Barron's Streetwise - Paramount Doubles Down On Streaming. Why Shares Tanked.

Episode Date: February 18, 2022

Jack talks Jackass, Yellowstone, theater windows and subscribers with Paramount CEO Bob Bakish. Plus, why so many earnings-day blowups? Learn more about your ad choices. Visit megaphone.fm/adchoices

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Welcome to the Barron Streetwise podcast. I'm Jack Howe. The voice you just heard, that's Bob Backish. He's the CEO of Paramount Global, which until this past week was called ViacomCBS. You might think that you just heard Bob say, screaming jackass forever, but you didn't. say screaming jackass forever, but you didn't. He said scream and jackass forever. Those are two totally different movies in theaters right now. And although they're not the biggest movies of the year, I think their performance says something about the health of theaters. And we'll also talk about the state of streaming and television and why Paramount's stock plunged this past week. And we'll say a few words about the broader outlook for corporate earnings. Listening in is our audio producer, Jackson.

Hi, Jackson. Hi, Jack. Have you been back to the movie theater since the pandemic started? Well, I went once to see Dune, but now after that intro, I'm curious about a scream jackass combo. Crouching tiger screaming jackass. That's waiting to get greenlit. You saw Dune. How did you like it? It was good.

Pack theater? Pack theater. Lots of worms, sand. On the screen. On the screen. On the screen. I was thinking, I remember the floors are pretty sticky in a theater, but there didn't used to be worms and sand. I'm not sure if anyone's in charge of like blowing a whistle to signal the end of a pandemic,

but this spring I'm going back to normal-ish life. I just checked the movie listings near me. Now, if you're unfamiliar with the Jackass franchise, it features a ragtag bunch of guys engaging in pranks, potty humor, elaborate stunts. There might be a human cannon or a charging bull involved. Scenes don't always end with someone getting kicked in the privates. All right, this is called nutball. Occasionally, they get punched in the privates. Oh!

It's lewd and juvenile, and I'd happily see it in a theater, except my wife would not like it. So I'd have to go as a solo weirdo who's 25 years older than everyone else in the theater, which is not a look I'm going for. Also, I'll probably go to the movies with my kids, which means Jackass for now is out. Best case scenario, I'll talk them out of the movie with a singing cartoon pig and we'll compromise on the latest Spider-Man movie, which is still in theaters because it has made huge money. Anyhow, let's come back to movies in a moment. I just want to say a quick word on the outlook for earnings.

Morgan Stanley wrote in a note to investors this past week that although everyone is obsessing over inflation and the likelihood of higher interest rates, it will probably be growth that will determine whether stocks head lower from here and for how long. Morgan Stanley thinks growth will disappoint. And I think that's worth watching. Financial results for S&P 500 companies are now mostly in for the end of 2021. And it looks like earnings jumped 47% for the year. Under normal circumstances, that would be incredible growth, but obviously last year's growth rate benefited from comparisons with 2020, when pandemic lockdowns were widespread.

There were other factors like a big rise in oil prices, which helped energy companies. The growth rate slowed a bit towards the end of 2021, and companies didn't beat estimates by quite as much as they had earlier in the year. Also, estimate revisions for future quarters switched from rising to falling. Now we're headed for an abrupt change in 2022. The latest consensus estimate for full year earnings growth is 8%. That's okay if we get it, but Bank of America Securities points out that historically, by mid-February in any given year, analysts have guessed five percentage points too high on that year's earnings growth. So low single-digit earnings growth is a possibility. I'm not sure if stock investors would love downshifting from 47% earnings growth last year

to 3% this year, just as interest rates are starting to climb. I think that's one of the reasons a handful of growth stocks has gotten clobbered after disappointing quarterly reports. You know, shares of Netflix were down about 17 percent into this report. Facebook, which recently changed its name to Meta, shares wiped out almost $175 billion in value overnight. Morgan Stanley downgraded the stock to equal weight, saying it was wrong in assuming Roblox would continue to grow users and bookings at outsized rates. Netflix, Teradyne, PayPal, and Meta Platforms, formerly called Facebook, each suffered stock declines of more than 20% following their latest quarterly results. All of these companies had disappointing growth outlooks. B of A says that

for S&P 500 companies, that's the biggest proportion of 20% plus earnings day plunges since the dot-com stock bubble of the late 1990s. Now, none of this is reason for investors to sell out of stocks, but I think it's a reason to keep return expectations low this year and to be careful with big bets on pricey growth stocks. Although, to be clear, it's not just growth stocks that have been vulnerable. And that brings us to Paramount Global. That stock nearly joined the 20% plunge club this past week. It dropped close to 18% after the company reported fourth quarter financial results. What made the decline even more remarkable was that Paramount performed better than expected on a number of measures. Wall Street thought revenues would come in at $7.5 billion. The Paramount reported $8 billion.

