Streaming Wars and the Future of Foxtel

November 2019 | MEDIA

Streaming wars and the future of

Foxtel

Up until a few years ago, Foxtel has enjoyed an uninterrupted run as the monopoly premium Pay TV provider in Australia.

Key takeaways But the arrival of / The Australian SVOD market is all set for a renewed bout of competitive intensity with the launch of Disney+ and Apple TV+. international SVOD / Foxtel, which has been quietly chipping away at its new players and the rise of strategy of developing standalone OTT platforms, is about to local challengers has see a pick-up in pricing pressure as the new entrants prioritise reach over revenues. Both platforms are priced at a 50-70% discount to comparable plans from Netflix, Stan and Foxtel Now. made a dent in Foxtel’s business. / Disney+ is the bigger threat to both Foxtel and SVOD players like Netflix and Stan as it offers a large and popular catalogue of content. Disney could also do a Verizon type deal and partner with an Australian telco to offer 12 months free access to Disney+. We believe the / Foxtel continues to face a number of issues – falling ARPUs challenges that Foxtel and earnings while programming costs remain high. EBITDA is down more than 40% in the last three years. Programming costs could faces are structural in take a few years to readjust as a majority of the costs are associated with nature and Foxtel sport codes that are already locked in. could find it tough to / As ARPUs decline, Foxtel will have to significantly increase penetration to maintain its current revenue run rate. We estimate if ARPUs recover lost ground. halve from current levels, Foxtel will have to more than double its penetration and even then, could see a 20-30% decline in revenues. / Foxtel will need to go beyond lower pricing, promo offers and SVOD. Foxtel should be looking to position itself as the aggregator of choice by offering multiple streaming services under one bill and one interface. The move to integrate and bundle Netflix with Foxtel was a step in the right direction, but it may be a case of too little too late as Netflix is already available on multiple other devices and platforms.

Foxtel and the coming streaming wars

In the past four and half years, there has been perhaps no bigger topic in the media industry than the arrival of Netflix and other SVOD players in Australia. With Foxtel being the largest Pay-TV provider, it has been at the receiving end as Netflix has captured a substantial portion of the latent demand for SVOD services in Australia. In response to these competitive pressures, Foxtel cut prices in late 2014, taking the basic starter bundle from $49 to $25 a month. The effect of this price cut saw an uplift in subscriber numbers, driving marginal revenue growth in 2015. However, the nature of this growth (volume growth through price decrease) proved to be short lived and Foxtel ARPUs and earnings have continued to remain under pressure with no letup in sight. With the launch of multiple new SVOD players in the next 6 months (Disney+, Apple TV+ and potentially HBO Max), the pressure on Foxtel is only expected to increase. In this report, we outline the reasons why we believe that Foxtel will continue to remain under pressure and why a turnaround in its fortunes could be a long drawn out process. 1) the video content market getting increasingly competitive and that is not expected to change in the near term 2) falling ARPUs and falling EBITDA driven by lower pricing is expected to worsen as new SVOD services could kick start a pricing war in the short term 3) growth in subscribers coming from cannibalisation of existing base and lower ARPU products and free and promotional pricing offers 4) debt burden continues to remain elevated with little to no appetite for market refinancing options plus major shareholder Telstra looks to have abandoned ship on the face of it by unwilling to participate in any debt refinancing 5) Sport remains the only asset, but is seeing disruption from new players i.e. telcos

The video content market is getting increasingly competitive and that’s not expected to change in the near term • For more than fifty years, FTAs and Pay TV networks have played an important role in aggregating television content from multiple content owners and creators. However, over the last decade, a proliferation of OTT video services has driven a significant transformation in TV viewing habits. • Viewers today, have unprecedented choice when it comes to content and how to watch the content. The result is a fragmentation of the industry, with a move away from a single, homogeneous bundle of channels to a much more diverse set of content choices. • In addition to SVOD companies, many traditional media companies, social media platforms (Facebook) and technology companies (Google, Amazon) are adding video streaming to their platforms. In many cases they are using the original production approach of Netflix. • And as audiences have quickly moved away from traditional cable and towards OTT platforms, television networks are beginning to launch their own streaming services in order to compete with the likes of Netflix, Stan and more recently Amazon. We have illustrated the

various video and platform choices (including FTA, PayTV, SVOD and streaming devices) for consumers in Australia in Figure 1. • The launch of multiple new SVOD services also means that Foxtel is at risk of losing broadcast rights to popular content – Disney has already announced that it will pull a large part of its content catalogue from Foxtel ahead of the launch of Disney+. This includes movies from Disney animation, Pixar, Marvel and most Lucasfilm productions.

