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Investors wary as Hulu losses surge, can Disney achieve the impossible?

Panic stations were triggered at Hulu last week after the true extent of cash losses were uncovered and projected out for 2018 – making for rather unnerving reading. However, perhaps the simplest way to approach the assessment of these financials is by comparing them to Netflix, which famously took a long time to reach profitability, but today is one the most valuable companies in the world.

Hulu made losses of $760 million last year, rising from $531 million in 2016 and forecast to rise to $1.6 billion in 2018, according to BTIG Research analyst Rich Greenfield. BTIG’s projection was made after digesting results from Hulu’s four parent companies Disney, Comcast, 21st Century Fox and Time Warner, where growing losses at Hulu have made hiding figures in and amongst financial reports a trickier diversion tactic.

So how is it possible for a company growing at a faster rate than its main rivals, now with more than 17 million subscribers, to be such an intrinsically and increasingly unprofitable entity?

The chief culprit for the surge is original content, taking a similar approach to Netflix by pouring huge investments into developing original Hulu titles. That strategy is beginning to pay off for Netflix after a prolonged period of dismay among the investor community, and Hulu is now experiencing the same feelings of uncertainty regarding its own original content funds.

Hulu’s original content spend spiked to $2.5 billion in 2017 while Amazon has pledged $4.5 billion. Netflix says content spend will reach $8 billion in 2018, the bulk of which will go towards making original titles. Original content spending between Amazon, Netflix and Hulu is expected to reach $10 billion annually by 2022, tripling the current spend on originals, according to a recent report from The Diffusion Group.

But just take Netflix’s last quarterly earnings as a fine example of how hefty original content investments are capable of returning the goods. Netflix’s operating income for Q4 came in at $245 million, jumping by $91.3 million year on year, to total $838.7 million for the year. Today Netflix has an EBITDA margin of around 5% and rising fast, expected to reach 33% by 2021, driven by its international expansion, according to financial analysts at MKM Partners.

Prior to committing to original content and live sports, Hulu’s previous business model was all about regurgitating old media as new, by buying up deceased TV networks on the cheap and giving them a new lease of life. Hulu is therefore late to the game, but a game for which appetites are growing – not that investors see it that way.

Other than attempting to shake off its “mutton dressed as lamb” image, the main drawback for Hulu is the lack of international presence, with the exception of Japan, yet Hulu could be on the verge of a major overhaul to spark a turnaround once Disney completes its acquisition of Fox, making it a 60% majority owner, leaving Comcast with 30% and Time Warner the remaining 10%.

Hulu’s rising losses look daunting, but we feel Hulu can eventually become a profitable company if Disney decides to cast Hulu as its answer to Netflix. The likely outcome is that Disney will continue to run Hulu as a standalone streaming service before eventually merging Hulu into its own streaming service, due to launch this Spring, and incorporate the business into its international expansion efforts. At present all that older content is already licensed, most of it exclusively, outside the US.

Although Comcast may have other ideas, as rumors of a $60 billion counter bid for Fox have resurfaced following a Wall Street Journal report. Comcast’s 30% share of Hulu yielded losses of $276 million in 2017, rising from $168 million in 2016 and $105 million in 2015.

Hulu’s subscriber influx is not reflected in its financials, growing its user base by 41.6% since May 2016, and its new vMPVD service reportedly has north of 450,000 subscribers, rising from around 150,000 last May.

Greenfield forecasts that Hulu’s four parent companies will invest an additional $1.5 billion into the company this year.

“When Hulu’s losses and parent-company investment were relatively small, its ability to skew financials at its parent companies was modest. However, now we know, via Disney, that Hulu’s losses will increase dramatically in 2018. The increased investment and losses are being used to buy content from Hulu’s parent entities, as Disney’s CFO pointed out, and to add vMVPD subscribers which boosts broadcast TV retrans fees and cable network affiliate fees for Hulu’s parent companies. Yet, we have virtually no disclosure on the positive impact Hulu’s spending is having on its parent companies,” said Greenfield.

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