The Impact of COVID-19 on Pay-TV and OTT Video
Economic crises, natural disasters, and other long-tail events tend to accelerate underlying trends, exacerbate balances of power, and unravel businesses, business models, and business practices that were sustained by a robust economy. COVID-19’s effect on the media and entertainment sector looks like it will be consistent with this history. Note, too, that the longer/worse the pandemic, the stronger the impact.
This essay covers the impacts of the Coronavirus on the Pay-TV/OTT video space. I’ve also written on how the theatrical film business and video games/our digital lives will be affected
PRE-COVID TRENDS:
#1: Sports Are Holding the Bundle/Pay-TV Together but Showing Signs of Breakage:
Sports’ role in Pay-TV stemmed from many unique attributes, including the pure volume of content produced and distributed through traditional TV, the widespread and intense popularity of this content, the importance of viewing of this content live, the impossibility of reliably delivering such content digitally nationwide, and the long-term contracts that ensured this content would remain stuck inside the Pay-TV ecosystem.
At the same time, the ratings for most major sports have been in sustained decline for years now thanks to an ever-growing number of substitutes, general disengagement from the Pay-TV ecosystem, and unending growth in the amount of sports content broadcast on television (the result of league expansion, season extensions, and proliferation of RSNs).
And after decades of ever-escalating prices for major sports rights, these too began to peak by the late 2010s, and it became common to wonder if long-term rights holders would even try to re-up their deals.
One of the best examples here is NFL Sunday Ticket, which was reportedly one of the key drivers behind AT&T’s acquisition of DirecTV in 2015. At the time, the satellite service was entering its third decade as the exclusive rights holder to Sunday Ticket, having been its first buyer in 1994 (for $25MM per year) and having recently signed an eight-year extension (at $1.5B). Only four years later, reports emerged that AT&T was unsure whether it wanted to renew the deal even at the prior rates. Most other deals, such as CBS’s NFL contract, are believed to be in similar circumstances.
Meanwhile, many of the largest RSNs were either struggling to sell, in economic jeopardy, being put up for sale in order to fund other content investments, or being dropped by MVPDs altogether.
#2: Resilient but Endangered Ad Revenues
Since 2010, the Pay-TV ecosystem has seen nearly a 30% reduction in overall viewing hours and as much as a 60% decline among 12–35 year olds. Despite this massive reduction, the total amount spent on TV advertising has remains essentially unchanged since 2015 and is actually up $10B, or 17%, since 2010.
Still, this strength seemed to have been propped up only by a record economy and unsustainable logic: reductions in viewership meant that the number of available ad impressions on TV was dropping rapidly, thereby creating shortages that made the remnant inventory more valuable.
This thinking wasn’t structurally wrong, but it faced many flaws. For example, most valuable audiences (e.g. 18–24) were shrinking their TV diets much faster than less valuable demographics (34–45). In addition, this rationale assumed that despite the rise of smartphones and tablets, audiences were paying as much attention to TV commercials as they used to. It also ignored the question of whether any of this planned ad spend (which was often automatically allocated based on the prior year’s allocation) would be better spent on another channel, such as web/mobile.
#3: Ongoing Shift of Time, Money, Relevance, and Subscribers to OTT Video
Despite the 30%+ erosion of Pay-TV viewing hours, total TV viewing is up according to Nielsen. To this end, OTT video services such as Netflix and Hulu have not just collected the time Pay-TV has lost, it has actually grown beyond it by making it easier for video to be consumed outside the home and living room.
In addition, SVOD continues to steal the “best” talent, content, and licenses from the Pay-TV ecosystem, grow its share of Emmy/Golden Globe/Oscar winners, and collect the most valuable IP (e.g. Disney+’s The Mandalorian and the Marvel series, Peacock’s Battlestar Galactica and Saved by the Bell reboots, Hulu’s FX partnership, etc).