Figure 1. Australia is a small market with plenty of choice in the video market

FTA/Pay TV and their OTT Streaming services Telco backed aggregators offerings (content providers) (Platforms)

Standalone aggregators (Platforms)

International Sports Players

SOURCE: Venture Insights, Company websites

Falling ARPUs and falling EBITDA – SVOD pricing wars coming up… • Foxtel’s ARPUs have been falling in the last few years as an increasing number of Australian viewers cut the cord and move to SVOD platforms. In response, Foxtel has had little choice but to cut its pricing in order to maintain market share.

Figure 2. Foxtel’s ARPUs have been falling (2014-2019, A$ per month)

$100 $96 $95 $93

$89 $90 $86 $85

$80 $80 $78

$75 2014 2015 2016 2017 2018 2019

SOURCE: Venture Insights, Company press releases

• We expect Foxtel’s ARPUs to worsen over time as it responds to competitive pressures from new SVOD services that are expected to prioritise reach over revenues. Both Disney+ and Apple TV+ are priced lower than the current incumbents Netflix and Stan. • But that is not all, unlike Netflix and Stan, both Disney+ and Apple TV+ won't have a tiered pricing system. While its competitors charge more for HDR/4K content and multiple streams, Disney and Apple are throwing all of that in for one baseline price, which makes their pricing about 50% cheaper than the comparable Netflix / Stan plan. See Figure 3 for a price comparison of the new SVOD services vs premium tiers of Netflix/Stan, and Foxtel Now Comparatively, Foxtel Now doesn’t offer 4K streaming and only allows up to 2 streams at a time.

Figure 3. SVOD price comparison (A$ per month)

15 25 10 20 15 5 8.99 7.99

0 Foxtel Now Netflix 4K Stan 4K Disney+ Apple TV+

SOURCE: Venture Insights, Company websites

• Decreased revenues from a falling subscriber base and increases in programming costs, especially the rising cost of sports content has translated into falling EBITDA. While overall revenues have declined gradually, Foxtel has seen more than 40% of its EBITDA wiped out in the last three years.

Figure 4. Foxtel’s EBITDA (A$mn)

1,000

800

600 976 400 731 543 200

0 2017 2018 2019

SOURCE: Venture Insights, Company press releases

Kayo – risks of cannibalisation and seasonality in subscriber gains • We believe a big proportion of the current Kayo subscriber base (331,000 as of June 2019) are on promotional pricing i.e. A$5 for 2 months and A$5 a month special offer. A quick look at Kayo’s FY19 annual report reveals A$21mn in revenues for about 8 months. This translates into about 117,000 subscribers on an average paying A$22.50 (ex-GST) per month. • Foxtel’s subscriber growth (if any) is going to be driven by lower ARPU Foxtel Now and Kayo subscribers and potentially from the rumoured launch of its SVOD – Netflix competitor service. Foxtel Now ARPU is estimated to be 60%-70% lower according to financial documents released by NewsCorp1. • As the customer base transitions to lower ARPUs, this means that Foxtel will have to significantly increase its household penetration just to maintain its current revenue run rate – we estimate Foxtel will have to increase its penetration to about 60% assuming ARPUs were to fall to A$30. • Foxtel has traditionally struggled to raise its household penetration rate beyond 30%. While its relatively high pricing has been a deterrent to increasing penetration, we also believe the robust content offering (especially sports) already available on FTAs has contributed to this. • The results from Venture Insights’ recent consumer survey confirms this theory with FTAs emerging as the most popular platform to watch sports amongst respondents classified as sports watchers. • But while Foxtel hopes that Kayo will help propel its household penetration beyond 30%, there is a risk that Kayo will also cannibalise a part of Foxtel’s existing subscriber base that is only on Foxtel’s more expensive plans for the sports package. • Of all those respondents in the Venture Insights survey who said that they watch sports, 34% said that they are Foxtel subscribers. Of these, about 18% of respondents said that they going to alter their Foxtel subscription due to Kayo.

Figure 5. Will Kayo Sports cannibalise Foxtel?

82% 66% 34%

18%

I am not a Foxtel subscriber I am a Foxtel subscriber and do not plan to change my subscription due to Kayo I am a Foxtel subscriber and do plan to (have) alter my subscription due to Kayo

SOURCE: Venture Insights Mobile Consumer Survey March 2019, n=1,026 • Assuming that about 60% of Foxtel households subscribe to the Sports package, we estimate the revenue impact to be between A$110mn (if subscribers cancel the Pay TV subscription and take up Kayo + Foxtel Now starter pack) to A$200mn (if subscribers cancel their Pay TV subscription and only subscribe to Kayo).

1 NewsCorp earnings release

• However, there is also a risk that this could trigger a churn event where subscribers leave Foxtel and subscribe to other streaming options in the market. Foxtel Pay TV churn increased to 14.7% in the quarter ended 30 June 2019 compared to 12.5% in the prior year. • We expect a certain degree of seasonality in subscriber gains for Kayo as subscriber gains are driven by major sporting events followed by a decrease in interest. We also note that the month-to-month nature of the service means that it could potentially see a spike in cancellations following the conclusion of major sporting events. Figure 6 shows a spike in Google web searches for the term ‘Cancel Kayo’ coinciding with the end of the Rugby World Cup.

