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Broadly speaking, media companies engage in the creation, aggregation, and distribution of content and then leverage this content to sell advertising based on audience metrics (e.g., readership, viewership) and generate subscription revenue. Thanks to technological innovation, the nature of content and its delivery mechanisms are rapidly evolving. Most recently, the transition to a digital and mobile world has made traditional forms of content—including newspapers, magazines, books, television programming, and filmed entertainment—available to anyone, anytime, anywhere.

Key Themes

It feels to us that the world of media is at a critical inflection point in its evolution: the explosion of smartphone devices and tablets has made connectivity increasingly mobile; the advancing penetration of streaming media in and out of the home is creating unprecedented demand for good content; the traditional advertising-dependent protocols are being challenged at every turn; and even the most diversified global media conglomerates are grappling with how to adapt to new operating ecosystems.

Though there are many angles one could take when evaluating the media industry for investment purposes, we decided to delve into the following themes:

 Transition to digital and mobile world;

 Evolution favors good content creators;

 Future of advertising; and

 Focused on shareholder returns.

For this report, we are trying to keep our analysis high level, fundamental, and relevant to rapidly evolving/shifting consumer, social, technological, competitive, and economic paradigms. Media investors are often at risk of focusing on single events, which may overshadow the macro, and in turn lead to myopic, short-term views and, sometimes, inappropriate weightings. We tend to take the long view, but we remain cognizant of the myriad challenges affecting media markets daily. We hope this report will put into perspective our insights into the media sector:

 Winners and Losers. Overall, we do not see media/telecom as a zero-sum game, because no single medium has ever obsoleted another. Video did not kill radio; TV did not put movie theaters out of business; cable/satellite did not pull the plug on broadcast TV; newspapers are still published daily; and even the paging business is still around (check your doctor’s belt).

Granted, technology and consumer behavior has put pressure on mature media valuations as operators scramble to adapt in order to stay competitive and relevant. Still, lucrative paydays are being generated by out-of-favor subsectors, while devotees of perceived high-growth new media have also demonstrated a capacity for “irrational exuberance” leading to speculation and perhaps unsustainable valuations. True, it is probably the natural order of progress and investment where there is always another new, new thing about to emerge.

 Infrastructure Challenges. Infrastructure is one of the biggest challenges facing

Genachowski’s prepared remarks, CTIA Wireless conference, March 2011). And, it is not just a big block of broadcast TV spectrum at risk for being reallocated—via so-called voluntary incentive auctions in order to accommodate growing wireless telecom carrier demand—but within wireless there are growing imbalances currently between incumbent and over-stretched 3G smartphone networks and new underutilized 4G networks.

 Goliath Versus Goliath. We root for upstarts even when our wallets are vested with incumbents—it’s the American way. Still, size does indeed matter in media. Only eight entities control the majority of broadcast and broadband content:CBS Corp., Comcast/NBCUniversal, Discovery/QVC/Liberty Media, Disney/ABC/ESPN, News Corp./Fox, Scripps Networks, Time Warner Inc., and Viacom. Using a wider, convergent mouth of the funnel to include new media, our list would expand to include tech/content titans Apple, Google, and Facebook. These new-order Goliaths could put incumbent media and broadband operators (large and small) at an inherent disadvantage, we think. should these powerful entities force a change in the economics and competitive landscape of content and distribution. This is because incumbent economic models have been built around ad-supported and subscription-based bundles.

 Valuations. Leading metrics for incumbent media—households, ratings, share, subscribers, time spent viewing/listening, ARPU, circulation, cost per thousand, etc.—are well more than a half century old. Investors, advertisers, and operators have had to scramble in just the past decade to learn a whole new lexicon of meaningful measurements: unique visitors, page views, search, megabits, etc.—that do not readily connect to valuations. That, in turn, implies that some entrenched models supporting common perceptions of value may be outmoded.

Investors, however, are likely to want to translate all measurements, new and old, into their own comfort screen of cash flow, multiples, yields and returns. It’s a learning curve, we think, that never ends.

