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st Claire Enders When its acquisition of 21 Century Fox closes, Disney will +44 127 361 1140 [email protected] own 60% of Hulu. If it bought ’s 30% stake (and WarnerMedia’s 10%), it could fully leverage the platform François Godard +39 3355 289127 for its US direct-to-consumer strategy [email protected]

Tom Harrington Comcast’s Hulu stake has little strategic value to it. We +44 207 851 0918 [email protected] argue it should sell to Disney in exchange for long-term

supply deals for ESPN, as well as for the upcoming Disney+ 7 December 2018 [2018-105] and Hulu, similar to its recent pacts with Amazon Prime

and

This could naturally be extended to Sky in Europe

depending on whether Disney decides to launch all direct-

to-consumer or sticks with pay-TV in certain markets

The ramifications of media consolidation are starting to take shape, and the different paths that the relationship between Comcast and Disney could follow in the UK and Europe are becoming visible. The eventual outcome will be

shaped by how the long-term partners sort out their US equity and distribution arrangements. This note outlines Disney and Comcast’s agenda and desired trajectory, and considers the relative importance to both parties of Disney’s

content licensing relationship with Sky.

In the US, Disney must balance its overriding urge to go direct-to-consumer with the preservation of existing lucrative distribution over pay-TV, in particular with regard to Comcast, the biggest cable platform. Meanwhile, the frontier between SVOD and traditional pay-TV continues to further blur, as demonstrated by the

recent Comcast carriage deals with Netflix and Amazon Prime.

Disney may want to extricate its content from Sky when its current licensing deal concludes in 2020, but it will need a partnership of some form—a lack of presence exposes it to the threat of an even closer relationship between the biggest

European pay platform and Netflix, HBO and possibly Amazon. Moreover it is no Related reports: accident that Sky is the chief pay-TV aggregator in Europe. Separately, the Comcast and Sky licensing deals are amongst Disney’s top five global licensing Disney, Fox, Sky and Comcast: future revenue generators. Together, these relationships are so important that Disney relationships [2018-091] and the other protagonists will work very hard to find solutions to the new What Sky means for Comcast [2018-088] challenges of the market. Hulu: Why Disney wants 21st Century Fox [2018-071] Sky values Disney’s content highly—and Comcast will be intent on securing continued exclusive access to it, along with HBO and Showtime—but its aversion The studio model: stay tuned! [2016-110]

to over-paying for Disney’s films and children’s channels increases the likelihood of Disney going alone, and launching its SVOD Disney+ service in Europe.

Disney’s agenda For several years, the Disney strategy has shifted towards a comprehensive view that the future is SVOD and the only way forward is direct-to-consumer. This is in great contrast to its previous history. Many content creators talk about being “platform agnostic” but Disney has lived it, forever licensing its films and television titles to a myriad of outlets, while simultaneously having its own (wholesale) channels; its base of IP, which it deftly exploits across lines of merchandise, theme parks, hotels and cruise lines, has only become even heftier with the acquisition of some of 21st Century Fox’s finest assets. Netflix, however, has shown a simpler, more direct vision; one in which most of its library can be accessed worldwide and partnerships with platforms can still be made but the presentation of content, and attribution reverts back to the streaming service. Disney must look at the world’s leading SVOD and feel that with its own wealth of content and IP, a similar journey to global domination of the streaming model can be, and indeed, must be, navigated. Some of Netflix’s success may well be due to its Disney content—the end of the licensing of which in 2019 will allow for the launch of Disney+—but there are a number of other factors that have enabled Netflix’s success and will be very difficult to replicate; proof being that no-one else has come remotely close. First- mover advantage, over ten years of accrued knowledge of streaming and what people want, technological innovation and luck in picking hits for its original production slate have combined with an acceptance by the market that such a ground-breaking product can be reliant upon the debt market as long as it displays growth. None of these will be easy for Disney to reproduce and, as a longstanding media concern it will be difficult to fund its online endeavours in the same way as Netflix has. Over 30 years, Sky has experienced similar financial and competitive benefit from first-mover position; the list of its doomed challengers is a very long one. Every one of these pretenders has been chiefly misled by estimates of consumer demand. Netflix benefits from first-mover advantages in Europe even more than in the USA. There are no better examples than the failure of most single market SVOD services. Sky’s NOW TV has launched in Switzerland and Spain where Sky has no prior pay-TV presence, and has only obtained a fraction of Netflix’s subscribers despite considerable marketing expenditure. In the UK and Europe, much will depend upon the success of the US launch of Disney+ in 2019. Indications from Disney point to a desire to launch Disney+ internationally as soon as possible. Disney+ as a proposition is on an entirely different level to past efforts. As a result of the current Sky deal, DisneyLife offered only a small part of Disney’s optimal content library, while in the US, initially, Disney+ will harness the company’s main family-oriented entertainment brands: Walt Disney Studios, , Marvel, Lucasfilm and the recently acquired National Geographic, consisting of both archival, new and original content. However, despite this being a compelling offering on paper, without the factors that have contributed to the success of the now entrenched Netflix, it is anyone’s guess whether the standalone service can

