Everything changed for cable after Netflix (NFLX +14.03%), but despite all the news about cord-cutting, the industry isn't dead. In this week's episode of Industry Focus: Consumer Goods, host Vincent Shen and Motley Fool contributor Dan Kline check in on cable -- where it is now, where it's going, and what investors should know about its future. Pure-play companies have really been struggling lately, but other players have found ways to diversify.
On the other side of the coin, Netflix is great, but how many a la carte subscriptions will it take to pop the only $9.99-a-month bubble? Can cable survive a generation that's increasingly going mobile? Why are sports so appealing for media distributors? Click play and learn more.
A full transcript follows the video.
This video was recorded on Dec. 4, 2018.
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. Thanks, Fools, for tuning in! Please welcome my guest today, Motley Fool contributor Dan Kline to the show. Hey, Dan! How are you, sir?
Dan Kline: Hey there, Vince! I'm doing great! How are you?
Shen: I'm pretty good! Glad to hear you're doing well! Have you been doing much shopping during the holidays this year?
Kline: [laughs] Everybody's getting Amazon gift cards.
Shen: That's not a bad route to go, giving people the option. I know people have different opinions of the gift card gift.
Kline: No, honestly, my son wanted the new Fallout game that came out last week. We bought it ahead of time. I'm sure I'll buy something for my wife. But pretty much anyone else is getting a gift card.
Shen: Something you mentioned to me that I wanted to talk to you about, I think the listeners will enjoy this, was the pants that you bought with the tailor online.
Kline: I brought this up because we've talked a lot about retail and why you would still shop in a store. One of the big reasons you'd still shop in a store is fit. If you buy a pair of pants from, I don't know, JCPenney.com and they show up, they might not fit. And that's a hassle. You have to send them back.
I used a digital tailor. I'm not going to say specifically which one, because I'm going to be a little critical of their product. Basically, I had to put on some spandex-like shorts, or you could wear boxer shorts or something, and you set up your phone on the floor, and there's a little level. It took maybe 15 seconds to set up. Then you do a spin and you record this spin. They promise you that you spinning in your underwear isn't going to appear on the internet anywhere. And I picked a pair of pants. I actually ordered two pairs of jeans. They show up maybe 10 days later. While I did not love the material they were made of -- I think they look a little cheap as far as jeans go -- the fit was absolutely perfect.
Shen: So it worked?
Kline: Yeah. I've been measured by a tailor. My wife has had jeans made, where you take 20 measurements, and they haven't worked. This, with just a very simple scan, worked. So, I really think this could be the next step in the end of retail. If you can get perfect fit with just a very simple measurement, I don't see why people wouldn't do that.
Shen: I know, when shopping online now, they try and do things where they get very specific with sizing charts. They have the bar where it says, "true to fit," "runs large," "runs small." But something like this, it seems like a pretty simple process, and they can really narrow it down.
Kline: That might work for you. You're a young, fit guy. I'm a little older, a little less fit, perhaps not as linear as you are. [laughs] So it's a challenge to figure out how a shirt's going to fall, or, frankly, if a dress shirt will button, and things like that. If I could be guaranteed -- plus, there's a shame factor. You don't want to walk into a store and have to be like, "Oh, we don't have one that big. You'll have to special order it." If you could just get your size, and not even know what size that is, there's something very magical to that.
I'm not saying this has to be purely at-home technology. This might actually be something where you walk into a Macy's, go into a room, and it tells you what products on the shelves will fit you. It's a very adaptable technology. But I was stunned at how well it worked.
Shen: Very cool! All right, let's move on. We have to get into our main topic for today. That is, ultimately, we're checking in on something you and I have talked about in the past, the idea of the death of cable. Several firms and research providers released their third quarter reports for the industry earlier in November. What are some of the big themes that you're seeing in these reported numbers?
Kline: It's the biggest one-quarter drop we've seen since cord cutting became the trend. It depends on exactly which data you look at, but it's one million to 1.2 million customers. That's more than most years have been since 2014, when the number started dropping. You're really starting to see things take hold.
It's actually a lot worse than that, because there are about four million people that have digital streaming services, things like Sling TV that are live television but they're cheaper products. If you look at cable, which is in about 90 million homes now, and subtract that four million, it's actually only about 86 million full paying customers, down from about 95 million only four or five years ago. It's a really stunning loss of customers.
Shen: Within this broad traditional pay TV subset of the industry, I'm seeing that one particular segment that took a really big hit also was with satellite. What were some of the numbers breaking down there?