And that was a 16% increase from a year earlier. And much of the growth was driven by streaming subscriptions. Wall Street thought the company would add around 6 million paying subscribers during the quarter, but the company added more than 9 million, bringing its total to over 56 million. And it raised its guidance on subscribers. to over 56 million, and it raised its guidance on subscribers. So what made investors so unhappy? In a word, spending. Paramount will put more money than previously expected into making shows and movies to support streaming, and that will make losses for its streaming unit larger than expected this year and next year. More on that in a moment. I had a chance this past week to catch up with Paramount CEO Bob Backish. I asked him about the increased spending.

He says it shouldn't be a surprise to investors. We said last year that we saw a significant global opportunity in streaming for this company and that we were going to invest in it. And we did exactly what we said we would do. The only difference being is we're outperforming even our own expectations. When Bob says the company is outperforming expectations, he means that it originally said it would hit 65 million to 75 million paid subscribers by the end of 2024, and that it now expects to have that many by the end of this year. That includes the Paramount Plus and Showtime Anytime streaming platforms. Bob calls Paramount Plus the fastest growing major streaming platform. Its content comes from television brands that were formerly part of Viacom,

like Nickelodeon and Comedy Central and MTV and BET, and from CBS, a longtime leader in TV ratings and the most-watched network last year. There's also Paramount's film studios and archives. Paramount Global's results can give a good read on the TV business and the transition to streaming without the added complication of theme parks like with Disney or wiring houses for cable like with Comcast. Bob says his traditional TV business continues to produce hits. Yeah, we had the top four shows in television between CBS's NCIS, FBI and Equalizer, and Paramount Network's Yellowstone. We had countless number ones in category, number one comedy in Young Sheldon, number one news program in 60 Minutes, number one kids program in Paw Patrol, number one premium show in Dexter

New Blood. Yellowstone, if you're unfamiliar, is a modern cowboy show starring Kevin Costner. you're unfamiliar is a modern cowboy show starring Kevin Costner. There's also an origin story spinoff called 1883 starring Sam Elliott. Picture Yellowstone, but with no pickup trucks and much bigger mustaches. What matters for investors, of course, is whether TV is still making good money. for investors, of course, is whether TV is still making good money. Last quarter, Paramount reported modest growth in both main sources of revenues for TV companies. One is advertising and the other is called affiliate revenue. That consists of things like the fees TV stations pay to be local CBS stations or that cable companies pay for carrying Paramount's networks in their cable bundles. Cable subscriptions are in gradual decline, but for now that's offset by rising prices. I asked Bob how long traditional or linear TV can stay healthy. How long are we

going to be talking about linear TV as a, you know, still a significant and lucrative business? 10 years? More? It's a big, profitable, stable business. You have revenues growing, you know, single digits. We're managing investment levels, and that's ensuring that we continue to deliver strong oibito from there. When Bob talks about managing investment levels in traditional TV, he means he's going to keep spending on shows in check there so that he can spend more on streaming. And when he talks about TV continuing to produce strong OIBDA, he's using an acronym for Operating Income Before Depreciation and Amortization. It's a measure of core profitability.

and amortization. It's a measure of core profitability. If you've ever heard of EBITDA, you can think of it and OEBDA as first cousins. Now, Bob says that traditional TV is not only profitable, but that it's also an advantage when it comes to creating new intellectual property or IP. One of the advantages we have versus a pure play streamer is the fact that we have linear television networks, that we have a theatrical business. Why? Because it provides us access to IP, which we can introduce like what we did with 1883, where we introduced it to the fan base behind Yellowstone before we moved it exclusively to Paramount Plus, and it became the biggest original on Paramount Plus yet. So this combination of traditional assets and streaming assets is a real advantage.

