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Netflix is like Real Madrid: why that’s bad news for these media stocks

Credit: Ver en vivo En Directo

Australia recently played host to some giants of international football in Manchester City, Roma and the biggest, most affluent club of all, Christiano Ronaldo’s Real Madrid.

In fact, the match day takings, broadcasting revenue and licence deals of the Spanish giant have led Forbes to estimate the value of the business of Real Madrid at a staggering $4.39 billion. Another source values the talent of squad at $1.12 billion on the open market, with the top three stars, Ronaldo, Bale and Rodriguez worth an incredible $421 million.

Now for a sobering comparison.

Australia’s own A-League is home to ten teams, with an average squad size of 20. And the total estimated value of those 200 players? $98 million. That’s right, our entire league is not worth one quarter of just three players in a world class team.

So what does all of this have to do with investing in the stock market?

Competing against the global giants

Until fairly recently, a big company in Australia might dominate its local area, a large one might be the leader in its state, while true national businesses were few and far between.

But those businesses were able to carve out big slices of market share and generate large profits for shareholders. But we now live in a time where almost every business faces international competition.

Woolworths Limited (ASX: WOW) has to contend with German interloper Aldi, while the car manufacturers have long since given up in the face of cheaper offshore production.

This year, the companies that will bear the brunt of the wave of disruption about to be unleashed are the established media players. These companies are the local equivalent to the A-League, so who is the international media equivalent to Real Madrid?

A mail order DVD company

The global giant that will cause serious pain for shareholders in Nine Entertainment Co Holdings Ltd (ASX: NEC), Seven West Media Ltd (ASX: SWM) and Ten Network Holdings Limited (ASX: TEN) began life as a mail order DVD company. But today, Netflix is the undisputed global leader of streaming video on demand (SVOD). Put more simply, it delivers subscribers high quality video content over the internet, which has allowed it to build a market capitalisation of over $46 billion.

The model works, with the company operating in over 50 countries with over 57 million paying subscribers accessing over 2 billion hours of content. Every month. And it is now operating in Australia.

Simple equation

Free-to-air-TV, at its core, is a very simple business. Great shows and movies draw viewers. Better shows attract more viewers, and crucially, they do this at the expense of their rivals: eyeballs can only actively view one offering at a time. More viewers mean that the price the owners of that content can charge for advertising is higher. And advertising is the lifeblood of free-to-air-TV – without it, revenue and profit can disappear as fast as the ex-contestants on a cooking show.

But the situation also works almost identically in reverse. Less viewers means less ability to charge for advertising. Businesses will only continue to pay a premium to show their ads on a channel if the audience is large, and ideally, growing.

But with Netflix having exclusive access to high quality, international content that is favoured by the majority of Australians, viewers are clearly migrating. Over 1 million Australians have access to Netflix less than six months after its launch. That number is triple the efforts of the next four players combined. Those competitors include the digital offerings of the major traditional local media players.

Going back to the Real Madrid example, it is clear that shows like House of Cards and Orange is the New Black are the superstar marquee players of the global behemoth. At the same time, smaller competitors like The Block and Masterchef might be popular locally, but will be completely unable to match the size, quality and buzz associated with their larger rivals.

Some local hope

There are some listed beneficiaries to the arrival of Netflix, with TPG Telecom Ltd (ASX: TPM) one of the strongest given its large market share and acquisition of iiNet Limited (ASX: IIN). The data plans and infrastructure supplied by TPG are the bridge between the content owned by Netflix and millions of homes that view it.

Telstra Corporation Ltd (ASX: TLS) has similar characteristics to TPG and iiNet, but its part ownership of Foxtel, which is haemorrhaging subscribers even as it cuts its pricing, largely cancels out any benefit accruing from selling more data to more customers as a result of the streaming video services.

Just as it’s impossible to see Melbourne Victory or the Brisbane Roar getting anywhere near Real Madrid in our lifetimes, the same is true of our local television and media companies in their fight against Netflix.

And while the share prices of Nine Entertainment, Seven West Media and Ten Network might ebb and flow over the next few years, it’s hard to see any reason to buy them, given the structural challenges that they face.

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Motley Fool contributor Ry Padarath has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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