Kline: The satellite companies took pretty big hits. Hold on, I'm pulling it up right here. DirecTV lost 359,000. Dish lost 367,000. They both made up a tiny bit of that when it comes to streaming customers.
But the reason for those losses are because the satellite customers used to be the low-price alternative to cable. That was the reason to put up with having a separate broadband provider. "Hey, I'll get DirecTV, I'll save money for a couple of years, maybe I'll bounce back and forth between providers to keep getting a deal." Those are no longer the low-cost options. They might be cheaper than traditional full-on cable, but they're not cheaper than cutting the cord and using streaming services, whether that's live TV or Netflix or Hulu or any of these different options. There's really no market for satellite TV anymore. It's sort of like, I'm going to get a product that's a tiny bit cheaper that's kind of a hassle that goes out when it rains. And I speak from knowledge because my building has DirecTV.
Shen: [laughs] There you go. I was looking at the trend line for these satellite providers. You look back to last year, DirecTV lost over 500,000 subscribers; Dish Network, another one million. Going back to what you said, in terms of some of the alternatives, I think they see what's going on with their core business, as well. DirecTV Now and Sling TV, those alternatives, made up pretty good chunks of those losses in 2017, both services adding about 700,000-800,000 customers.
But with this most recent quarterly report, they're really falling short now. You mentioned Dish Network lost almost 400,000 satellite customers. They only signed up about 26,000 people for Sling TV. AT&T's DirecTV business down about 360,000 subscribers in the quarter. But again, just 49,000 DirecTV Now additions. You're right, I think it really does come down to value and all the other alternatives that are out there now.
Kline: It's become unbelievably difficult as a consumer. I am both a cord cutter and a cable-haver. I have cable in my main home. I'm a cord cutter in the home I'm taping this from now right outside of Orlando, Florida. I have Amazon Prime, Netflix, Hulu, WWE Network, DC Universe, and I'm sure one or two other things I'm forgetting -- oh, and Sling TV. I'm probably spending more. [laughs] I don't know if cord cutting has been a benefit for me. It really becomes something you have to manage too much. Or, to save money, you actually have to say, "OK, I'm going to have Netflix for two months. I'm going to catch up on all my Netflix shows. Then I'm going to drop it and have Hulu for a month, and I'm going to catch up on Hulu." Consumers have a lot of choice. While that is a good thing, and it's about to get even more crowded, it is confusing. There are probably people who think they're saving money that aren't.
Shen: That's exactly something that we'll get to. I want to wrap up the show with that discussion.
The next group that I want to talk about, though, is the big cable providers. These companies are starting from much larger subscriber bases. You mentioned the 86 million cable subscribers. The penetration rate in general in the U.S. is still pretty big for this segment. They're seeing slower rates of cord cutting, but they're also leaning on growth in broadband or internet service as a crutch to keep up with that. Do the numbers in 2018 so far, in your opinion, paint this doom-and-gloom picture in terms of death of cable?
Kline: They don't. This isn't music, where records are going to go away, and people stop buying music in a meaningful sense and switch to streaming. There is still a huge base for cable. We may not have hit bottom. Bottom might be another 10 million losses. But there is still a place. If you're a family -- I have a 14-year-old, and I'm married, and we all like different things. To be able to have cable with 200 channels, there's a value to that. I don't think that value is going to go away.
Comcast (CMCSA +0.36%) has about 22 million cable customers. Charter has 16 million. Comcast lost 106,000 this quarter. Charter lost 54,000. Both of those gained more than that when it comes to broadband. While the broadband numbers have slowed down as we're nearing penetration, in general, the gains for broadband have been dramatically bigger than the losses for cable. Until we see a true alternative to using your cable company for broadband, or in some markets, there's one or two choices, maybe 5G changes that and some of the younger people decide, "I'm just going to watch on my phone or my tablet." But these companies are not seeing their revenue slow down. They're just seeing their basket shift up a little bit.
Shen: Absolutely. I've heard this analogy from a few Fools in the past, and I think it's pretty fitting. You take the comparison of these traditional cable companies like Charter and Comcast, and you compare them to big tobacco. With big tobacco, U.S. smoking rates have been falling for decades from their highs in the 1960s, over 40% to just 14% last year. But it took 60 years for that to happen. In the meantime, tobacco companies consistently raised their prices to make up for the reduced volume.
