THE DELTA PERSPECTIVE TV operatorsisfastapproaching The Blockbustermomentforpay- Irish Manipis-SeniorConsultant Stevens-AssociatePartner Vincent April 2019 THETHE DELTADELTA PERSPECTIVEPERSPECTIVE THE DELTA PERSPECTIVE

The Blockbuster moment for pay-TV operators is fast approaching

Authors: Vincent Stevens - Associate Partner Irish Manipis - Senior Consultant

The rules of the media next five years to $183 billion1. game are changing, so While pay-TV is still showing the identity of pay-TV moderate growth in some providers must adapt emerging markets, they are on and evolve course to decline in the mid-term. Only a handful of pay-TV markets, The winds of change are blowing such as Indonesia, Mexico, for the pay-TV industry and they Vietnam, have seen double- are moving fast. It is expected digit annual subscriber growth that worldwide pay-TV revenues over the last two years, with will decline over the next five gains slowing over the last year. years largely due to lower cost However, most of this growth is and higher convenience content believed to have come from lower alternatives. Global pay-TV value subscriptions2. revenues will fall 11% over the

1 Digital TV Research – Forecast: Global pay-TV revenues to decline by 2023, subscriptions will rise 2 Nagra Kudelski, MTM – The global pay-TV innovation landscape 3 THE DELTA PERSPECTIVE

Technology has exposed consumers to new TV transformed: Trends that are entertainment experiences, storytellers and shaking up the pay-TV industry programmes. Customers are spoiled for choice, having the ability to receive content where and 1. Change in video consumption habits when they want while paying less for it, legally or Though linear TV still dominates, media illegally. With millions of households cutting their consumption is shifting towards on-demand and cords or ditching them fully, the pay-TV industry is smaller screens. In recent years, on-demand viewing struggling to stem the bleeding. represented 42% of active viewing hours versus As Blockbuster failed to compete against the 58% for scheduled linear TV (global average). internet driven VOD disruption, the time has In 2010, on-demand viewing accounted for 3 come for pay-TV providers to re-invent themselves 30% . Users value the autonomy to choose what against the likes of , YouTube or TikTok. they want to watch, when they want to watch. Younger generations are leading the biggest media behaviour changes, spending 37% of viewing time on mobile versus 10% for the older people. Around 55% of younger viewers take-up on short form content against 15% for older generations4.

3 Ericsson ConsumerLab, TV & Media, 2017 4 Nielsen Global digital landscape survey

Figure 1 - Pay-TV macro trends

Global trend Emerging markets (EM) reflection

Production Creators Network Distributor Infrastructure Devices Audience companies

4 3 1 OTT players driving up costs for “golden PayTV penetration high in most Video viewing habits content” and sports, driving a value shift developed markets but facing changing from distribution to content production challenges from “cord cutting” • Linear to non-linear Local content still king in emerging mkts. Some EM. Pay-TV provider showing • TV to mobile screen Local content production on the rise, incl. initial signs of topline pressure • Single to multi-screen by OTT • Weekly to binge

5 SVOD becoming mainstream, yet with current economics questioning sustainability (S)VOD models are unlikely to scale up significantly due to pricing and other challenges

7 Advertising spend under pressure for 6 TV. Value shift towards digital Piracy rampant, undermining the EM. still enjoys growing TV ad spend economics of TV and SVOD

8 Analytics and experience become a competitive differentiator 2 New content formats becoming mainstream (pro-am, eSports, Tik Tok, etc.)

9 Industry consolidation (ATT-Warner, Viacom- CBS(?), -Sky, etc.)

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2. New content formats (e.g. pro-amateur, at least five videos online per day5. New content TikTok) becoming mainstream formats keep spawning, some at neck breaking speed. TikTok hits 500 million monthly active users The rise of the smartphone and 4G has made just two years after launch. T-series, an Indian new, direct-to-consumer, content platforms music label, has 140 million subscribers across its mainstream. The digital incumbents are the most multi-channel YouTube network, becoming the popular platforms for online video, not pay-TV most viewed YouTube channel since 2017. incumbents. 44% of polled consumers watch

5 Relevance – New report shows consumers prefer to watch content on Facebook vs YouTube

Figure 2 - Overview of new content formats

% who watch video content most often on each Other popular video content services include platform (2018, n= 500 consumers worldwide) • Tik Tok hits 500 million global monthly active users as China social media video craze continues • Tik Tok, Douyin's overseas version, was the most 47% downloaded non-game app in the Apple app store globally in the first quarter of 2018

41% • 650 million total global audience in 2018 • Average 9 billion monthly content views and average 3 billion video content views per month 8%

