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Disney on path of no return against Netflix and Amazon

A year which began with idle speculation over a Disney bid for Netflix ended with the entertainment group’s acquisition of premium media content assets from 21st Century Fox for $52.4 billion in stock. The aim was to compete head-on with Netflix and Amazon, remembering that during 2017 Disney had announced it was pulling its content from the former’s catalogue while launching its own ESPN-based sports streaming service in 2018.

The key second move would then follow in 2018 with a full-blown OTT offering combining live sports with movies, TV shows, documentaries and news. It was speculation over the synergy between Disney’s ESPN live sports content and the Netflix sVoD service that prompted that earlier speculation of a merger, but it did not make sense for various reasons, such as the premium price of around $70 billion that Netflix would have costed then.

Meanwhile during 2017 Disney came increasingly round to the idea that it had no choice but to converge towards the model being developed by Netflix and Amazon of combining original content creation with online distribution, but it saw the need to expand to do so. It envisaged an opportunity to become a global player through the Fox acquisition in a way that even Comcast/NBC Universal, its nearest legacy rival in content budget size, could not emulate. Of course there are differences between the models, with Netflix positioned as both a standalone streaming service and a content catalogue included by various distributors and pay TV operators on an aggregation basis, albeit still via a separate app. In fact Comcast has taken almost the opposite path to Disney by bringing the sVOD providers onto its platform rather than casting them off. It already offered Netflix, YouTube and Dish Network’s Sling TV via its X1 hybrid service and then in November 2017 was in discussions to bring Hulu’s on-demand service through its set tops as well.

But the Hulu connection raise an ironical and potentially significant sub plot, for Fox’s majority stake in the operator is one of the four prized assets acquired by Disney. There has been speculation that Disney wants to cast Hulu as its answer to Netflix, but Comcast may have other ideas. Its holding is sufficient to block Disney from turning that service into its own version of Netflix, or at least it may hold out for a high price, adding further to Disney’s big outlay. However, not least because of this complication, we think it more likely that Disney will retain Hulu for now as a separate streaming service majoring in more violent or edgy adult TV shows, which is the way it has gone through the likes of US pay TV channel FX’s American Horror Story. It may be that Hulu will then be eventually absorbed into the all-singing-and dancing OTT service Disney plans to launch in 2018, if it can resolve the Comcast complication.

Meanwhile Comcast itself is still a very successful large player, noting that it posted revenue up 7.9% to over $80 billion for its 2017 financial year, but it has failed to meet its earlier aspirations when it actually became the first big media company to embark on vertical integration between distribution and content with the acquisition of NBCUniversal in 2011.

Since then Disney has failed to land the big follow up deal it was seeking to acquire scale and dominance in the US market, most notably when the US Justice Department effectively blocked its $45.2 billion bid for TimeWarner because it was deemed to give Comcast too strong a position in US broadband, rather than pay TV. Comcast has also failed to make much inroad abroad through mergers and acquisitions, with no clear strategy for expansion in distribution or content.

The other major convergence in the US between content and distribution occurred with AT&T’s acquisition of DirecTV for $48.5 billion in May 2014. This has regional scope because of DirecTV’s presence across most of Latin America, but has run into all sorts of problems on the home front. Under AT&T’s umbrella DirecTV has been hemorrhaging traditional pay TV subs in the US, shedding 385,000 in Q3 2017. Although AT&T claimed 296,000 adds for the DirecTV Now OTT service in the same quarter, that too has been beset by issues over reliability. It still only has about 1 million subs, which is an underwhelming performance in such a large market where Netflix has over 50 million. The operator is feeling the squeeze on margins imposed by skinny bundles so cannot claim that customers downsizing to the OTT service are making a like for like swap. Furthermore little traction has been gained outside the Americas.

Disney meanwhile had established a global presence through various TV channels even before the Fox acquisition. Apart from that majority stake in Hulu Disney acquired the 21st Century Fox movie studio, FX and National geographic cable channels plus some regional sports channels as well as Fox’s 39% stake in European cable company Sky. The latter gives Disney a major presence in European pay TV as a springboard for its OTT strategy there, given that Sky already has a successful stand-alone offer in Now TV.

On the surface it looks as if Disney is well placed to compete with Netflix, being far larger with about 8 times the revenue, but that ignores a number of factors including that great elephant in the room Amazon. Disney has a poor record in recent years creating original content, with a failure to captivate at the box office, but is has more than made up for that by buying access to prize assets under the astute stewardship of its current CEO Bob Iger. The Fox deal reinforces that strategy by bringing on board a host of rights to both live and on demand content, including English Premier League football in the UK.