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generate the level of success to equal, and eventually surpass the easy revenues that the retained content would find across the channels and platforms that Disney could license to in the US and elsewhere. In the US, which has a higher propensity for additional SVOD services (see SVOD in the US and UK: a tale of three-player markets [2018-104]) and the opportunity to upsell existing subscribers of Hulu and ESPN+, there is promise. In a seemingly tighter market such as the UK (and positively even more so in continental Europe), and with the entrance of Apple imminent, the rationale for turning down Sky’s money from 2020 is less clear. DisneyLife has demonstrated that the Disney brand does not have the unwavering appeal to parents and kids as perhaps was expected, while the decision not to extend the current deal would likely cause mid-term damage to the Sky/Disney relationship. Even if Disney were to go it alone in the UK and other Sky European markets, it would be in the fledgling SVOD’s interest to have the service carried on Sky, along with other pay platforms. An icy relationship with the largest pay-TV platform in Europe is hardly beneficial for a service just starting out, especially when that company has recently embarked on a carriage, bundling and marketing agreement with perhaps your biggest competitor, Netflix. Along with the possibility of being frozen out of the TV sets of 10 million UK homes, future agreements for carriage of existing Disney channels—the values of which are diminishing due to declining viewership—would be a sobering experience for their owner. And, if it has taken Sky five long and expensive years to achieve two million NOW TV subscribers in the UK, how much longer will it take Disney? Or, for that matter HBO, if it went direct? And to what detriment the loss of visibility of these titans’ wonderful creations, characters and products within those homes with children?

Comcast’s agenda Contrary to Disney, Sky’s new owner Comcast is at a direct-to-consumer operation as its cable systems account for 62% of revenues. In this infrastructure business Comcast enjoys market dominance, because in most areas its high bandwidth offer is unmatched by the rival DSL-based provider. The main strategic challenge resides in slowing, or even reversing the decline in subscribers taking pay-TV—an historically high margin service now under strong competition from SVOD providers. Comcast’s content division NBCUniversal, unlike AT&T’s WarnerMedia, Viacom/CBS, or Disney, has no ambition of creating its own direct- to-consumer service, happy to stick to the classic Hollywood model of selling to third-party distributors and leveraging its sister cable division to extract the best deals. Comcast’s approach to the cord-cutting threat has been a relentless focus on user experience on Xfinity’s X1 set-top box (STB) in a bid to keep its status as gatekeeper to all the best content available. Comcast has been the pioneer in blurring the border between OTT and pay-TV with distribution deals with Netflix, , YouTube and Pandora (the music service) that make their programming available through its interface and smooth the way for subscribers of these services to migrate from alternative devices (Chromecast, Apple TV, etc.) to the X1. Users shifting from OTT to cable set-top boxes benefit from guaranteed bandwidth (which may help to watch 4k, and does not count in the data cap), a single point of access (including remote control and voice) and search for all

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content. Amazon Prime customers can also buy or rent films and boxsets on Comcast, while the Netflix subscription is billed by Comcast which has latitude to bundle the service with other offerings—like any old premium channel. It’s pay-TV Jim, but not as we know it. The decade-long evolution of Comcast’s strategy in the US is very similar to that of Sky over the same period. Besides their similar core telecom and TV businesses, their premium STB-based gatekeeper strategy is close—last spring, Netflix struck distribution deals with both almost simultaneously, while both have developed addressable advertising technologies. In the two markets, Comcast will seek to secure access to content for traditional pay-TV and to engage innovatively with the new SVOD services. And its Hulu stake could, conceivably, in our opinion, unlock a Disney deal doing both.