• By 2018, Twitch reached a level where it had 2.2 2% million broadcasters monthly • 15 million daily active users

2% • Revenues rose to $160 million in 2018, largely thanks to the launch of its paid subscription service 1% • Paid subscribers grew 9% on the platform, with 952,000 members at the end of 2018

Source: 2018 PROMO Online Video-Watching Habits Survey

3. Cord cutting pressures South Africa, Venezuela and Peru2, are also showing signs of slowdown indicating the global It is well established that pay-TV penetration is inertia of the media disruption. under pressure in established fixed broadband and 4G prone countries. Often expensive, multichannel, In Asia, Singapore’s pay-TV incumbent suffered linear and advertising fuelled pay-TV packages are a decline in revenues due to a lower number of gradually being replaced by cheaper on-demand customers6, Thailand’s pay-TV incumbent saw its advertising-light SVOD, AVOD or skinny bundles. subscription revenues soften by 2.3% year-on-year Emerging markets, however, are not immune to and Malaysia’s pay-TV incumbent suffered a 3.7% this trend and places such as Malaysia, Philippines, year-on-year decline in subscription revenues.

6 3Q 2018

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4. Rise in content costs driven by blockbuster respectively7. Indonesian ride-hailing provider Go- investments from OTT players Jek announcing entering the content business with VICE illustrates the remaining disruptive potential Disintermediation of the OTT value chain allows of the industry. OTT players to go directly to the end consumer, bypassing the need to abide by traditional As a result, production budgets multiplied infrastructure intense distribution channels. With drastically in the past few years. Game of Thrones more competitors vying for attention from the used to be produced at ~$3 million per episode same consumer, players are differentiating their in 2010, compared to a staggering $15 million offerings to survive. For OTT players like Netflix, recently. Amazon’s Lord of the Rings blockbuster is Amazon and , their strategies continue to estimated to spend ~$20 million per episode this focus on beefing up their content catalogue – with year9. It is a great time for content, less so for cable. a strong emphasis on original and local content. It’s a strategy that seems to be successful so far. With Costs for scripted content are not the only ones Netflix beating analyst estimates to add 29 million increasing, another major price hike is coming paid subscribers in 2018, a 33% y-o-y increase7, from sports licensing. For example, Facebook’s big on the back of an $8 billion content spend8. Tech leap into live sports, signing off a ~$257 million giants like Amazon and Hulu are also estimated to broadcast rights deal with the Premier League to be spending $4.5 billion and $2.5 billion on content broadcast live league games exclusively in Thailand, Vietnam and Cambodia.

7 CNBC – Netflix beats on subscriber growth, but misses slightly on revenue – stocks fall after hours 8 MoffettNathanson – Netflix spends more on content than anyone else on the internet 9 UBS Research – Production costs of super-premium dramas

Figure 3 - Evolution of production costs of super-premium dramas

Production costs of super-premium drama increasing (Cost per hour of first season of US premium dramas, $m)

2019 Lord of Rings 20

Game of Thrones (last season) 15 2017

The Get Down 12

Stranger Things 10

Westworld 9

Vinyl 10

2014 Sense8 9

Orange is the New Black 4

House of Cards 5

Game of Thrones 6

Boardwalk Empire 5 2010 The Walking Dead 3

Source: UBS Research, the Guardian, IMDB, company data, press reports; Delta Partners analysis

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5. SVoD players face pricing and scaling up they are still running a $3 billion negative free cash challenges flow11. The scale versus profitability equation seems to have gotten lost or strategically deprioritized. In the quest to win subscribers, SVoD players have While Netflix reports their investments are sparked a content arms race that is fast becoming producing positive ROI, smaller SVOD players seem a financial burden to them. Netflix’s 2018 reported to be faring worse, with many high-profile services results shows a 26% year-on-year subscriber shutting down or struggling. growth, reaching 139 million subs10, however,

10 The Guardian – Netflix adds 8.8 million subscribers as its stock falls over spending fears 11 Motley – Netflix hits 139 million subscribers, negative free cash flow reported

Figure 4 - News clippings on the sustainability of selected SVoD players

6. Rampant piracy poses monetisation rights. Globally, piracy hits yearly industry revenues challenges by around $7 billion (4% of revenues), with Asia Pacific losing ~$1.6 billion (6% of revenues)12. Piracy is a looming threat that causes pay-TV In emerging markets, one can simply buy a operators to lose revenue. It has surpassed basic whole content catalogue within an USB stick off content theft to provide fierce competition against the streets, while in developed markets, piracy broadcasters and operators. Pirates use the benefits becomes easier due to the abundant availability of of the internet – speed, accessibility, convenience set-top boxes, giving rise to signal piracy. and anonymity – to bypass regulation and content

