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Like many, I have some thoughts about the recent Netflix (NFLX) earnings report, which has done nothing less than turn the entire market psychology of streaming companies on its head. However, there is already so much being written about Netflix that I don’t think it would be helpful to add to the cacophony of repentant bulls and (seemingly) vindicated bears right now.
But streaming is increasingly central to media and entertainment, both in the US market and around the world. So for now, I want to set aside questions about Netflix and turn our focus to another company, which after a late start is trying to break through into the streaming space: Peacock, the new Comcast (NASDAQ:CMCSA) streaming service.
Put simply, I have growing concerns that Peacock will never become the viable streaming service Comcast hopes for it to be; although the source of my concerns is rather different than what some industry analysts point to. One of its biggest obstacles is likely to be sports, which are finally being added to the service in considerable quantities, much to the delight of not only subscribers but many analysts as well.
I have argued recently that sports strategy is one of the greatest differentiators among major US media companies; some are taking very profitable approaches and some are taking very unprofitable ones. Unfortunately, Comcast is looking more and more like it will fall into the latter category.
My Thesis
This article will be somewhat in depth, and have three parts.
First, I will simply call out one particular sports contract, the largest one NBC/Peacock has: the NFL, of course. I will make a detailed analysis of it and its profitability; or more accurately, as we shall see, its lack thereof. The dynamics here are not too dissimilar to that of other sports deals, though obviously individual mileage varies.
Second, I will explain that this detailed analysis actually drastically understates the red ink of that contract, and most probably all the other sports contracts just like it. There is a common misconception about streaming content and content costs which has led even seasoned analysts in the space to drastically overestimate the value of, well any particular piece of content on a streaming service, really, but especially sports contracts.
Third, I will briefly explore some changes Comcast will almost certainly be compelled to make to its streaming strategy, though there is no guarantee even with these changes Peacock will be successful.
Case Study: Sunday Night Football
In addition to being the biggest, analyzing the NFL deal also makes sense because I already did something very similar for Disney’s (DIS) ESPN and their Monday Night Football contract. If my rather brief summation of assumptions and methods leaves any lingering questions, you’ll find a more detailed explanation of my methodology in that article.
Sunday Night Football is the most lucrative property of the most lucrative sport of the most lucrative TV market in the world. So maybe it’s not so surprising that to keep it, NBC recently paid through the nose: $2 billion per year, a more than doubling of the prior rights fee. To examine whether that is a good deal or not, we first account for any offsets to that cost, then examine core “subscriber cost” and compare it to subscription revenue.
Offsetting Revenues
Super Bowl
I already examined this question in the ESPN article; the Super Bowl generates roughly $550 million in ad revenue, and rotates through the four broadcast partners channels. Over 11 years then, we can annualize the Super Bowl ad revenues to $50 million per year, times the number of Super Bowls they’ll get. NBC, like everyone except Disney, gets three.
So we can deduct $150 million from these costs right off the bat.
Regular Season Advertising
Now, the next step is to figure out how much ad revenue the rest of the NFL season will generate.
And, some of you probably wouldn’t believe just how hard that question was to answer.
Obviously, companies don’t usually break down advertising revenue by content, for competitive reasons. But you’d think that even if exact numbers couldn’t be retrieved, we could at least reach consensus on the trend, and perhaps an overall approximation.
In my ESPN article, I linked to articles saying the NFL generated $5 billion in advertising revenue, and the Super Bowl alone accounted for $545 million of that. But since then I was besieged by several people with conflicting information. By which I mean their information contradicted both mine, and each other’s. And each seemed to have a different industry report to support them.
The NFL only made $3.3 billion, not $5 billion. Close, but actually it was $3.4 billion. No, it was $3.9 billion. $3.8 billion, to be precise, everyone. Actually it was in the low-to-mid 4s. But whatever the figure is, it declined 6% from 2019 levels. No, it didn’t, it rose 14%.
It wasn’t necessary to try to resolve all this last time, because Monday Night Football accounts for such a small share of it. ESPN’s ad revenues aren’t that impressive, frankly, but as one of the Big Four broadcast nets, NBC generates considerably more revenue from ad sales. How much more is actually a little harder to tell, because there are conflicting reports of just how much ad revenue NFL games generate over the course of a season. But the low end of the estimates has it at around $3.5 billion and the high end is a little over $5 billion. I’m going to keep it in the middle. Reports generally agree that the postseason comes to about $1.2 billion, split almost evenly between the Super Bowl and everything else. The rest is regular season.
Peacock’s Share
At $3 billion for the regular season, dividing over 272 games yields almost exactly $11 million per game. But that average is rather meaningless since advertising revenue follows eyeballs, and games can generate very different viewership levels. Like ESPN, NBC owns an exclusive national window, which means unlike CBS (PARA) (PARAA) and FOX (FOX) (FOXA) it doesn’t have to compete with another channel for football eyeballs. But it also means it only has one game to run. If fans aren’t interested in that game, they might just tune out of football altogether and NBC still doesn’t get their attention.
