Paramount Global: Top Gun, In Streaming; Buy

Stock Market

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For a while now, I have been long on Paramount (NASDAQ:PARA) (PARAA) as it, like every media company in the US, attempts to make the transition from traditional media to streaming. As I’ve noted before, one of the big advantages for Paramount in this regard is its sports portfolio, which unlike most of its competitors appears to actually be profitable – and certainly, at the very least, not so unprofitable as to swamp the profits the company can expect a successful streaming service with general entertainment to generate.

Like a lot of stocks, Paramount got hit hard by this week’s blood bath in the market. It is now trading below $25. My confidence has not been shaken, however, so I am adding yet again to my Paramount position. Paramount may be uniquely positioned to create a true sports/general entertainment integrated streaming service, and in fact, its sports portfolio is even better than I thought.

With a P/E ratio poised to drop below 10 and a market cap below $19 billion, at an average S&P P/E Paramount now needs only $1 billion a year in profit to justify its current price. It is poised to generate substantially more than that. In fact, just two of its many content deals will generate over $1 billion in profit on their own.

Paramount’s Enduring Strength

Paramount has often been considered as too small to cut it on its own, but in fact its “small” size stems mostly from its lack of overpriced, unprofitable sports deals and sprawling cable operations in a decaying pay-TV bundle. In terms of movie and TV production, Paramount can stand up to just about anyone. It is one of the Big Five movie studios as well as one of the Big Four broadcasters in the US. Its Top Gun: Maverick blew the roof off of the box office and still generated $50 million in its third week to become the highest-grossing movie of the year, and CBS regularly leads all the broadcast networks in viewership.

Paramount supplements this strong general entertainment base with a carefully curated selection of reasonably priced sports deals. I already covered their March Madness deal, probably the biggest bargain in all of sports TV deals. It is not inconceivable that its profit margin is – or will be – as high as 50%, which would pencil out to almost $800 million per year. Albeit CBS is splitting that with Warner Bros. Discovery’s (WBD) Turner Networks.

I wouldn’t have believed any other sports deal could do nearly as well, but in fact, CBS may be poised to generate a similar level of profit from another sports deal: the NFL. This is significant for three reasons: first, simply because it is a large source of profit. Second, because it reinforces the soundness of Paramount’s overall strategy and risk management on content; a company that actually managed to profit off of the NFL, of all things, can profit from just about anything. And third, because the way Paramount is making money off the deal has implications for other companies and their streaming strategies as well.

Another Content Case Study

The NFL has sort of become my go to case-study for illustrating broader trends in sports and streaming, so a lot of this analysis will follow the process I already used in two previous articles. I’ll be going a little faster through the numbers this time, but if anything is unclear those articles contain more detailed explanations of my methodology. Essentially, we will be subtracting various offsets, including advertising, from the cost of the TV contract to calculate a “net content cost” number. Subscription revenue is then subjected to a similar offset for pre-existing subscribers, to derive a “net subscription revenue.”

Net Content Cost

Offsets

A lot of the work here is already done in my Comcast (CMCSA) article. My calculations showed Comcast’s NBC has annual advertising revenue and Super Bowl annualized contribution at a combined total of $950 million per year. Paramount’s contract is similar in many respects, but a little better from the broadcaster’s perspective.

The Sunday morning national window actually consists of two separate game slots, one on each channel, following which Fox and CBS alternate a second, exclusive window on Sunday afternoon before NBC’s Sunday Night Football broadcast. So they each have 1.5 national broadcast windows per week, instead of just 1 like the others have.

Given that each regular season broadcast window generates roughly $600 million in advertising revenue, an extra half window is worth some $300 million in additional ad revenue, again assuming the usual 10% markup I’ve been applying in all my calculations. Combined with the $950 million that Comcast already gets from a similar setup to Paramount’s, that means that Paramount can expect CBS to generate roughly $1.25 billion in NFL advertising/Super Bowl revenue per year, over the life of the deal.

NFL Payments Due

Reports are that Paramount agreed to hike its annual payment to $2.1 billion in the most recent set of contracts, that means it must generate $850 million in subscription revenue to make it to break-even. With a five-month NFL season, regular and post, that comes to $170 million per month.

