Discovery Communications (NASDAQ:DISC.A) (NASDAQ:DISCK) took the wraps off its new streaming service Discovery+ this week. But one thing management left out of its presentation was an outlook on how many subscribers it expects to attract and its breakeven timeline. That might make it hard to judge what success looks like for the latest entrant into the streaming wars, especially compared to competitors with massive appeal like Disney's (NYSE:DIS) Disney+ or Netflix (NASDAQ:NFLX).
What management had to say
There are a few sparse financial and operational details management provided.
The most concrete information Discovery executives shared was an expectation that its investment in streaming marketing, technology, and content would have a negative impact on operating income of between $200 million and $300 million in 2021. The increased expenses will only be partially offset by subscriber and advertising revenue next year.
At scale, however, management expects Discovery+ to produce an operating margin around 20%. To put that in perspective, Netflix's operating margin this year is expected to come in around 18%. And that's with over 200 million global subscribers. Discovery+ won't need that level of scale in order to achieve its margin expectations.
That said, Discovery is expecting a sizable subscriber base. While it didn't provide exact details, the company shared expectations for "tens of millions" of subscribers. It's building on an existing subscriber base of 5.2 million following a launch last month in the U.K. and Ireland, as it seeks to move beyond legacy video-streaming products.
And Discovery expects those subscribers to generate a lot of revenue compared to revenue brought in through pay-TV distribution. Its $7-per-month ad-free subscription is in line with its average monthly distribution revenue for its cable networks in the United States. Management says it's actually three to four times as much as it sees in most international markets. The $5-per-month ad-supported version should generate even more revenue per user when you account for the additional $4 per month per user the company expects from ad sales.
Maximizing long-term potential
Management stressed it's focused primarily on the long-term potential of Discovery+. Early results will dictate its strategy going forward with regard to things like customer acquisition spending and content development.
The company will provide regular updates on its subscriber count, but watching operating margin for the business may be more informative if executives share it. That's to say, if margins remain low in 2022 and 2023, that means Discovery is still seeing opportunities to acquire new customers with very positive lifetime values.
Success doesn't look like a sudden boost to Discovery's bottom line. And that bottom line could suffer considerably next year as cord-cutting continues to hurt its core business while it spends heavily to get Discovery+ off the ground.
That said, Discovery is well positioned to reach breakeven faster than Disney+ or its other big media company competitors. Discovery has a massive back catalog of mostly evergreen content. Additionally, its content costs are significantly lower than Disney or Netflix and the other big-budget scripted content providers. Discovery's content amortization expense through the first nine months of 2020 was $2.1 billion. Netflix amortized $7.8 billion in content during the same period.
CFO Gunnar Wiedenfels said, "We really don't need a crazy number of subscribers to be operating a profitable business here," on Discovery's fourth-quarter 2019 earnings call earlier this year.
Getting off the ground
Discovery's partnering with Verizon in the United States, Sky in the U.K. and Ireland, and Telecom Italia's TIM in Italy. It expects more distribution partners to come, which could be instrumental in building the broad subscriber base Discovery expects.
Disney also partnered with Verizon and Sky. Management said the free year offer from Verizon accounted for about 20% of its early subscribers as of early 2020, about 5.2 million total. To be clear, Verizon is paying Disney for those subscribers, and it'll pay Discovery for any sign-ups in a similar deal.
There's not as much brand affinity for Discovery's networks as for Disney brands, but investors can expect a nice contribution of subscribers from its various partnerships. Combined with the ability to advertise the service across its portfolio of cable networks and digital properties, the company could quickly amass a sizable subscriber base. Management noted it's seen better-than-expected uptake on its offer to Sky customers in the U.K. and Ireland in the first few weeks.
Investors shouldn't expect Discovery+ to be as big as Disney+ or Netflix. But Discovery has a lot more flexibility to make the service a success because it has relatively low content costs. Expanding its addressable market from pay-TV households to broadband households should enable Discovery to succeed in offsetting the negative impact of cord-cutting on its core business and produce a long-term avenue for growth.