NFL viewership has jumped all over the place the last five years. But switching to streaming should make it possible to once again reach viewers who are interested in watching football but weren’t interested enough to keep paying $150+ cable bills. So I’m going to assume that viewership returns to the recent-history peak of 18.7 million average viewers per game, recorded in 2015. That is substantially above where it is now.
Multiplying that by six game windows per week – three national windows on Sunday, Monday and Thursday nights, one national multi game window on Sunday afternoons, and a split window on Sunday mornings – yields roughly 112 million game-viewers per week. I will round that down to 110 million to keep numbers round.
Now, we need to spread those viewers out over each window. NBC has the best performing window of all – and yet they still paid less than ESPN – so they’ve been averaging 20 million viewers this past year. However, NBC has been streaming games online for several years, so they may have already gotten their streaming boost. I will leave this number as is, since it might be too much to hope there’s much growth left here.
At 20 million game-viewers out of 110 million per week, and dividing ad revenue evenly per viewer yields a regular season advertising total of almost $545 million, which I will round up to that number.
Postseason Advertising
To this, we can add the postseason, although those games rotate between networks. ESPN gets only one of the twelve non-Super Bowl postseason games. Dividing the $600 million of postseason ad revenue over those games yields $50 million per game. If we take the remaining $550 million from the remaining 11 games and spread them evenly over the three broadcast networks, it yields a little over $180 million. I will round down this time.
This brings the total to $725 million per year. To be super-generous to Comcast, I am going to apply one final escalator.
Reconciliation
When I wrote my ESPN article, I didn’t do all these calculations: I simply took the number one of the (many) industry reports gave. I went back and applied the same criteria to ESPN and came to a total of $460 million a year. Rather than write another ESPN article and adjust that number down, I’m going to assume its correct and that my method produces figures 10% too low. Applying a 10% boost to NBC as well brings Peacock’s NFL numbers up to almost $800 million. I will round up again this time. Combined with the Super Bowl annualized ad money, that is $950 million in advertising offsets.
Subscribers And Costs
This leaves $1.05 billion to be defrayed through subscription revenues. That is a hard hill to climb.
At its peak, about 40 million households tune into Sunday morning football when there are two games on, and therefore double the chance of finding a game that piques their interest. NBC and the Sunday afternoon game both drop off to about 20 million. Granted, some people probably want to watch the game but can’t on a given week. They still have subscriptions because of all the other games they do watch. So we can maybe raise that number somewhat. But on the other hand, some people who watch now because its included with their pay-TV might prefer to keep the money if it was broken out separately.
To say nothing of the fact that not all Peacock revenue can be allocated to content. There are also credit card processing fees, server costs, content delivery network, marketing…it all adds up. In my research, I’ve generally found about a $2 per month “non-content operating cost.”
If only Peacock’s $3 per month left over can go towards subscription costs, that would mean 350 million “subscriber-months” would be required, i.e., a one-month subscription by one subscriber. Amortized over the five months of the NFL season, Peacock would require a staggering 70 million subscriptions to break even, over 3x the viewership of SNF even at legacy pay-TV’s peak. And of course, the NFL isn’t the only content Peacock has to pay for.
Closing The Gap
To make profitability even remotely plausible, I am going to go out on a very small limb and assume that in reality, NBC’s plan is to, after Peacock has grown suitably, shift the NFL to Peacock Premium Plus. That is the very top tier of Peacock, offering not only the full suite of content but also, usually, ad-free viewing.
But of course, live NFL content is going to be ad-interrupted either way, so Peacock can move it to the top tier without losing any ad revenue, while doubling its subscription fee per month from $5 to $10. This seems to me the obvious play for premium sports content like the NFL; indeed, in time, for just about any sports content on a streaming service with multiple tiers.
At $8 available for content spending, again assuming everything was allocated to the NFL, Peacock would “only” need 26.25 million monthly subscribers. That is still over what it could reasonably hope for.
Preliminary Results
Realistically, Peacock is probably in the red at least a couple hundred million dollars on a single piece of content.
That’s bad, but it’s not a catastrophe. It’s basically about double what Comcast’s NBCUniversal blows on a couple of bad movies. If that were the real loss, Comcast could chalk it up to experience and move on … albeit its shiny new extension is for 11 years, so that’s a lot of experience it will be getting.
Except there is one final deduction that needs to be made. A very, very large one. And this brings me to the misconception about evaluating content costs and contracts in streaming.
Irrelevancies Like Viewership
In a monopoly, the monopolist (the cable/satellite operator) can charge the profit maximizing price for the bundle as a whole, and then the only fight between the operators is how to divvy up the spoils. If a channel accounts for a greater share of the total viewing, its owner can demand a greater share of a more or less already agreed upon total pot. Under that system, there is no real upper cap on returns for viewing. Even if you have nine of the top ten programs, you want to go out and sign the tenth and get even more money. And because of that, companies are willing to pay top dollar for that tenth program.