Figure 6. Google trends search result for the term ‘Cancel Kayo’ from November 2018 to November 2019

SOURCE: Google trends

Programming costs and debt burden remain elevated while revenues decline • For FY19, Foxtel reported a 2% decline in operating expenses while revenues declined by 13%. • Content costs continue to rise and currently stand at A$1.6bn split 50:50 between sports and non-sports content. Foxtel has said that it is in talks with content partners to reduce costs as contracts come up for renewal. • Foxtel has also flagged the prospect of reducing spend on non-marquee sporting content and increasing prices. In addition, sports codes such as Rugby Australia and A-League could be impacted2 as they are yet to finalise the renewal of their broadcasting contracts. Foxtel has already cut 3 sports channels dedicated to European Football as part of its efforts to scale back its programming costs3. • We believe Foxtel will find it tough to make any major changes to its cost base as a big chunk of the programming costs especially for sports are locked in for the next few years. The upside risk here will be if Foxtel bites the bullet and reduces

2 AFR – Foxtel looks to cut sport and programming costs 3 TV Blackbox

• Foxtel in recent months, has been looking to raise A$2.5bn in debt to refinance existing loans and also help fund its push into online streaming4. However, market sources suggest that their attempts have proved difficult. • This prompted parent NewsCorp to provide US$300mn shareholder loan to cover debt that is maturing in the next couple of months. Telstra which owns 35% of Foxtel reportedly declined to participate as it doesn’t want to increase its exposure to the Pay TV player5. • In its most recent earnings announcement, NewsCorp announced it was increasing its shareholder loan to US$500mn and there was no mention of Telstra participating in the shareholder loans to Foxtel. In addition to the US$500mn, NewsCorp has loaned an additional US$1.2bn to Foxtel.

Sport remains the only real asset but is seeing disruption from telcos • Foxtel risks losing some of its sports focused customer base to telcos that are looking to expand their content offerings using sports. • Optus in particular has established itself as the premier Football streaming provider in Australia with its focus on European Football. Optus recently announced that it has 700,000 Optus Sport subscribers. • Telstra on the other hand, has the digital rights to NRL and AFL and has about 2.6mn subscribers for its Live Pass sports streaming service. • In our report on 5G and sports streaming, we highlighted the potential for telcos to combine 5G and sports streaming to extract a revenue premium from customers willing to pay for a better sports streaming experience. • We could also argue that with Foxtel (Pay TV + Kayo), FTA’s and telcos, the sports watching households are covered and the chance of any significant upside in sports subscribers for Kayo are limited.

Final thoughts

• The Australian SVOD market is all set for a renewed bout of competitive intensity with the launch of Disney+ and Apple TV+. • Foxtel, which has been quietly chipping away at its new strategy of developing standalone OTT platforms, is about to see a pick-up in pricing pressure as the new entrants prioritise reach over revenues. Both platforms are priced at a 50-70% discount to comparable plans from Netflix, Stan and Foxtel Now. • Disney+ is the bigger threat to both Foxtel and SVOD players like Netflix and Stan as it offers a large and popular catalogue of content. Disney could also do a Verizon type deal and partner with an Australian telco to offer 12 months free access to Disney+. • Foxtel continues to face a number of issues – falling ARPUs and earnings while programming costs remain high. EBITDA is down more than 40% in the last three years. Programming costs could take a few years to readjust as a majority of the costs are associated with sport codes that are already locked in.

4 AFR – NewsCorp mulls $2.5bn Foxtel refinance options 5 Sydney Morning Herald

• As ARPUs decline, Foxtel will have to significantly increase penetration to maintain its current revenue run rate. We estimate if ARPUs halve from current levels, Foxtel will have to more than double its penetration and even then, could see a 20-30% decline in revenues. • Debt burden remains elevated with no support forthcoming from Telstra. NewsCorp announced that it has increased its shareholder loan to US$500mn in addition to the US$1.2bn that it has already loan to Foxtel. • Sports remains the only real viewing asset but is seeing disruption from telcos and some form of cannibalisation from Kayo. With Foxtel, Kayo, FTAs and telcos, one could argue that the sports watching households are covered and the chance of any significant upside for Kayo are limited. • Foxtel will need to go beyond lower pricing, promo offers and standalone SVOD services. Foxtel should be looking to position itself as the aggregator of choice by offering multiple streaming services under one bill and one interface. The move to integrate and bundle Netflix with Foxtel was a step in the right direction, but it may be a case of too little too late as Netflix is already available on multiple devices in Australia.

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