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Paramount Stock: Don’t Be Afraid of Rising Content Spending

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As part of my previous articles (ViacomCBS: Buy The Streaming, Get The Legacy Business As A Gift; ViacomCBS Stock: The Good Price To Buy The Solid Business), I analyzed the investment case of Paramount (PARA) and noted the undervaluation of its shares. I gave several rating methods, and within each method, Paramount was found to be underrated. However, Paramount shares fell significantly after the release of Q4 results and updated content spending guidance. Nonetheless, I maintain my positive view of the company’s stock. Let’s inspect the declarations in order to understand why I consider the fall to be unjustified. Let’s first review the top-level indicators, then move on to the segment level.

Quarterly revenue was $8 billion (+16% year-on-year). Adjusted OIBDA was $557 million (-53% YoY). Adjusted earnings per share was $0.26 (-75% year-on-year). The number of paid users of the company’s streaming services increased by 9.4 million (up to 56.1 million). The number of Pluto TV users increased by 10 million to 65 million. I highlight a very strong increase in subscribers and solid real results of the company.

Television (includes Paramount+)

Segment revenue was $3.7 billion (+18% year-over-year). Ad revenue increased 2% to $1.54 billion. Affiliate revenue increased 5% to $0.72 billion. Streaming revenue increased 64% to $489 million. Content licensing revenue was $938 million (+51%). Adjusted OIBDA for the segment was $147 million (-73% YoY). Segment-adjusted OIBDA is expected to be at 2021 levels in 2022 after adjusting for Super Bowl revenue (1Q 2021).

Paramount+. During the quarter, 9.4 million new subscribers were added, 80% of which were Paramount+ subscribers. The number of subscribers for all paid streaming was 56.1 million. Paramount+ has 32.8 million subscribers (+26.2 million over the year). Paramount+ revenue grew 115% year-over-year to $1.3 billion. Domestic ARPU reached $9. In 2022, ARPU is expected to grow due to the end of promotions and an increase in the share of advertising monetization. International ARPU will increase by entering markets with higher ARPU. The company now expects 100 million subscribers by the end of 2024 instead of 65 to 75 million under previous forecasts. The new 100 million forecast does not include an influx of users from the SkyShowtime partnership. They will be reflected separately. I wrote about the possibilities of this partnership in a previous article.

Cable TV (includes Showtime OTT and Pluto TV)

Revenue was $4 billion (+17% year-on-year). Advertising revenue was unchanged from last year ($1.1 billion). Affiliate revenue increased 1% to $1.4 billion. Streaming revenue up 40% to $826 million. Licensing revenue up 87% to $692 million. Segment-adjusted OIBDA was $532 million (-34% YoY).

Pluto TV. Pluto TV added 10 million users, which grew to 65 million worldwide. As for Pluto TV’s user forecast, everything is unchanged, 100-120 million by the end of 2024. Pluto TV’s global hours viewed increased by 50% year-on-year to 4.8 billion . In the United States, hours seen by MAU increased by 12%. Pluto TV added 21 million users and brought the company $1.1 billion in revenue in 2021 (+90% YoY, 5x more than two years ago). Global ARPU increased 17% year-on-year to $1.64. Home ARPU $2.54 (+44%). Together with Paramount+, I see Pluto TV as a major growth engine for the years to come. Especially given the possibility of some advertisers switching from social media to AVOD services due to changes in IDFA policy.

Studio

Segment revenue was $826 million (+61% year-over-year). The main growth was driven by content licensing, where revenue increased 54% to $787 million. Box office revenues also recovered ($39 million). The adjusted OIBDA was $54 million ($18 million a year earlier). The predictions of the OIBDA film studio are unchanged this year, unless there is a change in the theater schedule.

Growth requires increased spending on content

Last year, management expected $7 billion in streaming revenue in 2024. Under the new segmentation structure, this forecast assumed DTC revenue of $6 billion. The company now expects revenue of $9 billion, up $3 billion from its previous guidance. A higher forecast is expected both due to user growth exceeding past expectations and due to growth in ARPU, advertising and subscriptions.

Last year, management expected $5 billion in content spend ($4 billion in its current DTC segment). The company now expects to spend $6 billion in 2024. As a result, OIBDA margins will deteriorate in 2023 and not return to growth until 2024. Over the long term, management expects the margin OIBDA reaches the current level of the TV Entertainment segment (about 25%). This is similar to my DCF model assumption.

For 2022, management expects streaming revenue growth of 60%. Rising costs will cause the segment’s OIBDA to decrease by $500 million in 2022. The combined OIBDA is expected to deteriorate for the business in the first half of the year. Since last year, there was no part of the content costs in the same period. However, there will be an increase in total OIBDA in the second half of the year. The deterioration of FCF in 2022 will be less than EBITDA, as there will be an improvement in working capital management due to optimization in 2H2021.

A few words about streaming prospects

Not all investment banks are positive about the company’s prospects for expanding streaming. Nevertheless, I think streaming will allow the company to expand the addressable market. My view has been confirmed by Paramount management. According to them, streaming will increase the size of the addressable market from the current 300 million households to 600 million worldwide (excluding China and India). This number continues to grow due to the increase in the spread of mobile Internet and the penetration of smartphones. In addition, a combined subscription (subscription + advertising) will allow the company to earn additional revenue through advertising. Advertisers are interested in streaming advertising. In my view, an additional factor to this is the IDFA policy change, which will see many advertisers transition from social media to streaming advertising, where there are no issues with ad targeting and sound measurement efficiency. I also emphasize that a diverse model allows the company to get a better return on investment in content. The diverse model has the ability to earn from theatrical, streaming, television and cable release, releasing the same content step by step on each platform.

The content strategy

The company plans to expand content from current franchises and add new franchises to its library. Given the company’s large content library, there are plenty of opportunities to develop new content to attract viewers. A powerful advantage of the company is the age and diversification of thematic content. For the little ones, there are franchises such as paw patrol. For the older ones – Transformers, Teenage Mutant Ninja Turtles, Sonic, etc The choice of content is also wide for an adult audience. Among the most popular are television series Yellowstone and its prequel, 1883as well as the series Billions. For fans of the halo video gamethere will soon be a series release based on this game. Film studio franchises for adult audiences, I highlight the Impossible mission franchise, A silent place, and many more. There is plenty of news and sports content that the company streams as well. It will take a separate article to talk about the entire content library, so I’ll limit myself to what I quoted above. For those who are interested, I advise you to familiarize yourself with the company’s plans for content creation in transcription. To sum up, the company has enough content to attract viewers. Content is king now.

Risks and Final Thoughts

The major risk is that the investment in content will not be profitable. Some skeptics of the streaming business model point out that streaming companies will have to constantly increase content costs, which will put indefinite pressure on margins. I do not share this point of view, about which I have already written several times in my articles. Nevertheless, I will mark this as the major risk. Other risks can be found in the company’s latest financial statements (10-K). Despite revised content spending forecasts, I believe the additional investment will result in a larger-than-expected influx of new users to the company’s streaming services.

The crucial question now is whether the company will be able to transfer inflation growth to consumers without losing the level of demand for its services. The streaming business model has not yet gone through periods of high inflation in developed markets, but I believe it is more resilient in the current environment than the traditional media sector. In developed countries, it is possible to increase the cost of a subscription, since the cost of cable activity is much higher. I think given the undervaluation of the company’s shares, they look attractive, even taking into account the expected rise in inflation and the tightening of monetary policy. Accordingly, I maintain my bullish view on the stock.