Technological growth in the past two decades has made it difficult for the newspaper industry, but The New York Times (NYSE: NYT) keeps coming out on top — and outperforming the market handily, at that.
In this episode of Industry Focus: Consumer Goods, Vincent Shen and senior Motley Fool contributor Asit Sharma offer a preview of The Times’ upcoming quarterly report before discussing the initiatives that management are launching to fuel long-term growth.
The team also updates investors on the deal between Walt Disney and 21st Century Fox (NASDAQ: FOX) (NASDAQ: FOXA). Tune in to find out what this will mean for Disney’s upcoming streaming services and how Comcast (NASDAQ: CMCSA) is responding with another multi-billion dollar deal.
A full transcript follows the video.
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This video was recorded on July 31, 2018.
Vincent Shen: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. I’m your host, Vincent Shen. It’s Tuesday, July 31st. We’re putting a spotlight on media companies today — first, with an update on one of the biggest stories in 2018, and then an earnings preview and outlook for an “old” media stock. Joining me via Skype for this discussion is senior Motley Fool contributor, Asit Sharma. Hey, Asit! How’s it going?
Asit Sharma: Hey, Vince! Fantastic! How are you doing today?
Shen: I’m doing really well. We’re on a tight schedule here, so we’re going to dive right into our first topic, and that’s the Walt Disney and 21st Century Fox merger. It’s been a few months since we last checked in on this ongoing saga. The news from last week helps to put a nice bookend on the deal. We’re going to discuss what happened and what investors should expect going forward.
First, back in late May, Dan Kline and I spoke about a potential counteroffer for the Fox assets from Comcast, and the inherent uncertainty that accompanies this type of bidding war. It wasn’t until mid-June, in the immediate aftermath of the Justice Department announcement that they would clear a different deal, a big one between AT&T and Time Warner, that Comcast stepped up to the plate. They put out an offer for $65 billion in cash. Disney was forced to respond with a $71 billion deal that includes both cash and stock. Earlier this month, ultimately, Comcast chose to withdraw its bid.
This brings us to the past week. Shareholders at both Fox and Disney have approved the deal. The Justice Department has given its approval as well, with one small requirement, and that’s that Disney will divest itself of Fox’s regional sports networks that compete with ESPN. Beyond that, Disney still gets the valuable film and television properties, a majority ownership of Hulu, stakes in Star India and Sky, which we’ll discuss a little bit more later.
Asit, my question for you is, what comes next for Disney and its shareholders, besides the fact that, I’m sure a lot of people at the company are popping champagne. What should they be looking out for in the year ahead?
Sharma: The major thing that shareholders want to look to next is, when will this deal close? Past regulation from the U.S. side — U.S. regulators have approved the deal — but we’re looking for European regulators, Chinese regulators, major markets, to give their blessings on this deal. The soonest time frame that I can see is an early 2019 approval, which means that shareholders can start expecting to see some impacts of the merger, probably, in the back half of the year.
If you’re looking for significant accretion opportunities, that is, putting two companies together, and net revenue and earnings increasing, that might come from this interesting investment that Disney has undertaken in what’s called over-the-top services. This refers to streaming services which bypass traditional channels. As most of our listeners who follow or own Disney know, the company is going to pull much of its content from Netflix in 2019 and offer its own streaming service. This service will focus less on quantity. That’s Netflix’s model. They’ll focus more on quality and its gold-plated shows, which go back decades, movies as well.
I want to talk briefly about what that means in the combination of these two companies. To go back a little bit on what the service will look like, Disney is expecting to have about 7,000 television show titles in fall of 2019. It’s also going to have franchises that viewers love, such as the Marvel Universe, Star Wars. Those movies will be available, they’ll be pulled from Netflix. All R-rated content is going to live on Hulu. Vince, as you mentioned, both Fox and Disney were joint partners, along with some other media properties, in Hulu. This deal makes Disney the controlling shareholder in Hulu. They’ll shove R-rated content over to that, and the Disney family programming that it’s known for will live on this streaming service. The company will also have some original content, including five original movies and five TV shows, by the end of 2019.
What we can expect is that once this merger completes, there will be some immediate shifts into the new streaming service. I expect that we’ll probably see the National Geographic show, which is a really lucrative Fox property, shipped over pretty quickly. I think Disney CEO Bob Iger has already signaled that. We’ll also see great film properties such as X-Men and Avatar also migrate over to the streaming.