AS one key movie example Disney had already acquired the studio Marvel in 2009 but Fox retained rights to some of the most popular characters such as the X-Men and the Marvel Comics. So Disney’s acquisition of Fox means future movies and TV shows will feature the X-Men and characters like Iron Man and Thor sharing the same screen, adding significantly to audience appeal.

Disney is not immune though to the margin squeeze afflicting OTT services that deliver premium content worldwide, which brings the Fox deal sharply into focus. Before that announcement in mid-December the common view was that Disney would take care not to cannibalize its existing pay TV revenues. Disney appeared set to retain the dual-distribution model which HBO pioneered in particular, moving to sell retail OTT services directly to households, while continuing to distribute wholesale TV programming through pay TV operators. In that light pulling its content from Netflix was seen as a way to reduce the latter’s value to consumers. In the case of live sports via ESPN, this dual strategy involved restricting the top rights such as NBA and NFL games to pay TV services.

But that has all gone out of the window with the Fox acquisition, although the writing was already on the wall. ESPN has been struggling to retain subscribers on the pay TV front in the face of cord cutting pressure. In fact ESPN has been losing subs ever since 2011 when it peaked at just over 100 million customers accessing the service through various pay TV bundles. That has come down by 29 million to about 70 million, while its annual content costs have escalated to $7.3 billion per year, including $3.3 billion for NFL and NBA alone.

Disney has vowed to restore ESPN’s fortunes but this will depend on attracting a far larger subscriber base at a lower cost around $10 a month for the ESPN online package due for launch this year. This puts into shade calculations over how many subs Disney needs to attract online to make up for the $300 million a year it earned from Netflix for distributing its content. That would be just about 2.5 million, compared with at least 60 billion for ESPN, and that is before considering marketing and distribution costs.

Similar calculations hold for movies and TV shows. If Disney plans to go all out online it will have to gather a similar number of subs for the OTT service slated for launch in 2019. But this plays two ways, because Netflix has to continue expanding its original content production as rapidly as ever to meet the Disney challenge. Netflix plans to release 80 movies next year, according to chief content officer Ted Sarandos, compared with approaching 50 in 2017. Its gearing requires constantly increasing subs while it treads a delicate balance between raising prices to boost revenues and not choking off growth, tuning this to different markets.

But Disney also has to contend with other big OTT players, notably Amazon and Google, both of which are racking up their content spending and have the resources to play a longer game than Netflix. This has its downside for Amazon at least in that its video offering is rather lost among its Prime bundle and it is impossible even to compare viewing numbers accurately with Netflix, Hulu or others.

But the advantage is that Amazon does not see making money from video as an immediate priority. The worrying point for competitors like Disney is that video seems subservient to other major areas, including e-commerce but also web services and most recently the Alexa voice computing platform, as well as AI.

There is an old business saying that only fools compete with major conglomerates – in this case Amazon and Google – that have no immediate need to return a profit in their sector, or might regard it as a lost leader. Of course Disney and Bob Iger are no fools but their strategy is certainly high risk with a serious chance if not of outright failure than at least stagnation.
At least Disney looks well placed to avoid some of its earlier technological mistakes when it comes to video delivery. It has a poor record so far in reaching out beyond its traditional means of distribution and until recently clearly lacked expertise or understanding of key issues such as scaling and latency that must be addressed for large scale live OTT services. This was evident from the embarrassing failure of its Applause app during the celebrations for Disneyland’s 60th birthday on its ABC network in 2015. This was a phone based companion app for selected TV events, but during the celebrations it failed widely to synchronize and frequently crashed.

This focused minds of course but Disney concluded it lacked the inhouse online video distribution expertise and turned to BAMTech, the streaming specialist spun out from MLB, to create the platform for its forthcoming two OTT services. Disney acknowledged in August 2017 that consumers were moving away from traditional pay TV to streaming services even faster than it had anticipated. Accordingly Disney exercised its option to acquire an additional 42% stake in BAMTech for $1.58 billion. This took its holding up to 75% and valued BAMTech at $3.75 billion, reflecting the premium that has to be paid for a proven specialist in live streaming infrastructure. It is this move as much as the much larger Fox acquisition that signals Disney’s serious intent to become one of the major global converged content and distribution providers and that it will put up a serious fight.

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