Cable penetration, on the flip side of that, it's still really high. It's still like 78%. It's down maybe 8% from their highs about a decade ago. But even if cord cutting accelerates -- and we're not seeing it accelerate to the extent that a lot of headlines will make it appear -- traditional pay TV companies still have a lot of time to come up with different solutions, to develop these other businesses like broadband to make up for that. That's something that tobacco companies, frankly, haven't had yet until now with some of their other opportunities, but that's another episode.
These solutions, they've taken different forms. We're seeing more and more streaming services, which we'll talk about later. We're seeing price increases with the cost of an average cable package almost doubling in the past 15 years. Even some of the newer services like DirecTV Now, Sling TV, PlayStation Vue, they've all raised prices in the past six months. I think a big driver of these growing monthly bills for consumers lies in sports. Dan, you sent me a bunch of reports of these huge deals being made for the rights to sports programming. What does that look like?
Kline: There's a theory, and maybe it's true, that live sports is the last thing people will watch not on a DVR, meaning they will see the commercials. It's not only valuable in terms of selling ads, it's valuable in terms of promoting the rest of your schedule. There's a bunch of examples. The rumor is the new Major League Baseball deal with Fox is going to be 30% higher, despite the fact that it's a declining audience. But the biggest one I'll point to is, Fox is paying $1 billion over five years for rights to two hours of programming from WWE. That show, SmackDown Live, is going to air on Friday nights. Right now on USA, where it airs live on Tuesday nights, which is a better night to air, it does between two and a half to three million viewers. That is about a million viewers less than the sitcom block that almost certainly costs less than $200 million a year for Fox to produce. That said, there'll be 52 weeks of live WWE programming. They're saying that a million less people is worth more at a higher cost because we know people are going to watch it live. And that's for wrestling, which traditionally gets pretty lousy ad rates compared to other sports.
So, any sports. UFC got huge money from ESPN to be part of their streaming service. DAZN, which is a service you probably haven't even heard of, is paying billions for mixed martial arts and boxing. Really, if you and I were going to start up a sports league right now, we could probably get like $50 million a year from someone. [laughs] Dan And Vince Play Ping-Pong Live could completely be a thing.
Shen: Do you think, then, there is some merit to this idea, where sports programming still is king of the heap in terms of the content that some of these traditional pay TV companies can lean on to maintain their audiences?
Kline: I think the premier stuff is. If you're the NFL, the NBA, to a lesser extent hockey and baseball, which, while their audiences are small, they have a very loyal, defined audience. I think the WWE contract is too high, but they're going to perform exactly how they've performed, plus or minus 10% over the five years. They know what they're getting. It's not a mistake.
But, you're going to see -- Bellator got big money from DAZN. I don't think you're going to see those deals get renewed. I think right now, there is a huge rush to sign anything up. "Hey, we've got soccer from Spain!" Whatever it is. I think the lesser sports are going to prove to not be valuable enough, so there will be a bubble as opposed to rates have been up, up, up. But, do I think someone will pay more for the NFL or the NBA when they come up? Yeah. I don't think we're there yet, because people are still watching, and they'll watch on whatever platforms you can put them on.
Shen: We're also seeing some non-traditional players get into the mix with sports content, as well. I'm on Amazon Prime, I'm streaming through my Roku or my phone, I'm seeing them advertise their NFL content constantly. Watch it live, watch it live.
Next up, we're going to look at some of the MVPs, in terms of the sports analogies, in television, and the long-term outlook for the industry.
All right, Dan. As someone who closely follows the industry month after month, I'm sure you have your favorites when it comes to the different players in this business. For the traditional pay TV side of the business, who do you think is best in class?
Kline: I think Comcast is best in class. You have to look at, they're managing their subscription loss in the U.S. well. The Sky deal in Europe gives them an almost identical business, but Europe has not had the cord cutting. It may come, but when it comes, Comcast knows how to manage it.
The second piece of this, which Charter doesn't have, is Comcast owns this huge array of content. They own Universal Pictures and all the related stuff from that. What they can do is, as things move to other formats -- let's say they have to make an NBC streaming service. Well, they can back that up with all their properties, their movies. They may not quite be Disney (DIS +0.52%), but they still have a nice array of stuff. They're very well positioned to have things consumers want to see, and they can pivot to whatever format it is consumers want to see it in. That could mean licensing to someone else or creating their own thing.