The last thing I want to point out about this merger is that both of these companies have a prodigious film studio operation. They’re projecting $2 billion in cost savings and synergies by 2021. Part of this will be realized in cost-cutting. Both companies replicate many of their services in film, such as production, distribution, marketing. You’ll see an emerging news story over the next few quarters of, unfortunately, layoffs, because so much in the film side of both businesses is duplicative and redundant. That has a good bottom line impact, but unfortunately it comes with people losing their jobs.
All in all, for 2019, look late in the year for an impact. I really think you’ll see most of the significant momentum start to happen in early 2020.
Shen: Awesome, thank you! Something I’d like to mention before we move on to our next topic is the framing for this story. Listeners, remember, these multi-billion dollar deals, all of this jockeying is as much defensive as it is offensive. Keep in mind that recent estimates indicate that consumers are cutting the cord at an accelerating rate. By 2022, as many as one in five people will have abandoned the pay-TV model in favor of streaming alternatives from companies like Netflix, Amazon, HBO, and others. With this jockeying for these Fox assets, Disney is answering this long-term trend with these streaming offerings that you mentioned, Asit. They have all of these projects in the works that cater to sports, kids, or adults, plus Hulu. Ultimately, the Fox franchises, the studios, those assets will really make those services more appealing.
The last thing I’ll mention is, don’t forget that part of the acquisition is, Disney’s taking over Fox’s 39% stake in Sky. This is the leading traditional pay-TV business in Europe. Fox has supplied bids for complete ownership of Sky, but that was previously held up by regulatory concerns. Disney is now in the driver’s seat, and the company is still likely to pursue that outstanding 61%, with Fox’s latest bid at over $15 billion for that outstanding stake.
If you turn to the other camp, all these negotiations and this bidding, there are still Comcast shareholders, as well. On one hand, they lost the opportunity to increase their scale with the Fox assets. That means they have even larger, more influential competitor in Disney. On the other hand, Comcast leadership has shifted its dry M&A powder to taking over Sky entirely to branch out of the North American market. Sky has over 23 million customers that can be added to its ranks, and Comcast is offering over $34 billion for that European business in its entirety. It’s the better offer at this point in time, and they’re still going through that process.
Our next media company that we’re going to cover comes from earnings season activity, and that’s The New York Times, ticker NYT. They’re expected to report their second quarter 2018 results in early August. Asit, we briefly covered The Times last fall. The stock is up another 25% since that show in October. To kick things off, can you talk about the company’s results year to date, and what’s on your watch list for this next report?
Sharma: I follow The New York Times every quarter. I’m very interested in their digital-only subscription revenue. If you look at the last quarter The Times reported, they showed an overall revenue increase in subscriptions of 8%. That was driven, of course, by digital subscriptions. Those subs, short for subscriptions, jumped about 26% to just over $95 million. Within that category, their news product digital subs improved by about 24%. This is really driving The Times’ growth. It’s the theme that we talked about in October. At that point in time, Vince, we were curious, “The Times is up 76% this year, can it continue?” As you pointed out, since that show, up another 25%.
One other thing that I’m looking for this quarter is its Other category of revenue. The Times has, now, a crosswords product, it has a cooking content product. It also has revenue from the Wirecutter, which is a referral site that The Times acquired last year. These comprised a much smaller part of the business. However, they’re growing rapidly. I want to call out one of these. If you take crosswords and cooking together, their growth rate is over 60%. It’s about $5 million in revenue, not a huge chunk of the total top line, but this foray into content services that are peripheral to news is one of the growth drivers that has investors excited.
I’m going to hand the baton back to you, Vince, but I do want to get into, in this conversation, a little bit later on, is there a potential for this quarter to be a little bit of a jolting call for investors who had it good and have some profits on the table? But, what are you curious about yourself? I think they’re reporting the first week of August?
Shen: I’m getting some conflicting dates. Capital IQ says August 8th, I’ve seen others say August 3rd. Basically, in the next week or so. The thing that you mentioned, in terms of that jolt for shareholders, is definitely on my mind. You have this incredible subscriber growth from the past year, driven a lot by the headlines and news with President Trump. But management does ultimately expect some of those growth rates to come down based on these tougher year over year comparisons. Keep in mind that the paid, digital-only subscriber base has doubled from early 2016 to early 2018. That’s just two years’ time, and it’s gone from 1.36 million subscribers to 2.78 million.
