Morningstar Magazine - October/November 2016 - 83

Cord-neverers are generally millennials who have moved out of their parents' house, but who have never paid for cable. There is no value to them to pay for TV. Cord-shavers have had pay TV, but they have decided to go down to a much more basic package. They may just pay for a channel like HBO, but they no longer want ESPN. Do viewership changes depend on demographics? Macker: What we found is a lot of the cord-cutting or cord-nevering is happening on the younger end and as the customers get older you see a lot more cord-shaving. "I'm not getting the value out of it any more. My cable and phone and Internet bill is coming out to $200 a month. It's just too much. I don't need all these channels. Let's cut back." What is also happening is that when people bought cable TV they were buying network access, right? And that access is part of the cost. However, nowadays if you are also buying Internet from the same company, you are also paying for network access. You are paying for network access twice. So, if we move to over-the-top TV or linear TV, you are paying for network access once. We think that is a more efficient way of paying for that. So, is price the most important determinant for a cord-shaver or a cord-cutter? Or does competition matter, too? Macker: I think it is a little of both. Price is definitely part of it. The rise of Netflix, Hulu, and Amazon Prime has made it such that consumers don't have to necessarily watch a show right when it happens. So, this idea about a typical family eating dinner and then sitting down to watch a hit TV show during prime time doesn't exist any longer? Macker: That has died off as a general concept. You see that in the ratings for news. Fox News does well. CNN has done well on occasion, as has CNBC. But the ratings for national newscasts have consistently come down. And those viewers who are watching tend to be older. The way the media sector has been explained to me in the past is that you either control the content or you control the distribution of that content. But that argument doesn't seem as clear-cut to me with the rise of such firms as Netflix and Amazon. Is that right? Macker: Yes. These guys are all partners together, too, right? They are all trying to keep that cable ecosystem together. One of the other things to think about is TV works because we all subsidize each other. ESPN costs $6 or so a month per subscriber. But if it was just the subscribers who actually wanted ESPN, it would be a lot more expensive. You hear all these arguments-the average household watches 17 channels so why do they have 200? Well, the next household might not be watching all those channels, but it works because we balance each other out. As that concept changes, where does that profitability move to? One of the ways we think about media companies such as 21st Century Fox FOX, Discovery DISCA, and Time Warner TWX is that they should be opened up to whatever pay distributors are out there-Sling TV, PlayStation Vue, Comcast CMCSA, or Apple AAPL. Figure out the pricing and then be open to everybody. You want as wide as distribution as possible. Is there resistance to that? Macker: There has been in the past. There has been a little resistance to putting channels on Sony PlayStation Vue when it first launched. But, now most companies have come around to that idea. NBC Universal is a little more resistant because it is owned by Comcast. How do companies such as Netflix fit into the media picture? Macker: The thing you need to remember about Netflix is that most of its content comes largely from traditional content providers. Its library of TV shows comes from CBS CBS, from Disney DIS, from Fox. If you look at its famous original programming, it has financed it, but it still uses traditional movie studios to build that out. "Orange Is the New Black" comes from Lions Gate LGF. All its Marvel shows obviously come from Disney. Dreamworks Animation DWA does a lot of the children's animation. So, all this original content is coming from the traditional media companies. It has to have that. There is a relationship there that is built in. Does Netflix go a different way? If you look at Amazon, obviously their back catalog still comes from traditional media companies. But when it does original content, Amazon is the studio. It is doing a lot of the work itself. That is what will be interesting to see about Netflix. Will it move that way-competing with those companies instead of working with them? As we move forward, the world is going to be mix of live and what we call SVOD, or subscription video on demand. That is the world that is out there. Another interesting company is CBS. It has a channel called CBS All Access. It is linear streams of whatever is on CBS outside of NFL games. It has a video-on-demand library behind the channel. It is streaming the new Star Trek show. It will only be available on the All Access site. That is a really interesting model that you might see some companies migrate to over time. Are companies such as Sony and Apple trying to control more than your viewing habits? Do they want to control all of the electronics in a given household? Macker: If you look at the Sony PlayStation Vue service, we think it is largely selling it at cost. There is maybe a slight markup, but not a very big one. What Sony is really interested in is locking in consumers. The way to do that over time- maybe there isn't exclusive deals with channels, but there is a better interface, the thing that people have complained about with set-top boxes for years. To have that user experience, that portability of content-that is what people want. So, that console is the heartbeat of the home. Macker: If we are looking down the road, Apple definitely wants to do that. If you look at Amazon, its products now do smart home stuff. It used to be called the battle for the living room. I think we are seeing that come back. So, when you look at the future, are you convinced which companies have the smart business models and which ones will struggle? Macker: We think companies that have a broad amount of content with a strong production studio are the ones that are best suited. There are three media wide-moat names and then there is one wide-moat name on the cable side. Companies like Disney, Time Warner, Fox, and global.morningstar.com/Morningstarmagazine 83 http://global.morningstar.com/Morningstarmagazine

Table of Contents for the Digital Edition of Morningstar Magazine - October/November 2016