Shen: I'll just add, for example, Comcast's third quarter report, revenue was up 5%, net income up just under 10%. We mentioned this a little bit earlier in the show, but even though video subscribers declined 1.7% during the period, their broadband subscribers were up over 5%. Again, these are both huge segments, over 20 million people signed up for each. I think the really notable catalyst, which you briefly mentioned for Comcast right now, is this Sky takeover. Sky is based in London, the biggest pay TV company in Europe. Now, it's under Comcast's control. It almost doubles Comcast's total customer base, and it takes Comcast out of the U.S.
Kline: Which is a big change for a company that was very regional for a very long time.
Shen: Exactly. The deal was very expensive. A lot of the coverage around this is the fact that the deal cost Comcast $39 billion in this bidding war against Disney -- another bidding war, because before, they were both going after Fox. Comcast also ponied up another $15 billion for Disney and Fox's stake of Sky. This basically solidified their position. They're the controlling shareholder now. They have Sky. Just to put into perspective how much they paid, there was a 60% premium for what Comcast paid to what Fox paid originally for its investment in Sky just a few years ago. A huge jump in that time. It's ultimately a really nice windfall for the combined Disney-Fox entity, because it's $15 billion of cash to bolster their coffers.
Kline: If you're Comcast, though, yes, you're taking on a lot of debt, but you're buying an annuity. Even if you start to see, a year from now, a similar trend to the U.S. of cord cutting, that's almost irrelevant. I don't know what the exact cash flow of this is. They haven't reported as a combined company yet. But they're going to make money on these 19 or 20 million subscribers. Even if that declines by 1-2% every year for 10 years, it's going to pay off, they're going to come out well of the game. It's really a question of, yeah, they paid more, but does that change their earn out to four years down the line from three? It's really somewhat irrelevant as long as you believe -- and I do -- that this customer base isn't going anywhere anytime soon.
Shen: I do agree. I think the deal makes sense. Sky has encountered some issues that these American companies have, in terms of the European market. Satellite business there is also declining, for example, I think Comcast will have to execute well, though, make sure that with everything being integrated, they do it very smoothly to justify the very large amount of money that they spent to take control of this business.
Let's move to the other side of the industry with the next MVP. I'm curious now, who's your pick among the newcomers in pay TV? We're looking away from traditional cable companies, things like that. Who's your MVP?
Kline: I mean, I feel weird saying this is a newcomer, but you can't argue with what Netflix is doing. Whether you have cable or don't have cable, in the U.S., two-thirds of you with cable have Netflix. It's kind of a stunning number of subscribers. If you said today, "From scratch, I'm going to create a company that has the intellectual property that Netflix now controls, and the amount of hit shows that they own outright," it's almost impossible. Netflix came together almost by accident. It was a service that was basically just rebroadcasting other people's stuff that dabbled in originals that had some hits and has gone to the tune of about $6 billion a year in creating this massive firewall of originals. Other than Disney, which obviously owns a ton of originals, and maybe Comcast, there is nobody out there. If you and I had $20 billion to start a streaming service, that wouldn't get us to half of what Netflix has now. That's a very hard business to go after.
Shen: I think most Fools are familiar with the Netflix story. There's one data point that I'll make here to emphasize what I think will shape up to be a really nice tailwind for Netflix long-term. There's this latest Piper Jaffray Taking Stock with Teens survey. I think you've heard of this, Dan.
Kline: Yes.
Shen: They said that Netflix and YouTube accounted for 70% of the daily video consumption among teenagers. 70%. There's an honorable mention for Alphabet's YouTube. I know that service has started to offer an ad-free experience with the monthly subscription. They also have their own YouTube TV bundle.
In the same survey, cable TV's share of daily consumption among teens stood at just 16%. That's down from 30% just three years ago. I bring that up because Dan, you and I have discussed this before, it's the very real potential for younger consumers and TV subscribers to basically grow up never having access to these traditional pay TV packages, meaning they'll never really miss it or have the desire to sign up for it as they grow older, because there are all these other alternatives. I do think there's something there.
Kline: Yeah. There's also a seismic shift of my generation. I'm, I don't know, 18 years older than you, something like that. We wanted a bigger television. I went from the 13-inch black and white television to, now I have a 60-inch big wall television. My son will happily watch "TV," YouTube or whatever, on his phone, in a room that has a big television that has YouTube on it, if you wanted to be watching those things. I think that's a seismic shift. You're right, you can't miss something you don't have.