If you look at these quarterly growth rates from just 2017, the lowest quarter was 41.8% growth. The biggest quarter was 63.4% growth. Huge numbers. Something that’s really promising, and I think still encouraging for shareholders and investors to keep in mind, is that the retention is still strong among these post-election additions. The interest that these new customers have — which happen to be younger, with a higher proportion of women — they’re not falling off after initially subscribing. They’re actually coming to reflect the churn rates that are similar to older, loyal subscribers today. Definitely a positive there.
In terms of the longer-term outlook for this company, I’m curious, Asit, what are you seeing, in terms of what The Times’ management is doing to sustain its growth and adapt into more of a platform business? I know we have Wirecutter, I know we have some of the vertical expansions into cooking and the crosswords business. Anything else you’re seeing, in terms of things that are irons in the fire for the company a few years from now?
Sharma: Sometimes, someone on an executive team wakes up in the morning, and they have a thought come into their head, a few words, and it’s a very persuasive narrative which they can communicate with the rest of the management team. I like something that I’m hearing out of The Times’ management over the last couple of earnings calls. They’re starting to focus on what they call “the story behind the story”. It’s an easy, five-word phrase. What it refers to is the really persuasive interest that subscribers have over how content is made at The Times.
Let’s talk about the elephant in the room. We talked about this in October. In the overarching theme of the current political climate, in which The New York Times and the Trump Administration are foils for each other, and each benefits, as we talked about in the fall, from this relationship, consumers of media want to understand how the stories that are breaking news — it seems like, to me, every few hours, not even every few days — how those get made. The Times is capitalizing on the regard for its content. It has a surprise hit in The Daily, which is a podcast, which seeks to uncover how an emerging news story breaks. They’ve announced a couple of interesting partnerships. They’re going to now have a spin-off concept on The Daily called The Weekly. Hulu — which we talked about just a few moments ago, in relation to Disney and Fox — is going to have rights to screen this content.
Always, with The Times, remember as well that its lofty reputation is driven by investigative journalism. I have noticed that while the company did cut some of its copy-editing staff, it has poured more resources into investigative journalism. They broke the Harvey Weinstein sexual assault story, and won a Pulitzer Prize for that. That’s turning into more content, as now, The Times is making a feature film about breaking that story.
You see how even just reporting the news, for a company which has the brand dominance in journalism, The Times, can be parlayed into something greater. There’s an ever-growing field of content. It’s really analogous to this idea of Disney and Fox taking their assets and trying to make something of them.
That’s what I’m looking for longer-term — how The Times takes its content and monetizes it further. Certainly, consumers seem to have a growing appetite for this.
Shen: I’ll expand on that. I think, maintaining that brand and monetizing it and working off of it is going to be really important. You have this situation, thinking longer-term, where the print business is mature, it’s still profitable, but it’s ultimately running on a timer. Management has framed it as a cash generator that can fuel other investments for the company, with the digital platform also consistently growing, becoming a bigger part of The New York Times. I’ll just point out, this time ten years ago, advertising in terms of revenue was over 60% of the top line. In the most recently reported quarter, the advertising share was just 30% of revenue, with subscriptions filling the void. The problem there is, as print advertising budgets shrink — this has been a long, ongoing headwind for The New York Times — that part of their revenue is also shrinking with those advertising budgets. It was down 14% last year. They’re losing out on an income stream that they’ve said has 95% gross margin, really profitable for them.
They’re experimenting a lot with the podcast, which has been immensely successful. They’re spinning it out into shows, movies. The company is really thinking about these other opportunities, dedicating teams and resources within the company to looking at what else can work, in terms of these different verticals, things that are similar to cooking or crosswords or Wirecutter. They’ve mentioned a few other categories, such as parenting, or brain teasers, that readers might enjoy, as other areas that they can experiment in and play with.
I’ll also add, CEO Mark Thompson had some interesting comments during an industry conference in May. Again, coming to the issue of The New York Times’ brand and how powerful it is. In the print business, customers largely accepted, year after year, about a 5% price increase, with low churn as a result of that. That’s encouraging for the company, ultimately. Right now, they’re really focused, in terms of their subscriber strategy. They have a goal of expanding the subscriber and reader base. But there’s a point when, with the precedent set, in terms of the print business and the trend that they saw there, ultimately potentially being able to increase prices for the reader base, once they’re at the point where they want to start maximizing revenue, looking at that more, and boosting profitability for the long-term.