#4: A Rapidly Declining Pay-TV Ecosystem; Big Media Beginning to Burn the Pay-TV Boats
As vMVPDs proliferated and rapidly accumulated subscribers throughout 2016, 2017, and 2018, many in the Pay-TV industry had come to hope that their mix of better UI/Xs, lower prices, and monthly commitments would sustain the industry. But by 2019, this narrative had collapsed. Pay-TV penetration was not just declining at a record rate, it was still picking up speed. Worse still, many leading vMVPDs were either raising their prices or shutting down altogether. This meant 2020 was likely to be a particularly painful year for the industry, to say nothing about 2021… or 2022.
However, this realization seems to have led to a stark mindset shift in Big Media. After years of prioritizing the traditional Pay-TV ecosystem, then trying to simultaneously optimize for both the Pay-TV present and a post-Pay-TV future, Big Media has begun to firmly shift away from its legacy interests.
It’s not accurate to say that the largest media companies, such as Disney, AT&T-WarnerMedia, Comcast-NBCUniversal, are outright abandoning the traditional Pay-TV ecosystem. However, they have each decided to reduce their future investments in it, place most of their best content onto their OTT services (most of these series were previously announced for their linear networks, too), and further undermine the Pay-TV ecosystem by offering customers online substitutes with drastically lower prices, both more content and better content, and far fewer ads. This strategic undermining of Pay-TV will obviously hasten the decline of their traditional (and cash rich) business. However, each of these Big Media giants hopes that by burning their boats relatively faster or harder than their peers, they’ll be better positioned in the future.
Related Essay: The End of Pay-TV
#5: OTT Video Competition Is Intensifying
2019 represented the “official” start of the “Streaming Wars”. In January, Viacom bought PlutoTV; in May, Disney took operational control of Hulu; and in November, Apple kicked off its original TV slate while Disney launched its Disney+ service. 2020 will be even hotter. March has already seen Fox buy Tubi for $400–500MM, while April will see the launch of Quibi, May will have HBO Max, June or July will have Peacock, and the back half of the year will include ViacomCBS’s united “House of Brands” OTT service. Although tens of billions of dollars have already been spent on OTT content, tech and customer acquisition, this is only just the beginning of the competition.
#6: Netflix Facing Library Pressures as Companies Verticalize
As Big Media has shifted its focus away from licensing its content to emerging OTT services and toward its own platforms, Netflix has lost the rights to many of its most valuable catalogue (e.g. Friends, Black Panther). In addition, the company has faced a reduction in the supply of new original content, too. Disney, Fox, and WarnerMedia, for example, have committed to ratcheting down third-party sales of new content and plan to only make content that will go to their services. Marvel’s Defenders series, for example, went to Netflix. Today, all Marvel adaptations will go to Disney+ or Hulu, otherwise they’ll never be made in the first place.
The consequence here has been profound, even if Netflix’s engagement and subscriber growth hasn’t (yet?) been affected. Although Netflix’s cash content spend is up fivehold since 2014, its US movie library has shrunk by nearly 40% according to ReelGood, while its TV library is down 25%. Many argue the drop has been even greater after adjusting for “quality”.
#7: The Rise of AVOD: As consumers adopt even more paid subscription services, many believed that ever-escalating video bills would lead to a resurgence of ad-supported video, especially among households with less disposable income. As part of this thesis, Viacom, perhaps the latest major entrant to the streaming wars, bought PlutoTV in January of 2019. Comcast/NBCUniversal, another late entrant that was particularly hampered by long-running licensing agreements that would keep much of its best content away on competing services until 2022–2024, announced its plans for the AVOD-based Peacock in September 2019. February 2020 then saw Comcast buy AVOD service Xumo, with Fox buying Tubi a month later.
#8: Increasing Investor Scrutiny of Big Media’s OTT Video Strategies: Many shareholders have become increasingly hostile and doubtful as the major media companies have increased their commitments to money-losing OTT services (see point #5) with multi-year break-evens, while halting margin-rich SVOD licensing (#6) and not just experiencing the decline of Pay-TV (#3), but accelerating it (#4). For example, 2019 saw activist investors Elliott Management take a $3.5B position in AT&T and publicly criticize the company’s plans for WarnerMedia and HBO.