That said, I do think as people get older and they get into relationships and they have kids, cable TV starts to make more sense. I think that's the firewall for the industry. You don't have kids yet, but if I want to watch the NFL, and my wife wants to watch a Lifetime movie, and my son wants to watch Cartoon Network, I could probably buy all those things in streaming packages, but it's easier to have cable. I do think that's going to protect the industry. Young people also live in dorm rooms. They're not used to having a big house yet. At some point, most of them go out and get a decent-sized house. I don't think this is the end of cable, as some have predicted.
Shen: Sure. With that, keep in mind, we've seen similar trends, though, where a new market will go without something that the more developed markets think is necessary. I think about, for example, how mobile phones are the primary computing device in a lot of developing markets. If you think about personal computers, they aren't taking as much of a hold, as much of the market, in those regions. It changes the equation entirely for how people are using their computers, how people are using their mobile phones. It's interesting to see how that will evolve for this younger generation now, where, for example, they're watching it all on this six-inch screen on their phones.
Kline: And I think, obviously, you have to factor in that network speed is only going to get better. It is still somewhat a frustrating experience if you want to watch a non-downloaded movie on your phone. There's buffering. It depends where you are. Where I am now, in Davenport, Florida, if I'm not in my house with wi-fi, in general, the service is two bars, one bar. I probably wouldn't want to be watching YouTube or Amazon Prime or something on it. As 5G networks get rolled out, that won't even be a consideration anymore.
Shen: Yeah, that's a bottleneck that I think will cease to exist in just a few years' time.
The last thing I want to hit today, you mentioned this earlier. I was talking to my brother recently about streaming TV. We piggyback on each other's subscription sometimes.
Kline: I won't tell.
Shen: He's starting to get really frustrated by how many different services he needs to sign up with to catch everything that he wants to watch. He said he's basically starting to feel like they're going back 20, 30 years to cable packages, and the cost is catching up. You rattled off like eight services that you're subscribed to, and you mentioned how the cost ultimately might be more than a traditional cable TV package. He's in a position now, he's like, "It's only a matter of time until there's another Netflix kind of disruptor to come and change things up again from what we're building toward." What do you think about that?
Kline: I think there are two problems. Now, I am not typical, because I feel justified having all these subscriptions because I do this show and write about these things. For me, when I'm deciding, "Do I add DC Universe?" it's not so much a question of "Yes, I want to watch the new live action Titan show," as it is, "Well, I should check this out and be familiar with it."
But, when it comes to organizing your subscriptions, that is where I think the next explosion is going to be. I have a smart Roku TV here. If I want to switch between Netflix and Sling and WWE Network, I have to go find it and hit the app. It's almost like changing a cartridge on an old video game system. It's not a fun experience. I do think there's going to be a layer of management, where you can have access to everything you subscribe to, where you might be able to very easily go in and say, "I don't want Netflix this month." I will point out, T-Mobile pays for my Netflix based on their promotion. I do think you might see devices or software that makes it a lot easier to say, "These are all the services. This is what I have. I'm going to turn off Hulu because I haven't watched it in three months." My phone will tell me, "Hey, last month, here's how many hours you spent on social media." I think at some point, we're going to get something that tells us, "Hey, you haven't watched Netflix in two years. Maybe you should stop paying for it."
Shen: It's an interesting idea. All these different services are trying to differentiate themselves with these great shows, these original movies. Netflix, Hulu, everybody's doing this. If you want to catch everything, it really does become a challenge. With enough services, all of a sudden, it's like, "You know what? I'm paying more than $100 again every month for my TV bill."
Kline: Oh, I'm definitely paying more than $100. [laughs]
Shen: I can understand the deja vu that my brother feels. I'm not quite there yet. I try and keep a moderate list of shows I'm following.
Kline: I think the challenge is going to be the next wave of stuff. You have Disney's service coming. Every week, I vacillate on the ESPN+ service. Should I get that even though it only has a couple of things I'm interested in? You're going to start to see some $299 a month things, $199. The basket is going to get so much bigger. Then you'll see a pushback. You'll see some things go out of business. Yahoo tried hard to have a paid service, and that didn't work. I don't think some of the YouTube paid options have worked. You're going to see things fail. But there are going to be more big players. Disney, maybe Comcast, and maybe one other. It's getting very confusing.
Shen: That's all the time we have today. Thank you, Dan, for joining us!
Kline: Thanks, Vince!
Shen: Fools, thanks for tuning in, as always! People on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don't buy or sell anything based solely on what you hear during the program. Fool on!