Transition to Digital and Mobile World. It is safe to say that we are becoming multiscreen consumers of content. Not only do most homes have television sets, but with the proliferation of smartphones and tablets, many people have ample opportunity to stream video in this increasingly mobile world. It certainly helps that user-generated content has exploded online and digital competitors (e.g., NetFlix, YouTube) are now investing in content to compete with traditional media producers. Consider the following statistics:

 According to a July 2011 In-Stat survey, nearly two-thirds of smartphone owners have watched video on their device, while nearly 86% of tablet owners have done so. Tablet viewers watch more video and are willing to pay a higher price for that video compared to smartphone viewers.

 Video streaming is the largest component of data traffic on mobile networks, at an average of 50% of total. Volume due to video content is 69% of total mobile data traffic, based on a February 2012 Bytemobile, Mobile Analytics report.

 A recent Viacom study (Viacom website, “Tapping Into Tabletomics” study, April 17, 2012) of more than 2,500 people ages 8-54 revealed that tablets have “risen to second-screen prominence for full-length television (FLTV)-show viewing,” taking up as much as 15% of total FLTV viewing. Most media activities on the tablet, such as playing games and watching TV shows, peak with the 18-24 demographic.

 About 60 hours of video is now uploaded to Google Inc.’s YouTube video website every minute, compared with approximately 48 hours in May 2011, according to Reuters (January 23, 2012).

 Requiring New Strategies to Monetize Programming Investments. Undoubtedly one of the biggest challenges currently facing the media industry is how to get paid for quality-produced content in nontraditional distribution channels. The average consumer, particularly of the younger demographic, is quite accustomed to getting content free online. For example, YouTube hit the four billion streaming online videos per day mark in January, but, according to the company, only three billion videos per week are monetized.

INTEGRATED RESEARCH & ECONOMICS According to research firm SNL Kagan (Economics of Mobile Programming, 2012 Edition),

“free video iPad apps from major content owners, including Disney, Viacom, and Time Warner are doing great; however, paid video apps are not doing as well.” The route the industry seems to be taking to solve this problem is an authentication model whereby content is made available online to consumers who can prove that they subscribe to a multiservice operator (MSO), be it cable, satellite or telecom provider. The most popular application is TV Everywhere, which is the official name of the Comcast and Time Warner Cable authentication programs (the two-largest domestic cable operators with roughly 30% of total broadband subscribers).

 Online Viewership has Created an “Any Time, Anywhere” Consumer Mindset. Not only is the media industry attempting to “crack the code” on how to monetize its content digitally, but to complicate matters, consumer demands and expectations on that front are only increasing. The now-mobile-heavy users of media want even more bells and whistles, be it personalization (do you have an app for that?) or configuration across devices (you are cloud-based, right?). It has led to a growing list of audience demands to meet what we consider to be the “any time, anywhere” mindset of the new media consumer—yet another challenge facing the current media programmers.

Evolution Favors Good Content Creators. However, we believe that the ongoing evolution to a mobile world does indeed favor those media players that produce high-quality, highly desirable content. Recently, we have seen substantial proof that programmers have become more protective of their content. For example:

 News Corp. instituted an eight-day window for new Fox television programs for unauthenticated viewers in August 2011.

 Time Warner doubled its 28-day rental window with Netflix and Redbox to 56 days in January 2012.

 HBO is no longer selling DVDs at a discount to Netflix.

 Disney, which had initially questioned the merits of TV Everywhere, signed a ten-year carriage agreement with Comcast in January 2012. This extensive agreement spans sports, news, and entertainment content, live and on-demand, to Comcast Xfinity subscribers via television, computers, tablets, and handheld devices.

 Authentication is Real. With the ten-year programming agreement between Disney and Comcast that was announced in early January, combined with the success of HBO Go, Showtime Anytime, and Time Warner’s TV Everywhere app, we see evidence that the authentication model is not only “real” but is actually gaining momentum, which does several things:

› Underscores the partnership between content and distribution;

› Provides visibility for both sides (content AND distribution); and

› Satisfies consumer needs/wants without compromising monetization.

On April 30, The New York Post reported that Hulu, which attracted 31 million unique users in March with its free-for-all model, is taking steps to move toward an authentication model and that Fox (owned by News Corp.) is expected to begin talks soon with Comcast on a TV Everywhere authentication deal.