COVID-19 IMPACT
A. Pay-TV Subscriber Losses Will Accelerate, as Will SVOD Subscriber Growth: It’s obvious that the multi-month loss of traditional sports will accelerate cord cutting. And while some of these subscribers will come back once sports resume, many won’t, and those that do will return via lower-priced and month-to-month vMVPD services. But more importantly, the Coronavirus’s greatest impact on Pay-TV won’t stem from the acute shocks of suspended sports seasons, but the long-lasting consequences of a recession.
As a high-value “all-you-can-eat” entertainment service, Pay-TV is the sort of product that typically thrives in a recession. At the same time, SVOD and AVOD services offer not just far greater value but also lower prices and better content. Furthermore, Pay-TV is the largest recurring discretionary entertainment expense for the average household. This makes it one of the first places families will look when struggling with bills, unemployment, or other financial pressures — especially when they already have Netflix, Amazon Prime, and Disney+. Note, too, that Comcast reports linear TV viewership is up 6-7%, while OTT video is up 38%.
Although the analogy isn’t perfect, we can look to the landline-to-mobile transition as an example. Even though landlines were materially cheaper than mobile phones, the first time landline penetration began to decline was after the dotcom crash. Landlines, which had nearly perfect service reliability, better pricing, and unlimited “minutes”, still had value. However, recessions force hard choices and many choose to abandon the old, dying thing earlier than expected. This, in turn, will force the major Pay-TV players to lean even harder into their OTT businesses and further reduce their linear TV investments.
The other side of this cancellation equation is the likely acceleration of SVOD adoption rates. The most drastic impacts will be over the short term. As COVID-19 forces people to spend more time at home, they’ll have more entertainment hours to fill. OTT Video services offer not just much of the best content, but also the highest volumes of it. In addition, linear TV remains stuck on traditional programming hours — meaning there isn’t much to watch outside of the three to four-hour primetime window.
Data backs this up. Although Nielsen reports that while overall TV viewing is up 20%, HBO claims consumption of its OTT service HBO Now is up 40%, with “daily binge viewing of 3+ episodes” up 65%. According to Antenna, the seven largest SVOD services (excluding Amazon Prime Video) saw an average 75% increase in daily signups, with Disney+ up more than 225% in the first week of the shutdown, and 110% jump in the second. Free AVOD service Tubi has already reported more than a 50% increase in new signups and a 22% hike in viewer hours, while PlutoTV claims daily active users and total viewing hours are up double digits. According to Comcast, searches for “free movies” are up nearly 50%.
This is a boon to all streaming services, especially those new and/or relatively undiscovered. Although a new subscriber/user isn’t necessarily a long-term one, you can’t keep a customer you never had and won’t keep a subscriber that doesn’t get hooked on your shows. It’s clear COVID is driving record levels of free trials, which should lead to extra sampling and thus give many services a shot they would never have had. It also means the cost of customer acquisition, which has skyrocketed in the “Streaming Wars”, has plummeted, thereby increasing lifetime values. (Note, too, that this means the services that have so far been later to entering the “Streaming Wars” - e.g. HBO Max, Peacock, Viacom’s House of Brands wrapper service - will themselves falling farther behind those already in market).
And even as recession sits in, many of these customers are likely to stay. Again, we can consider the dotcom recession. As landline penetration turned negative, mobile phone adoption continued. Another good example is SiriusXM during the Great Recession. Many analysts the company, which was saddled with debt and owned costly satellites, couldn’t compete with free, ubiquitous terrestrial radio in a downturn. But to millions, the company’s low cost offering of high volumes of content, all ad-free and in higher quality, plus exclusives like Howard Stern, more than justified the $10 monthly fee. Accordingly, the service continued to grow during the recession (at least 60% of the drop in growth is attributable to a drop in new car sales) and churn only modestly increased.
