened, and start to go down.
Shen: I will add that, big picture, there's two other things that I want to wrap up with. The first is, even if, I think DirecTV Now, with this service, they wanted to raise prices and boost margins, let's say it really does take off, and they're able to build up five to 10 million subscribers, and it starts to make a bigger impact on their financials, it's only going to get more competitive in this space. Hulu is coming out with a competing service. Amazon, you know, is coming out with one.
Kline: Apple is talking about one, Comcast is talking about one.
Shen: Amazon will put that out at or below cost, too, just to take market share.
Kline: And the problem is, when you're selling a service based on price, you lose a lot of pricing flexibility. So they are not going to be able to slowly raise this so it costs what cable does, unless cable goes away, which, as we talked about earlier, the physical cable box might. But for that to happen, these services have to feel like the experience of watching TV.
Shen: That is a possibility, though, in terms of, looking out three to 10 years, as, they understand, or they see this as becoming the future without the cable box, no more waiting for the cable guy, replacing their model, and this is their test.
Kline: Some of this I blame on your generation, who is willing to watch television on an iPad when you have a 60-inch flatscreen sitting in front of you. (laughs) I've never understood this!
Shen: The second thing I did want to discuss was with the coming acquisition, still uncertain, of Time Warner, which will give AT&T an incredible library of content. Think about what Time Warner runs -- HBO, Warner Brothers, they have some great networks like AMC. Obviously, there's going to be some rules and regulations about making sure that there's somewhat fair competitive practices. But ultimately, Time Warner gives them that leverage to offer exclusive content to DirecTV Now subscribers. And that has worked for companies like Netflix.
Kline: And even, forget the ability to say, "Hey, you're going to get HBO shows two days early," or some of the things that maybe will fall under regulation, though debatable, given the incoming administration and their stand on --
Shen: Call that uncertain, yeah.
Kline: Yeah. Tom Wheeler, the FCC chair, has been pushing a lot of this, and he is probably not in political favor going forward. But, forgetting that. The buying power of this combined company -- one of the first deals they announced was a Taylor Swift Channel. Now, I know you're a big Swiftie. I am not so much. I am much more a Gwen Stefani camp -- no, I'm teasing, completely. But that said, Taylor Swift has a decided audience. And they could throw the money at her. So, her back catalog of performances, videos, exclusive interviews, whatever the heck it is, Taylor cooking Thanksgiving dinner, I have no idea, can be a channel. And that itself may not be a draw, but you start to pile two or three of those things together, and they have the ability, just like HBO has a deal with Bill Simmons and Jon Stewart, some of those deals are very amorphous as to what the content is going to be. They could say, "Hey, look, Bill Simmons' podcast is going to be on video on a channel," the way they do with The Dan Patrick Show on Audience, which is the AT&T video channel. So, their ability to just buy up the marketplace in terms of content -- and I'm sure they offer Audience to other cable companies and none of them take it -- eventually, they might be able to tip the balance in favor of them. But it's still not going to make you buy an inferior, unpleasant service.
Shen: Yep. So, it seems, overall, you are not all that bullish on what this offer provides them.
Kline: Not for today.
Shen: My view is, it's an interesting step. I would watch it rather tentatively. But ultimately, this could be what the company sees as a step into what the future of distribution is going to look like.
Kline: I think every cable and wireless player believes in this a lot more than I do, to be positive. (laughs)
Shen: Thanks a lot, Dan.
Kline: Thank you.
Shen: That wraps up our discussion for today, but you can reach out to us and the rest of the Industry Focus crew via Twitter @MFIndustryFocus. Or, you can send us any questions via email to email@example.com. People on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear during the program. Thanks for listening and Fool on!