And I realize that's not in vogue, but that is the truth. So then why did the stock tank this past week? Investors might be skeptical or impatient or both. The analyst at B of A Securities downgraded the stock to neutral from buy and used the name of a Paramount film franchise in her report title, writing, not mission impossible, but a tough road ahead. In her view, it's good that the company is taking a bold approach with streaming, but that will push free cash flow down from levels that are already depressed by streaming costs. Paramount says that streaming profitability will ultimately resemble that of traditional TV, with margins in the low to mid 20% range. But B of A's analyst says that won't happen until the back half of this decade,

and traditional TV is under pressure now. The analyst at Benchmark Securities kept his buy rating on the stock and wrote, At least it feels like all the cards are on the table now. He points out that the company has an excellent balance sheet and $6.8 billion in cash before the proceeds of the planned sale of its Simon & Schuster book division. So its dividend looks safe, even with the increased spending on streaming content. The stock recently had a dividend yield of 3.2%. For a bottom-line financial assessment, look at estimates from the analyst at Credit Suisse, who started at neutral on the stock and stayed at neutral.

He chopped next year's free cash flow estimate by 45%, and now thinks the company will clear just $715 million. But the following year, in 2024, he expects that number to roughly double to $1.4 billion in free cash flow. Paramount, after its big stock drop, has a market value of just over $19 billion. So in other words, the company could generate free cash flow equal to more than 7% of its stock market value by 2024. And by then, Credit Suisse's analyst expects that

free cash flow will still be growing by more than 20 percent a year. That's a lot of numbers, I know. It's another way of saying that the stock could take a while to gain fans among investors, but it could also be attractively priced for long-term holders, provided Paramount can deliver on the subscriber growth it expects. So can it? Top draws for new Paramount Plus subscriptions last year were NFL Football, 1883, iCarly, and A Quiet Place 2. Now, I know that A Quiet Place 2 was the movie where the monster eats anyone who talks too loud. I use a similar rule when doing a TV show or podcast from my home. I had to look up iCarly.

It's a Nickelodeon show about the lives of teenage internet celebrities. I asked Bob to tell us why Paramount Plus will be among the streaming services that customers will want to hang on to rather than churn out of. Paramount Plus, we launched it with a belief that being broad was differentiation and also a way to unlock the value of this company. We call it new sports and a mountain of entertainment, and the entertainment spans kids and family, unscripted, scripted, movies. We've seen churn progressively drop each quarter, and we see this business scaling very materially. There are other topics to cover like Paramount's

free ad-supported streaming service called Pluto, which is growing quickly and generated $362 million in revenue last quarter, and the company's plans for overseas growth. But I want to get to movies in theaters. There have been some false restarts for the theater business that were spoiled by surges in COVID cases, but there's a new movie called Spider-Man No Way Home. I mentioned it earlier. It's not a Paramount movie. It came out just before Christmas and it's still in theaters and has made more than $1.8 billion worldwide. That's not just a good pandemic number. That's good enough for sixth place on the all-time box office list. The only films higher are ones like The Last Two Avengers movies and Avatar and, and Disney's first big Star Wars movie

in 2015. So either Spider-Man is a fluke, or theaters are once again ready to capitalize on hits. I asked Bob what he's seeing in films he sends to theaters. The trend lines in theatrical are clearly moving the right way. Both Scream and Jackass Forever for us did particularly well because they skew younger, and we are finding that the younger audience is more prone to go to the theaters at the moment than the older audience. That new Jackass movie has grossed $50 million worldwide. That might not sound like much, but it cost a reported $10 million to make. Everyone talks about box office receipts for movies, but

few mention returns on investment, which is what matters most for investors. Paramount will swing for the fences later this year with a Top Gun remake and a new Mission Impossible movie. For now, it's a good sign that it's hitting solid singles and doubles. Scream, the new reboot of the slasher film series, cost a reported $15 million to make and has brought in $130 million worldwide. Those movies will make their way to streaming. Bob says a day-and-date strategy

where films are released simultaneously in theaters and on streaming works well for some family titles like the recent Clifford and Paw Patrol ones, but he thinks the sweet spot for most movies is a 45-day theater window. We did that with A Quiet Place 2 as an example last year. That was the first title we did that with because it allows you to benefit from theatrical and that revenue pool, but have it on streaming quickly enough that you benefit from all the theatrical marketing and it's still a fresh title. Thank you, Bob. I'm not making any kind of a call

or prediction here on Paramount stock, by the way. The company's strategy seems sound, but there's an element of what you might call unlucky timing for shareholders. For years, with interest rates stuck near zero, all stock investors cared about was growth. So when Netflix said, we're not going to generate free cash flow just yet, but we're bringing in loads of subscribers, investors cheered and shares soared. And when CBS and Viacom at the time said, look at all the cash we're bringing in, investors said, we don't care. We want streaming and lots of subscriber growth. So now Paramount is saying that it's bringing in plenty of streaming subscribers