12 Nagra Kudelski, MTM – The global pay-TV innovation landscape

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Figure 5 - Pay-TV revenues lost to piracy

Most important forms of piracy Industry revenues lost to PayTV piracy (estimated)

(% of respondents who identified it as a challenge) Global = c.$7 billion (-4% of revenue) Online streaming 79%

Peer-to-peer downloads 57% North America IPTV piracy via pirate set-top boxes 45% EMEA

$1.4bn Signal piracy (e.g. cloned cards) 43% $2.6bn Asia Pacific (-3%) (-3%) Pirated DVDs / USB storage 30% $1.6bn (-6%) Recording on screen 19% Latin America $1.4bn "Content piracy is getting worse. In the old days of BitTorrent, (-9%) we could at least measure the extent of it, but it's much harder as it a lot of it has shifted into IPTV and OTT boxes. The reality is that most people who are fighting piracy don't have good visibility of its extent."

Source: Nagra Kudelski, Delta Partners analysis

8. Using analytics to differentiate user experience and ROI 7. Decline in TV advertising on an international scale Beyond content, the user experience has become a critical competitive differentiator. Earlier IPTV With eyeballs shifting to online platforms, interfaces left many consumers with a challenging advertising revenues are moving from TV to experience, including cumbersome content digital, adding to additional pressure on pay-TV discovery and few or no interactivity features. and channels. In the US alone, TV advertisement A good user experience can drive retention spending is estimated to drop by 0.5% to $69.9 and upselling through sticky content discovery, billion, as digital ad spending rises by 19% to frictionless browsing, seamless multi-screen 13 $108 billion in 2018. However, TV advertising experience or receiving pro-active churn reduction in emerging markets, where TV is considered as offers. the only measurable and wide-reaching channel, is still growing in line with general GDP growth. Additionally, advanced analytics can help a content The traditional media industry has yet to transition distributor to increase ROI through delivery of successfully to an online advertising driven content highly targeted, higher CPM advertising, increasing model. the return per content dollar invested through parametrizing content production.

Two-way communication between content provider and consumer opens the door for improved user experience and ROI.

13 eMarketer – TV ad spending to drop by $1 Bn in 2018 as digital rises 19%

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Figure 6 - Examples of how Netflix and Sky use analytics to improve advertising ROI

Recommendations & content parametrising Improving advertising ROI

Time and date Ratings Searches Household data Viewing behavior of viewing Input Input Browsing & When is show paused, Device Device type Ad viewing behavior scrolling behaviour rewinded, forwarded

Parametrising successful shows Programmatic TV advertising Recommendations (e.g. House of Cards) Output Output Segmented ad targeting in lineair stream Select content to license based on Prioritisation of increasing happiness per dollar “continue watching” CPM based advertising spent

Netflix’ analytics contributed to an ROI increase Sky’s analytics contributed to an ROI increase

Netflix ROI Sky Advertising revenues (TTM EBIT / Total Assets) (GBPmln) 7% 1,000 8.6% pa.

6% 800 R² = 0.8873 R² = 0.9334 5% 600 4% 3% 400 2% 200 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18 3Q18 4Q18 2013 2014 2015 2016 2017 2018

Source: Operator reports, Delta Partners analysis

9. Consolidation as a potential strategy with glee, an anecdote about visiting a Sky store in Westfield Shopping Centre in West London, “To be successful, you either need scale that where he saw a demonstration of the kit. He enables you to compete with the world you are was impressed by the user experience, and his gut heading into or really unique franchises that instinct was to pursue the company16. enable you to distinguish and build value off those unique strengths,” said 21st Century Fox Vice Chair The emergence of such media titans would greatly Chase Carey about 5 months before the Disney influence the way consumers access content. With acquisition14. Consolidation can mean merging the pay-TV market looking set to decline, scale will pure-play pay-TV providers to gain greater scale become a critical driver, as it will become harder or merging a telecommunications operator and a to grow subscriber share organically. The increased pay-TV provider to gain access to unique content. scale will allow pay-TV operators to gain more clout in content costs negotiation – hello variable One prominent example is Comcast’s successful contracts, goodbye minimum guarantees. An 15 bid to take over Sky . The key advantages from additional stronger control over fixed and wireless this deal include the addition of Sky’s 27 million broadband networks could provide greater subscribers across Europe, access to Sky’s presence leverage against OTT – is saying goodbye to net in digital media/ OTT entertainment, technological neutrality on the horizon? IP consolidation and greater scale in set-top box procurement. Brian Roberts of Comcast relayed

