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Morningstar | Changes in Media Continue to Pressure Pay TV Bundle; Comcast and Disney Best Positioned to Adapt

The constantly evolving media ecosystem has put tremendous pressure on the traditional pay-television bundle model as people find new ways to consume content. Three years ago, we offered the view that the traditional pay-television bundle was broken but not dead. Since then, there have been a number of new entrants that use the Internet to distribute pay television, so-called over-the-top services. However, the pace of change within the pay-television delivery marketplace remains frustratingly slow and the price of the traditional bundle is stubbornly staying much higher than it needs to be. As a result, subscribers continue to flee the traditional delivery methods from cable, satellite, and telecom firms.

While the new OTT entrants have not forced traditional platforms to lower their pricing, these newer competitors have helped stabilize the overall pay-television market by signing up 7 million subscribers over the past few years. The subscriber growth at the new platforms has been driven by smaller households and "cord shavers," who value the bundle but not at the much higher price of traditional services. However, the growth at some of the largest OTT services has slowed down.

As we examine our coverage across media and cable, two firms, Walt Disney and Comcast, stand out as having both a wide moat and the ability to sustain their competitive position in the face of the ongoing changes across the pay-television landscape. Both firms are trading well under our fair value estimates of $130 for Disney and $42 for Comcast.

Our Observer, "The Evolution of the Television Bundle Part Deux: OTT Can Save the Bundle," examines the changes in the pay-television market over the past three years, the growth of OTT distribution, the differences and similarities of the five major OTT platforms, and the impact on media firms. In short, we think that both traditional and OTT platforms will survive by adapting and changing the composition of bundles and price points. We expect that subscriber growth for the OTT platforms will be captured by those firms that have more to offer consumers in terms of broad technological capabilities than the traditional television distributors.

Newer OTT platforms like Hulu with Live TV and YouTube TV appear to be breaking even at best as content costs alone eat up well over 90% of the $40 in monthly subscription revenue. Given the additional expenses, these services are likely losing money on a per-subscriber basis. Additional revenue sources, such as advertising, additional channel packages, and add-on services, may not currently be able to completely make up the gap between subscription revenue and expenses. But this gap could close as the platforms gain more subscribers. Instead of hiking prices to deal with affiliate fee increases, we think that the OTT platforms need to work with media firms to make the bundle somewhat skinnier by removing low-value networks.

We believe that YouTube TV is among the best-positioned OTT platforms to capture new subscribers, as Google will continue to promote the service across its own brands. We think that the current market leaders, Sling TV and DirecTV Now, will soon be surpassed by YouTube TV, Hulu, and potentially even new entrants.