At first glance, that seems only a little better than Comcast, which has to generate $1050 million. But in fact, Paramount is not only in no danger of losing money on the deal, it very well might generate a substantial profit.

Subscriber Levels

It comes down, again, to the nature of what’s being broadcast on the respective services. I said before that CBS is getting a bit of a boost to revenues just because they have an extra game slot, or more accurately half of one. However, while CBS only controls slightly more game slots than the other TV partners, it controls far, far more games in those slots than Disney (DIS) or Comcast. In fact, between the two of them Fox and CBS broadcast close to 70% of all NFL games in a season. And even though they don’t have much extra slot space to show them in, this is still hugely significant.

Football games, like any other sport, have two different kinds of fans: those who tune in to watch a good team play, and those who tune in to watch their team play. The difference in viewership of NFL Sunday games gives some indication of the relative size of those two buckets. National broadcast windows typically average 15-20 million viewers. But on Sunday morning, when most of the actual games are being played, viewership shoots up to almost 40 million. In other words, CBS gets viewership comparable to everyone else on Sunday morning despite being the only channel that has to compete against another NFL game in the Sunday morning time slot. And so does its NFL competitor, Fox.

This has massive implications for CBS’s viability in a streaming context. It means that NFL fans who only want to watch one team, and therefore have no reason to tune into Peacock or ESPN+ more than once a year, have reason to tune into Paramount+ every month. CBS’s customer base is 40 million, not 20 million.

Superior Customer Appeal

This base-boosting effect is amplified by a number of changes in the most recent set of NFL contracts. I am thinking in particular of the NFL’s decision to expand to a 17 game season. That extra game was meant primarily to make dropping one “base” channel or the other much more difficult for NFL fans, which is why the NFL’s newly added game will feature exclusively inter-conference matchups.

This brings the number of games teams play in out-of-conference stadiums up to 5 per year. NFL teams already have a 5-game, strictly enforced cap on primetime matchups for a team. Since primetime matchups tend to be more dramatic if they are intraconference and preferable even intradivisional, this usually means even the AFC-focused CBS can count on getting even an NFC team 4 times a season, ie., once per regular-season month. Just often enough to keep a fan subscribing every month of the regular season.

To make doubly sure of this, the NFL also agreed in the most recent set of contracts to completely overhaul the way Sunday morning games are assigned between the two channels. Previously, it was a very simple arrangement: Fox gets NFC-based games and CBS gets AFC-based games. Even this was usually enough to get a team on a channel fairly frequently…but everyone decided they could do even better.

Now, both channels get a chance to essentially “draft” games by each team. There is still some Fox/NFC and CBS/AFC slant to the draft order, but the games are much closer to freely assignable than they were before. This means that both channels are almost guaranteed to draft games from each team at least once a month…because neither channel can “seize” half the teams’ games without the other seizing the other half, leaving each poorer. It is in both their interests to allow each other to secure a sufficient position on all 32 teams schedules.

Net Subscription Revenue

Subscription Revenue

Thus, CBS can reasonably count on a pool of NFL subscribers twice as large as Comcast or Disney can for their services; despite paying only a fraction more than Comcast, and considerably less than Disney. This transforms the money-losing operations those companies are faced with as the streaming revolution progresses into a considerable profit source for CBS.

Like the others, I will assume that the plan is for the NFL to be migrated to the top-tier plan when the streaming revolution reaches its zenith. That plan charges $10 per month, but we deduct my usual $2 for other operating expenses, leaving a “subscriber content budget” of $8 per month. Multiplied by the 5 months the NFL season is ongoing, that equals $40 per subscriber.

Multiplied by the 40 million subscribers CBS could draw if every NFL fan followed them over into streaming, CBS could expect to generate $1.6 billion of subscriber payments on content that cost only $850 million in net subscriber content payments to get.

Existing Subscribers

From this, however, as I covered in my Comcast article, we must make one more major deduction: existing subscribers. You can read about this in more detail there, but basically, some percentage of those NFL viewers are already subscribing to Paramount+, and would be even if it didn’t have NFL content. But because it now does they’re going to watch it, too. These viewers, however, don’t net any new subscriber payments for Paramount. So we need to deduct them from the subscriber revenue pool.

What percentage should we deduct? This is always the hardest part, and you could reasonably make an argument for a pretty broad range of numbers. Honestly, I’m not sure, so instead I’m going to reverse the question: how large would the percentage have to be to turn the NFL into a bad deal for Paramount?