Of course, recessions still led to substantial reductions in the subscriber growth rates enjoyed by mobile phones and satellite radio. However, the Pay-TV to SVOD handoff is distinct. As households disengage from Pay-TV, they will free up $100 per month and hundreds of hours of TV viewing. Furthermore, AVOD services such as Pluto, Tubi, and Peacock are likely to benefit from the end of a record-setting economy and an unfortunate retreat into economic contraction and stagnation.
B. Netflix’s Short-to-Medium-Term Pressures Will Exacerbate: In the short-term, Netflix will benefit from both the Coronavirus shutdown and a recession. It has the largest, modest, diverse, and fastest-growing content library, and, at $12 per month, an incredible value.
At the same time, Netflix’s optimal operating pattern is one where its subscribers finish each subscribing month feeling overwhelmed by all of the “stuff on Netflix” they have left to watch and plan to watch. This keeps these subscribers from both unsubscribing from Netflix and subscribing to a competing service. And while Netflix benefits from and wants its subscribers to continuously increase their viewing hours, it doesn’t want them to be frontloaded. As an example, Netflix would prefer you watch 30 hours per month over 20, as this should positively affect your retention rate and its pricing power. However, it doesn’t want you to go from 20 hours in February, to 90 hours in COVID-19 March if this means that by May, you’ve barely 5-10 hours left to watch.
In other words, Netflix effectively “buys” a consumer’s subscription by investing in content that it “sells” to consumers each month. Although its content costs don’t literally go up on an accounting or cash basis if that consumer’s viewing hours spikes in a given month, this subscriber will have essentially “consumed” more “investment”. And this investment would have otherwise earned the following months’ subscription dollars.
(To use a simplified example, Netflix might spend an allocate $X per subscriber per month on content and $12X per year to keep Subscriber A a subscriber. If Subscriber A watches $3X in March, there might only be $7X left for the remaining 10 months, or $0.7X per month).
Worse still, Netflix generates no incremental revenue from this engagement. At least ad-supported services, such as Hulu, receive more direct revenue from more usage. And thus, if Netflix was running out of library before COVID, it’s going to run out even faster now.
Note that this is uniquely threatening for Netflix as the default streaming service. Although networks like CBS All Access and Starz have a number of excellent series, a consumer will only adopt them if/as they run out of “stuff to watch” on the service they’re already using - which is typically Netflix. Again, Netflix’s best-case scenario is that each month, it’s subscribers watch more than they did the last month, and have even more to watch in the next one.
As a result, increased consumption of Netflix may in turn lead subscribers elsewhere. To point, data from Antenna suggests that in the US, nearly every Netflix competitor is at least closing the gap between its raw subscriber adds and Netflix's, or surpassing them (though, as a far more saturated service, Netflix has less COVID-related headroom).
At the same time, there are several compensatory effects in Netflix’s favor. First, the company has the largest catalogue in the marketplace today. If a prolonged COVID-19 leads consumers to exhaust what they wanted to watch on Netflix and look elsewhere, they’ll rapidly burn through the libraries of smaller SVODs like CBS All Access, too. In this case, Netflix will have the most back-up content (the Coronavirus might just force English-only viewers to try foreign series, for example).
Furthermore, COVID-19 has already led Peacock, a forthcoming entrant, to announce that almost none of its originals will hit its service until 2021. Quibi may run out of highly produced long-form within months. Every service, of course, will face pressures when it comes to releasing new content, including Netflix. However, the streamer has (by far) the greatest volume of international productions. Accordingly, its flow of new content should rebound faster and in greater numbers than any US-focused provider – especially if markets like Germany or South Korea resume filming before American does. In addition, consumers will keep watching video even if they’re less excited about what they’re watching. Especially if they’re still stuck inside.