and that it's free cash flow will take a hit in the years ahead to pay for the content. But the mood has changed. Interest rates are expected to climb soon. Investors are saying growth is fine and all, but what we really want is immediate free cash flow. We'll have to see whether Bob can deliver on his plans and produce growth and plenty of free cash flow and whatever else investors decide they want in the years ahead. How about we hear from a box office expert on just how big this year could be for movies? That's next after this quick break. how big this year could be for movies. perk and more, only at RBC. Visit rbc.com slash get 100, give 100.

Conditions apply. Ends January 31st, 2025. Complete offer eligibility criteria by March 31st, 2025. Choose one of five eligible charities. Up to $500,000 in total contributions. Jackson, have you ever heard of ASMR? Hey, it's ringing a bell. That's where people listen to sound effects for titillation.

Sounds like you're just snacking. I mean, I had a bag of Ruffles in a can of a dry. I thought I saw a business opportunity. Let's move on. Welcome back, everyone. There are more movie companies than the studios hoping the theater business will bounce back this year, of course. There are theater operators like AMC Entertainment and Cinemark and IMAX, which licenses technology to theaters. To learn more about what's possible at the box office this year, I reached out to someone who specializes in measuring show business audiences. Paul Dergarabedian, Senior Media Analyst for Comscore.

And the first thing I did was compliment Paul on the bar in his Zoom background. Scotch, bourbon, mezcal, tequila, cameras, Saturn V Lego, rocket. that's everything you need in a well-stocked bar it really is and i actually got a 10 out of 10 on room raider last year if you're not familiar with room raider it's a twitter account that rates the zoom backgrounds of people who've been doing tv from home during the pandemic. And if you're wondering, I haven't received a score for my own lazy Zoom background of four books and a fake plant, which technically means I've avoided humiliation, but also that I carry the shame of not being interesting enough for Room Raider to notice. Jackson, my sad music, please.

You know what? There's no time movies paul says that despite a handful of hits the box office is off to a slow start but that could change soon it's really been about spider-man scream jackass forever but uh i think that we're getting off to kind of a slow start if we didn't have spider-man in the marketplace we'd be really off to a slow start. But I think this is going to be a comeback story, a really good one for 2022 at the movies. Paul, like Bob, says young people have been the first ones to return to movie theaters and that the rest of us could follow soon. He says Jackass's success reminds him of a slapstick favorite from when he was a kid. I mean, when I was a little kid, I loved the Three Stooges. They were way older than me,

but they acted like complete goofs, and I loved it. So to me, you don't have Jackass without the Three Stooges, but it really has done well. And it's about the comedy being such a great genre that plays really well in a movie theater. such a great genre that plays really well in a movie theater. You can't have a big box office year without big movies. Studios have been reluctant to bring them out because of virus rates, but films scheduled for later this year include a new Batman, Thor, and Black Panther, a Buzz Lightyear movie, plus the Paramount movies I mentioned earlier. And hopefully, studios are

done pushing back release dates. Here's Paul. I think we've seen that the studios that kind of stay on their dates have actually done really well. I mean, clearly Paramount could have said, oh, we're going to not put out Scream, too much Omicron news out there. But they put it out there and it was a huge movie and it did really well. So I think it's going to be a year, again, that right now is moving rather slowly, but I think we're going to see a snowball effect over the course of the year. Last year was a pretty low grossing year overall in North America, $4.5 billion. A traditional year in North America is around $11 billion, just over $ 11. This year, maybe we get to 8 billion plus. So maybe $8 billion at the box office versus a more typical $11 billion before

the pandemic. Paul says in the age of streaming, we might have to recalibrate what we consider a box office hit. But he also says that theaters have proved resilient. As a movie fan or fan of entertainment or a consumer of entertainment, it's actually never been a better time if you can parse out what you want to watch or see, because there's a lot out there. Thank you, Paul and Bob, and thank all of you for listening. Jackson Cantrell is our producer. Jackson, say goodbye to the folks using only ASMR, please. Oh my God. Are you okay?

Yeah, I'm okay. Put some ice on that. Subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcasts. If you listen on Apple, write us a review. If you want to find out about new stories or new podcast episodes, you can follow me on Twitter. That's at Jack Howe, H-O-U-G-H. See you next week.