That math is pretty simple: $1.6 billion minus the $850 million in net payments, divided over the original $1.6 billion. Paramount would need a pre-NFL market penetration of over 45% before the NFL contract became a bad deal.

Total Profit

I’m going to go out on a limb and say that whatever the penetration number is, it is nowhere near that high. Aside from Netflix (NFLX) pretty much no one is penetrating anywhere near half of US households with their streaming service. Even Hulu is not close to hitting that mark. Amazon Prime (AMZN) probably is but that’s because it is far more than just a streaming service.

Penciling in a penetration of 1/4 of subscribers pre-NFL, Paramount’s net profit on the NFL deal comes to about $450 million or so. Combined with the $800 million from March Madness, that brings total profits to $1.25 billion.

If Turner is getting 1/3 of the profit on March Madness and CBS the other two-thirds, that would put CBS’s total on the two deals around $1 billion even.

Of course, one could make the argument for a 50-50 split on March Madness, which would take CBS down to about $850 million combined. I would make the argument that given their respective track records on sports profitability, it wouldn’t be surprising at all if CBS got the more profitable portion of their shared deal.

Paramount’s Many Profit Streams

Between the two sports deals, only half of Paramount+’s months of the year are accounted for. I will assume – and I think this very conservative – that they are the only source of profit for those months, and that the other half of the year has no more profit than this half. That means another $850 million-$1 billion of profit in the other six months of the year, which almost perfectly corresponds to the $900 million of net interest payments in Paramount’s TTM.

Thus, Paramount+’s DTC profit alone covers all interest obligations and the current market cap. This makes everything else Paramount does pure gravy for investors. And there is a lot left. The Showtime premium network, BET, Pluto TV, Paramount Studios movies, all international operations including India where Viacom’s joint venture Viacom18 just won the coveted Indian Premier League streaming rights bidding war, US linear TV profit (however longer it lasts) and syndication of many of Paramount’s titles to other channels and services. Two of Netflix’s most streamed shows every week without fail are Criminal Minds and NCIS, both of which are owned by Paramount and licensed to Netflix.

This article is already sufficiently long that I won’t try to put a precise dollar amount on these surplus profit opportunities. Paramount’s limited disclosures don’t make it easy to calculate anyway. Suffice to say I expect profits from these areas to be quite substantial.

This is why I have once again increased my stake in Paramount.

This Model Travels

Before we conclude, one final point: as I said, Paramount’s approach has implications about how we assess other companies. As this (very, I know) detailed research shows, Paramount’s profit from NFL where so many others are probably doomed to losses stems in no small part from the fact that it shunned the “marquee” national broadcast deals in favor of a more comprehensive agreement for a much larger number of games.

Yes, such games cannot all be broadcast nationally, but Paramount is far more integral to an NFL fan’s hometown team loyalties than a national game strategy network that only shows that fan’s team once or at most a few times a season. Whether in the NFL or other sports, other streaming services should have their claims of “strong position” in various sports evaluated accordingly.

Investment Implications Of Paramount Success

Based on these numbers, I believe Paramount may be on the verge of doing something no one else in streaming has done yet: create a truly universal category streaming service, offering top tier content in both general entertainment and sports. Netflix and Disney+ exclude sports and Amazon Prime’s success with sports isn’t clear yet.

It is a little harder to say exactly what the implications of Paramount’s success are for other companies because we still can’t quite decide what the final number of tickets on the streaming train are. Certainly, Paramount taking one means one less for Netflix, WBD, Disney, Amazon, Apple, etc. But to say one of them doesn’t have a seat on the train now would require knowing how many seats there are.

My best guess is that Netflix and Amazon Prime already have guaranteed seats, that Disney’s fate is more or less in its own hands depending on how it handles ESPN, and that HBO Max and Peacock are the ones “on the bubble.” But then again, if there’s enough seats to go around maybe there is no bubble.

Conclusion

Paramount’s fall has not been pleasant to watch, and of course the selling pressure in general has not yet abated with everything going on in the world right now. But I am confident that Paramount is worth considerably more than it is selling for, so I am not going to try to time the bottom before the bounce so precisely. I remain Long on Paramount.

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