C. Pay-TV Ad Revenue Is Likely to Crash (and Then Decline Forever):
Pay-TV ad revenues have been resilient despite the overall decline of Pay-TV overall and a 30%+ in total decline in viewership (and as much as 60% in key demographics). A recession is likely to end this stability. Here, print is a good case study.
While print circulation was dropping throughout the 2000s, total ad revenues remained essentially unchanged… until the Great Recession. It was here that ad buyers were forced to re-evaluate all ad spend and determine where they had to pull back. Print, which represented one of every three dollars spent, was the hardest hit. Although every category, including digital, saw a drop in 2008 or 2009, print saw the greatest decline and is the only medium to have never recovered. By 2014, total spend was down 43% since 2007, with print’s share of total spending more than halved to 15%.
Today, TV still represents 34% of total ad spend in the United States, making it the second largest bucket of spend behind the Internet (51%). Despite this gap, it’s likely to face a disproportionate share of cutbacks, while digital is likely to remain largely unchanged.
During the Great Recession, for example, digital ad spend saw both the smallest decline and fastest recovery. By 2010, total spend was up by even more than 25% from 2007. This stemmed from the fact that, unlike television or print, digital ad spend was the easiest to analyze, measure, and justify on an ROI basis. TV remains a black box. And while there’s still some radio, print, and outdoor ad spend left, TV will likely suffer the greatest rationalization.
D. Over the Medium Term, Legacy Media Players Will Find Themselves Incredibly Stressed as They Build Their SVODs:
The accelerated decline of both Pay-TV subscribers and Pay-TV ad revenues will strongly harm all traditional media players at the time they’re most exposed. AT&T-WarnerMedia, Comcast-NBCUniversal, Disney, and Viacom each hold more debt now than at any time in their history. The first three have each committed to enormous dividend and capital investments programs that span 5G rollouts and theme park constructions, while the last is struggling with its debt covenants. AT&T and Comcast, meanwhile, are hit not just by declining affiliate fees and ad revenue via their networks businesses, but also in their MVPD businesses. In addition, all four companies will also find their ancillary entertainment businesses (e.g. merchandise, theme parks, toys) affected by reductions in disposable income. And Comcast-NBCUniversal has seen its largest promotional opportunity for Peacock — the 2020 Olympics — kicked out a full year.
This is not great timing for any Big Media company looking to invest billions into money-losing SVOD services years away from break-even (remember, Disney plans to take Hulu global in 2021). This is especially true when the alternative, licensing to Netflix or Amazon, would deliver risk-free, pure margin revenues.
Exacerbated Pay-TV and recessionary pressures doesn’t mean these companies will shut down their SVOD services. However, it’s likely that spend and commitment will be negatively impacted. By definition, not everything can remain “business as usual” during a recession. Note, too, that the decline in consumer discretionary income, national ad spend, Pay-TV subscriber revenues, and Pay-TV revenues will further exacerbate investors scrutiny. If institutional shareholders hated Big Media’s SVOD plans during a record economy, they’ll certainly not be pleased about funding long-term losses on speculative but likely low-margin businesses during a recessionary period.
At the same time, the major tech companies remain relatively unscathed by the Coronavirus. Amazon and Apple will see reduced revenue, assuredly, but their ability to invest in video content will be unaffected and their business cases unchanged.
Netflix does require healthy capital markets to fund its current plans. However, COVID-19 and a follow-on recession should deliver stable, if not accelerated, subscriber growth to sell to would-be bondholders. In addition, interest rates are now lower than they’ve been in a decade while Netflix’s credit rating is at its highest point in years. Furthermore, Netflix’s debt-critics typically overlook the manageability of its liabilities. For example, close to 50% of all content obligations are due within the next 12 months. Netflix, which is still growing revenues at $4B+ per year, will not struggle to make these payments. In addition, more than 75% of its debt obligations occur beyond 2025, with annual payments peaking at less than $1B before then. Where companies get into trouble is when they have a large maturity tower that occurs near the start of a downturn. In Netflix’s case, front-end maturities are fairly low.