In a competitive ecosystem like the one that is being created in streaming today, it works a little differently. The goal is to persuade someone to resubscribe to the service for another month. A service whose price is more or less fixed, at least in the short-term. Overkill, never really a problem in a monopoly bundle, becomes a real possibility. You might spend a lot more on content than you need to keep them hooked.
This means that the return on content isn’t strictly measured by the number of viewers of a program. Rather, the return is measured in subscribers. And what that means, is that NFL content isn’t good value for money for the service if it is viewed by 30 million people. Rather, it is good value if it attracts 30 million subscribers who otherwise wouldn’t be subscribing except for that content.
This is a big problem no matter how you slice it. Comcast is putting a lot of money into new originals for Peacock, as well as foregoing syndication revenue to put reruns of scripted shows onto the service – taking The Office off Netflix cost $100 million a year by itself – as well as other sports, including the Olympics, college football, etc. Presumably all this spending is already drawing some subscribers to the service. If they tune in and watch the NFL as well, their viewing hours may double, but Peacock doesn’t get to charge them a monthly subscription fee twice in the same month.
So the relevant profitability test is subscribers added, not subscribers watching. Peacock does get the added advertising revenue still – that’s why we had to deduct ad revenue before calculating the subscriber element – but the subscription mountain gets a lot steeper when you shift from viewership to net adds.
Calculating A Discount
How much steeper? Well, Comcast gives away Peacock for free to anyone who subscribes to its broadband Internet service. It has deals in place with Cox Communications and a few others to do the same. Currently, Charter Communications only offers a 12-month “extended free trial” but it’s not hard to imagine that becoming permanent at some point as well. And presumably at least a few Peacock subscribers came attracted to its other content and would stay just for Office reruns and other non-sports content Peacock offers.
Comcast’s own cable Internet footprint and even a small non-sports subscriber head start would probably add up to about a third of the target market. If we multiply the above calculations by two-thirds, we effectively increase the necessary subscriber/viewership number 50% to break-even. Tack on Charter’s and Cox’s giveaway and the number only gets higher. A lot of Peacock’s NFL viewers are simply not going to be new subscribers.
With Peacock barely hitting break-even before applying this factor, it should be clear that there is just no plausible path to profitability on a net adds basis. Even putting every benefit and break on Peacock’s side of the ledger, they just can’t get there. And for those who say that Peacock’s exclusive NFL day games will even the score… that “exclusive” consists of precisely one game per year on Sunday afternoon.
The Problem With Streaming
Altogether, it’s not unreasonable to conclude that of Peacock’s $2 billion NFL spending, approximately $1 billion of it is dead money. Similar dynamics, albeit with different numbers attached, will be at play for pretty much any sports on Peacock.
This leads, I believe, to one unavoidable conclusion: while moving sports to the top ‘Premium Plus’ tier is still a good idea, as the pay-TV bundle continues to collapse it’s just not going to be enough. At some point, Comcast is going to have to follow the Disney model and break out its sports content to a separate service from its scripted content, much as Disney+ and ESPN+ are already separate services. That way, it actually can charge two subscription fees to sports watchers who also like Peacock’s scripted entertainment.
But while necessary, that’s almost certainly going to alienate customers who were just told that sports would be part of their Peacock subscription. It is also going to reduce the appeal of Peacock proper, diminishing those already not great subscriber numbers that were disclosed last quarter.
The core problem here is simply that streaming, as I’ve been saying for a while and as Netflix is even now admitting, simply isn’t going to be nearly as profitable as the legacy pay-TV system, for anyone; the increased competition of the streaming space means that consumers will be able to get more value for less money. In streaming, even a behemoth like Comcast or Disney can’t simply shrug off a $1 billion a year hole and keep chugging.
Across The Board
This was a Comcast-focused analysis, but the same principles apply across the board. I have growing concerns about Disney/ESPN and Warner Bro. Discovery’s (WBD) Turner networks for much the same reason. The best of the legacy operators so far has been Paramount whose CBS actually managed to put together a large but profitable portfolio of sports deals – uniquely so amongst traditional pay-TV.
But also relatively more valuable as a result of these dynamics are the original entrants and their non-sports focused services. Amazon Prime (AMZN) and yes Netflix itself remain more viable in the streaming space precisely because they don’t have large legacy sports contracts they need to find a way to transition to streaming. And yes, I know Amazon also has a new NFL deal, but that deal works a little differently than Comcast’s or Disney’s and is unlikely to prove to be anywhere near as debilitating.
Investment Summary
Comcast is more than just Peacock, and this article is way too long to dive into its other divisions. I’m not prepared to recommend a short on Comcast before we know how its broadband division is holding up. But Peacock has a real sports problem that isn’t being appreciated yet, and the point about the right way to measure content’s value (adds, not views) will I hope be useful to investors as they evaluate the whole streaming industry.
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