My last couple of points, Thompson has also pointed to a goal of about 10 million total subscribers, though he didn’t really lay out a specific timeline for reaching that milestone. That’s triple the current number. The Times has 30 to 40 million people visiting its website each month. Management has looked at its total addressable market as being something in the hundreds of millions, when you include all English-speaking readers. That kind of subscriber growth does seem like a potentially achievable number, given the momentum that they’ve had recently, and the focus that management has on expanding into more of a platform kind of business, beyond just the print and online newspaper.
Again, this is another case — we’ve talked about this a lot with brands in consumer and retail, about how important it is to nurture that, and how that can really drive some of the important results and growth for the company. Any final thoughts from you, Asit, before we roll off?
Sharma: I have two points. One is, undergirding all of the things you just talked about has to be a sound financial strategy. The Times is a weathered, sleeves rolled up, bare-knuckled company when it comes to looking at their income statement. Any company which runs a newspaper for decades, successfully, has this acumen.
What I like about The Times is, all the investments that you’ve just walked us through, they need to come from somewhere. I’ve noticed, as I’ve been following The Times over the last two years, that the company consistently controls its costs. Every quarter, you see operating margin improve just a bit. It improved by 130 basis points in the last reported quarter over the prior year to 8.2%, which is not a high operating margin, but for the newspaper business, it isn’t bad.
I also have noticed that they’ve been whittling away at what used to be a pretty big debt burden quarter after quarter. When you’re running at some $400 million of revenue in a quarter, just reducing debt from $7 to $8 million down to under $5 million, where it is today, that makes a difference in earnings per share. It’s one of the reasons that this stock has climbed. It’s not just this really great subscription growth that the company has enjoyed. It’s also how they manage the profits that flow to the bottom line. I think that’s one of the persuasive reasons to own this stock — it’s well-managed from an economic point of view.
My last point is, looking at this coming quarter, I do feel that the company has had a pretty good run. It’s trading now at around 27x forward earnings, not seriously overpriced. But given the climate that we have in the market today, especially after Facebook‘s earnings unsettled the market, and some of the tech companies disappointed, it may be a quarter where The Times has just enough of growth for it to sell off a bit. Now, listeners out there, that means you should go out and buy the stock, because I’m usually wrong about these predictions. [laughs] However, if I’m not wrong, I think, this isn’t a signal that you should run away from this stock. I do believe in what Vince has laid out, that it has a platform which will grow with judicious management of these new content strategies.
All in all, they may have a little bit of a bump in the road ahead, is my guess, in this quarter. Maybe not. But still a strong investment proposition. The company has this great brand, which, if they manage it well, will continue to provide value and increased earnings per share going forward for the next couple of years, at least.
Shen: Great. Thanks, Asit! I’m going to end with a quote from the CEO. It’s from a conference in May. I think it’s interesting. It touches on what’s ultimately a tailwind for The Times and all of these different verticals that it’s looking at. He says, “We’re not satisfied with our current rate yet, given what we think is the size of the market, the competitive context, and the fact that the background, because of Netflix and the other streaming services, because of Spotify, is manifesting a growing awareness and willingness, not just in the U.S. but in other countries, to pay for high-quality content.”
It’s an interesting parallel to draw with streaming music, streaming video. Ultimately, people are showing that, even with multiple services — I’m a subscriber, for example, to Spotify, Netflix, I have an Amazon Prime account, I have Hulu. When the content is there, I’m willing to pay for it. The New York Times seems to be benefiting from this same swoon of interest and growth of people who want high-quality news, high-quality journalism. I think that’s something that’s here to stay, and that really speaks to the longer-term prospects for the company. Thanks a lot, Asit, for joining us today!
Sharma: Thanks a lot! This was a lot of fun!
Shen: Thanks, Fools, for listening! Remember that the company should be reporting in the next week or two. We’ll follow up if there’s any major updates there. People on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against any stocks mentioned, so don’t buy or sell anything based solely on what you hear during the program. Fool on!
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Asit Sharma has no position in any of the stocks mentioned. Vincent Shen owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon, Facebook, Netflix, and Walt Disney. The Motley Fool recommends The New York Times. The Motley Fool has a disclosure policy.