Closed credit markets would, of course, still harm Netflix’s growth ambitions. However, Netflix would be able to trim 60–75% of its annual cash burn just by halting its year-over-year spending growth. In addition, the company would still benefit from 12–18 months of increased year-over-year output due to the lag time between greenlights and airdates — meaning that a recession-related pullback wouldn’t harm Netflix’s offering until 2022 or so.
Collectively, this means that the gaps between today’s OTT streaming leaders and the legacy players now entering the market is likely to expand or exacerbate, as is the gap between the “leading” legacy players, such as Disney+ and AT&T’s HBO, and the laggards, such as NBCUniversal and ViacomCBS.
E. Sports May Break Right Open
As any gambler will tell you, sports is particularly hard to predict. However, a few things seem likely.
First, the accelerated decline of Pay-TV subs and ad spend will harm the prices the major leagues can charge from the traditional TV ecosystem going forward. This might result in some packages, such as NFL Sunday Ticket, being split into smaller deals, or perhaps more deals being split into linear and digital-only rights (see Amazon’s NFL simulcasts).
Second, investments in live sports deals just became much riskier. Even if the next round of deals includes additional and more automatic remedies for the cessation of regular seasons, networks and D2C services can no longer rely on large sports rights deals as they once could. This itself matters, but it’s also important to put sports rights in strategic context. Many platforms, as far back as the launch years of Fox Broadcasting and DirecTV, used sports rights as their “core” offering. This is because major sports packages were unique in that they offered not just high volumes of regularly scheduled content, but truly must have content. And while the fees were enormous, they were in many ways less risky than trying to cobble together comparable slates of one-off series. Now, every buyer knows that if they make sports their “core”, the backbone of their service and strategy might suddenly disappear (and with no clear timeline to normalcy)
If the cessation of physical, professional sports lasts for several months, we’re likely to see even more dramatic moves – such as MVPDs invoking force majeure clauses to terminate their distribution agreements with ESPN and other sports networks. It’s hard to believe, for example, that Comcast will continue many to send hundreds of millions of dollars to Disney month-after-month for content that isn’t received, especially when this is Comcast’s single largest programming cost and essentially everything being paid for isn’t there.
(Update: Note, too, that some sports networks, such as TBS/TNT, have now received refunds from sports leagues such as the NCAA, because they haven’t received the promised sports content. This means that unless MVPDs reduce the paid fees to these networks, TBS/TNT will become enormously more profitable because they… don’t air their promised programming. In addition, Disney’s subsidiaries are now legally invoking force majeure clauses for massively smaller and less COVID-affected deals, such as an overall with two writers at Marvel Television. This will fundamentally erode ESPN’s ability to claim COVID-19 is not a force majeure event).
It could be argued that ripping up multi-year agreements between the major Pay-TV networks and distributors is excessive. However, many MVPDs, especially Dish, have been itching for the opportunity to cancel out or renegotiate the affiliate fees for networks like ESPN and TNT. After all, these deals were mostly set years ago and thus at a time in which Pay-TV overall, and especially live sports ratings, were much stronger. To this end, any re-opening is likely to disappoint the major leagues and sports broadcasters – even if we ignore the post-COVID discount. This may even lead to sports rights shifting OTT video platforms earlier than expected (though of course, the vast majority of rights will remain in the Pay-TV ecosystem).
More broadly, COVID-19 will increase the need for leagues and broadcasters to invest in alternative monetization models/opportunities, such as gamified viewership (e.g. microtransactions for stickers, cheers, digital items, etc.) and web-based gambling. Billions in revenues have already been lost, COVID-19 may return again in the future (or we’ll see another similar outbreak), and even after the regular season resumes, it’s likely to be several more weeks until fans are allowed into stadiums, and months more until revenues return to normal.
This essay covered the impacts of the Coronavirus on the Pay-TV/OTT video space. I’ve also written on how the theatrical film business and video games/our digital lives will be affected
Matthew Ball (@ballmatthew)