14 CNBC – Expect continued media consolidation, because scale matters (October 2018) 15 CNBC – Comcast outbids Fox in a $39 billion takeover of Sky (September 2018) 16 BBC – Why comcast wanted Sky so badly

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Strategic thrusts for the pay-TV operator of the future

Within this fast-changing environment, Delta Partners believes the pay-TV operator of the future must embrace four strategic thrusts. Figure 7 - Strategic thrusts framework Lack of traction yet in Pay-TV industry Pay-TV industry fully moving ahead

4 EVOLVED OPERATING MODEL

TRADITIONAL OPERATING MODEL

1 2 Re-imagine the PayTV Place bets beyond proposition, move traditional core towards OTT

3 Become an efficient, analytics-centric future-proof media pipe

Organization Platforms Infrastructure Analytics

1. Re-imagine the Pay-TV proposition capabilities; Anytime/Anywhere proposition; PAYG vs 24-month contracts; skinny bundle; advanced Despite the threat posed by SVOD & AVOD players, digital recording; and improved user interface/ pay-TV operators can extend their survival by experience. Making pay-TV less TV-centric is the adopting incremental innovation and re-defining first step to fending off OTT threats. their core proposition. Among others: multiscreen

Figure 8 - Ways for pay-TV operators to enhance their pay-TV proposition

Lack of traction yet Pay-TV industry in Pay-TV industry fully moving ahead

Strategic thrusts Customer sentiment

1a Create flexibility for the consumer (e.g. non- “I can select the channels I really want”, “I am able to locked-in build-your-own packs) stop the service whenever I want”

1b Improve UX/UI and personalisation for a better “I discovered a new show which I love through customer experience – e.g. Sky Q recommendations”, “It is so easy to navigate” Enhance 1c PayTV Enable anytime and anywhere multi-device “I want to catch up with a show at my convenience”, convergence “I want to switch between devices seamlessly”

1d “I want to watch high quality video content”, “Voice Advanced functionalities (i.e. Digital video control is a useful option to navigate through the recording, 4K video quality, voice control) session” 1e Become a super-aggregator offering pay-TV “I want to combine my traditional PayTV package with and OTT services through a single subscription a Netflix subscription in a single bill”

1f Launch Offer App-based PayTV “I want to watch content on my mobile phone” OTT 1g “I don’t want to have a physical set-top box at home”, Launch standalone OTT proposition “I want flexibility and premium content”

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2. Place bets beyond traditional core ii. Customers prefer to deal with a single provider – pay-TV operators hold the billing relationship As a hedge against the current industry landscape, with and insights on the customer (to be able pay-TV operators should consider moving into to target the right customers). natural adjacent industries. Though we are still in the early days of such diversification, most common iii. Relevant experience in managing similar services adjacencies include advanced advertising, home – pay-TV operators are equipped to address the security, automation and entertainment. While key issues in subscription management, device there may be many players exploring the Smart management and customer support. Home market, pay-TV operators have some key advantages: iv. Relationships with advertisers and a supply of highly segmental info i. Already in the home – pay-TV operators have a central presence in the home via the set-top box. Additional functionalities can be built on top of it to transform it into a “smart” device.

Figure 9 - Potential bets for pay-TV operators to place beyond their traditional core

Lack of traction yet Pay-TV industry in Pay-TV industry fully moving ahead

Strategic thrusts Rationale

2a Take advantage of set-top box presence in homes Evolve set-top boxes into connected and improve functionality, e.g. home security, Smart Home appliances monitoring

B2C 2b Venture into new content industries (e.g. eSports) Monetize emerging content and platform categories to stay relevant and create new 2c revenue engines Introduce new platforms (e.g. AR/ VR)

2d

• Leverage customer and audience data for B2B advanced advertising solutions Monetise data assets through advanced Capture a piece of the digital advertising pool and programmatic advertising • through creating programmatic TV advertising capabilities

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3. Become an efficient, analytics-centric understand their customer base, decide on future-proof media pipe marketing channels, determine which contracts need to be re-negotiated and identify the most Within the mature pay-TV industry, it is essential effective technology. for players to adopt an ROI state of mind. Using in-depth analytics, pay-TV operators can better

Figure 10 - Methods for Pay-TV operators to become more efficient and future-proof