Hulu as a bargaining chip Presently, there are two ways of looking at Hulu. One is that it is an escalating success that has hit on a viable identity in the US market and is currently growing faster than its director competitors (see Figure 1). The other is that it is a very expensive undertaking, with cumulative losses for its partners—Disney (soon to be 60%), Comcast (30%) and AT&T (10%, through WarnerMedia) since its inception a decade ago—of at least $3.5 billion so far, and a further $1.5 billion in 2018. Both of these are true and both are instructive when appraising Disney’s further SVOD ambitions: there is a knowledge base in Hulu that can be mined for Disney+ if corporate politics can be navigated, and despite the perception created by cheap subscription prices along with streamlined UIs and content flows, SVOD is a tremendously expensive undertaking, especially in the USA.

Figure 1: US SVOD services by subscriber number (m)

60 58 50

40

30 26 23 20

10 7 0 2011 2012 2013 2014 2015 2016 2017 2018 Netflix Hulu* *Includes subscribers to Hulu’s skinny bundle Amazon** HBO Now **Estimated active Prime Video viewers [Source: Enders Analysis, company accounts and announcements, estimates]

On face value, Hulu, with content-appeal extending beyond the family-oriented entertainment brands, is the Disney SVOD that should have the more pressing international ambitions. Notwithstanding various licence agreements—such as the recent BBC2/FX deal—that would have to be patiently waited out, it has already co-produced original content with UK PSBs (such as and with the BBC, Harlots with ITV and The First with ) while originals such as The Handmaid’s Tale (Channel 4) and 11.22.63 (Fox) have found an audience across the Atlantic. Although the reception of those co-pros has been mixed, Hulu has an

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established presence in the UK in terms of high-quality drama —something the yet-to-be-launched Disney+ does not have. The current ownership structure of the streamer also raises interesting possibilities. Disney valued its 30% share in Hulu at $2.43 billion (giving the service a total value of $9.26 billion), in a November 2018 SEC filing. Comcast’s 30% grants the new owners of Sky an enticing bargaining chip. Even with Disney in control of Hulu, however, there is still sense in Comcast holding onto its shareholding, given the upwards trajectory of the service and the possibility that the launch of Disney+, along with any international expansion of either product will drag up Hulu’s valuation. But this ticket to possible success is expensive, and in itself Hulu has little strategic value to Comcast, apart from guaranteeing that Hulu would not give a better treatment to a Comcast rival. If it were to divest, Hulu would presumably still buy valuable NBCU content on a commercial basis. In fact, it will need it more if Time Warner pull all their licences from Hulu and other SVODs to beef up HBO NOW and the other mooted new Time Warner SVOD services. Conversely, full control of Hulu would allow Disney to leverage it for its direct-to-consumer strategy. The basis of a deal for Disney to buy the Comcast stake could include a long-term—say ten year—supply deal for Disney content including Disney+ Hulu, and ESPN+. Adding Disney+ and Hulu to its integrated offering would significantly increase the appeal of Comcast’s X1. As it grows the number of its SVOD suppliers, Comcast will also boost its negotiating leverage with each of them (and premium services like HBO and Showtime) as it will be in a position to be able to afford losing one, which is the ultimate threat to a supplier. Conversely, such a deal would allow Disney+ to launch with the support, rather than the hostility, of the nation’s top cable operator, allowing for the prospect of a managed transition of viewers and content between communicating vessels of traditional pay-TV and SVOD. Comcast would surely also greatly value a long-term deal for premium sports, the cornerstone of pay-TV. But for the time being Disney has no other option than to stick to pay-TV distribution for ESPN, as OTT cannot always be assured to give live sports the security of bandwidth needed for real-time HD and without buffering (ESPN+, which launched OTT in April 2018, is conceived as complementary to its broadcast sister channel and constitutes a cautious first foray into internet sports distribution by Disney, rather than an alternative to cable and satellite like, say HBO NOW). So in the short term, striking a distribution agreement is a no-brainer. But in exchange for the Hulu stake Disney may agree to extend the length significantly; Disney would probably insist upon keeping clauses ensuring the widest distribution of ESPN as a basic service, while Comcast could seek to secure any content previously exclusive to ESPN+. Comcast would very likely seek to replicate such a deal in Europe.