Lack of traction yet Pay-TV industry in Pay-TV industry fully moving ahead

Strategic thrusts Rationale

3a

Support and enable significant revenue Analytics Create an advanced and entrenched analytics (advertising, recommendation, upselling, etc.) and organisation supporting all C-levels cost enhancing (content optimization, CAPEX prioritization, etc.) initiatives

3b

Shift fixed and MG prone content Identify ROI of content contracts, assess impact of agreements to revenue and risk sharing Content contract shifts based

3c

With pressure on topline, costs have to be Create a frugal, efficient organisation that reduced yet the organization needs to be Organisation embraces innovation designed to embrace innovation

3d

• Enable new products and partnerships Adopt technology innovations (Android STB, • Become more agile in product development Automated & virtualised NMS, OSS and and time to market orchestration platform) • Automate and save costs and time • Increase security Platforms

3e

Adopt anti-piracy platforms, such as CAS and • Disable streaming, signal, IPTV piracy revenue DRM cannibalization

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4. Evolve operating model can either collaborate with competitors or with players along the value chain. Among the strategic Pay-TV operators can consider new operating thrusts, adopting a new business model requires models to address the changing nature of the the most extensive efforts, including commercial media landscape. To combat rising costs and due diligence, partner evaluation and financial to reap economies of scale, pay-TV operators modelling.

Figure 11 - Potential operating models for Pay-TV 2.0 operators

Potential operating model Rationale A ProcurCo: Create a STB & content procurement JV • Pro curCo combines legacy content rights & submits joint content bid on behalf of both Company B and Company A Company A STB/ContentCo Company B and creates economies of scale to purchase STB with advanced features to avoid having to resort to Android STBs Company A Company B

B RetailCo: Become an independent PayTV provider • R e tailCo is an independent PayTV provider with licenses, content, platforms and organization. Retailco resells RetailCo packages to the telcos and goes to customers directly • Maximum economies o f scale possible Company A Company B Retail consumers

C WholesaleCo: Provide support to other customers as well • WholesaleCo becomes a national/regional customer agnostic supplier of content WholesaleCo

Company A Company B Client X Client Y

D WholesaleCo: Produce content as well for wholesale customers • WholesaleCo becomes an integrated media house where it combines the RetailCo model with proprietary content Open ServCo Content production production; economies of scale and proprietary content are needed to fight with the likes of Netflix on a long term basis Company A Company B

E Carve Out: Divest any organic pay-TV business • C arve Out allows the telco operator to focus on profitable, core businesses by divesting their organic pay-TV business. Telco business units This strategy needs to be evaluated against the need to keep Pay-TV as a loss leader to protect the fixed broadband Business 1 Business 2 Business 3 Pay-TV business

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Pay-TV Operators need to revolutionise and prepare for the Blockbuster moment

The pay-TV industry is far from its former status quo. The traditional value chain is being shaken up and value is being re-distributed in the chain with new innovation and content formats arising every day. The pay-TV industry has not yet been the winner in this paradigm. For operators where the downward trends are already in force, action is top priority in order to protect revenues or diversify to hedge against the risks. For operators who are still enjoying growth, be wary and benefit from the time to prepare for the battle ahead.

No matter where you are in the pay-TV industry curve, there is no doubt that the Blockbuster moment is approaching fast, and you need to be ready when it arrives.

14 15 Vincent is an Associate Partner at Delta Partners’ Singapore office, with more than 12 years of telecom advisory experience, with regional exposure in Southeast Asia, Africa and the Middle East. He has a functional focus on strategy, commercial strategy and analytical marketing. Vincent graduated with a Master’s in engineering from Ghent University, Belgium, and is a Certified International Investment Analyst. Irish is a Senior Consultant at Delta Partners based in Singapore. She has worked with major TMT firms across North America, the Middle East and Southeast Asia. Irish has a functional focus on corporate strategy, digital transformation and analytical sales and distribution optimisation. She graduated with a Bachelor’s of Business (Accountancy) from the National University of Singapore. If you would like to contact the author to further discuss this topic, you can email to: [email protected]

Delta Partners is the leading Advisory and Investment firm specialised in Telecoms, Media and Digital with offices in the Middle East, Africa, Europe, Asia, Latin America and the United States of America. We partner with global and regional telecom providers, digital players, other TMT clients and our investors to help them address their most challenging strategic issues. Our unique combination of Management Consulting, Corporate Finance1 and Investments2 creates unparalleled value for our clients, investors and business partners. For more information, please visit www.deltapartnersgroup.com and follow us on Twitter @Delta_Partners 1 Delta Partners Corporate Finance Limited and 2 Delta Partners Capital Limited are members of the Delta Partners Group of companies and are authorised and regulated by the DFSA.