Why Disney needs Sky Sky correctly prizes Disney content, noting the value that its quality brings to Sky’s ecosystem. Its acquisition by Comcast (rather than Disney), however, while increasing the likelihood that Time Warner—and, in particular, HBO—will renew its existing deals with Sky, means, obviously, that retaining Disney’s content is less certain than if Disney owned the company.

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Sky is in the business of securing a supply of marquee, quality content for its subscribers to consume seamlessly across every device. With Netflix now bundled on , almost all quality content is available to its subscriber base. Conversely, could Disney afford to bypass the 20 million plus European Sky-subscribing households that constitute the core target group of Disney film and video content?

Figure 2: Viewing* to UK broadcasters' kids' channels by ages 4-16 (2010=100) 140 120 *Consolidated TV viewing 100 67 80 66 60 62 40 54 20 24 0 2010 2011 2012 2013 2014 2015 2016 2017 H1 2018 BBC ITV Turner Broadcasting Viacom Walt Disney Co. Note: Channels included are CBBC, CBeebies, CITV, CITV Breakfast, Boomerang, , Cartoon Network Too, , Nick Jr, Nick Jr 2, Nickelodeon, Nicktoons, Disney Channel, , , Disney XD [Source: Enders Analysis, BARB/AdvantEdge] The loss of Disney content would be keenly felt by Sky, especially its films, which are perhaps the engine of , but in other areas it is a diminishing asset being crowded out by Netflix. For example, Disney’s kids’ channels (see Figure 2) have seen a decline in viewing far beyond comparable channels. This is a direct effect of the vast range of children’s material already available on Netflix and Amazon Prime as well as YouTube. However, Disney remains the centrepiece of Sky’s family offering, declining or otherwise.

Dramatic choices The storming rise of Netflix and the consolidation of the US media industry are reshaping rather than shrinking pay-TV. The 2018 crop of announcements point to a convergence of SVOD with ‘cable’, rather than a substitution of the second by the first. The direct-to-consumer plans of AT&T (with HBO and Turner) and Disney, with their tiers and options, increasingly look like multichannel packages rather than standalone services à la Netflix. Meanwhile, the latter, and other SVOD services, are getting ever keener to gain distribution on traditional pay-TV platforms. This makes a win-win deal possible between Comcast, the top pay-TV platform and Disney, Hollywood’s Lion King. Comcast could sell its 30% stake in Hulu against a long-term supply deal with Disney that would include SVOD services. If sealed in the US, such a deal could plausibly be extended to Sky in Europe. But however pragmatic this sounds for Comcast and Sky, it remains to be seen if Disney fully understands the challenge of selling, late in the cycle, a new subscription service to consumers who already have basic packages, a couple of premium channels, and a couple of SVOD services.

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About Enders Analysis

Enders Analysis is a research and advisory firm based in London. We specialise in media, entertainment, mobile and fixed telecoms, with a special focus on new technologies and media, covering all sides of the market, from consumers and leading companies to regulation. For more information go to www.endersanalysis.com or contact us at [email protected].

About Venture Insights Venture Insights provides a subscription research service covering the media, digital and telecommunications industries in Australia, NZ and Europe, with a special focus on new disruptive technologies. For more information go to www.ventureinsights.com.au or contact us at [email protected].

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