It’s tough to stand out in the crowd of reporting this week on the Viacom-CBS merger. I was primed to pass strategic judgement on the merger, but don’t feel quite ready to do that (yet). Instead, let’s try the good ol fashioned Entertainment Strategy Guy slightly different take.
The Most Important Story of the Week – Viacom and CBS Merge for “Scale”
Specifically, some context on the biggest word of the week “size”.
(Programming note: I’m already calling the remaining pieces of 21st Century Fox “NuFox” and I refuse to call ViacomCBS that name because it is awful. I’m calling them SuperCBS for today’s article.)
This deal is about “size”, but what does being “big” mean?
This was the widely repeated headline of the week. The buzz for this deal was that Viacom and CBS had to merge to get bigger to compete. That’s actually been repeated for weeks. Here’s a sampling from Recode, NBC, and Indiewire, either using that set up in the headline or quoting an analyst. (And in fairness, I think Bob Bakish and/or Shari Redstone has said this too.)
The piece of the coverage, though, that bugged me was that if I did see “size” quantified, everyone trots out the same measurement.
How did we measure size this week? Market capitalization.
This Recode visualization (and it really is high quality work, I’m just using it as an example) shows size by market capitalization.
Axios made a similar chart here. (Again, a great visualization and they’ve been doing great work.)
These are just the two visualizations I saw. Most other articles referred to market capitalization for the need to get bigger in the current entertainment landscape. I mean just look how small CBS is!
The problem with market capitalization as a metric.
Let’s start with an analogy to explain why this doesn’t make sense. And of course, I’ll use an NBA analogy. Let’s say I told you someone was the biggest player in basketball. Am I talking about height? That’s what you’d assume, and that’s the most common measurement in the NBA. Of course, those people really in the know understand that arm length is actually more valuable than raw height. Combining the two for “reach” is another measure that is arguably better than either of the previous two.
But why talk height when I said “big”. Maybe I just meant weight. So who is the heaviest basketball player? While being heavy doesn’t matter as much, tell that to centers facing Shaq at his peak. The point? When it comes to “size” in basketball, we have multiple ways to measure it.
One more analogy? Okay. My other go to is the Army. When it comes to militaries, you can measure the total number of troops (manpower), the total military expenditures, the total number of vehicles, the weight of the combined vehicles. The amount of firepower that can be brought to bear. (One guy with a machine gun is worth many with an assault rifles, for example.) And on and on. Again, when saying “biggest” you can measure in so many different ways.
The challenge for me, when using market capitalization–share price times shares outstanding–is that it relies so much on the opinion of the market (Wall Street). Which is fine. It’s accurate as far as anything is accurate in today’s efficient market, because the market is efficiently allocated. You can ask the Nobeler’s precisely what that means. (Fine, there is no Nobel prize for economics, but you know what I mean.)
But an example gnaws at me when it becomes the stand in for size the way height is a stand-in for size in the NBA. Take Netflix a few weeks back. They had a bad earnings report and suddenly they lost 20 billion in market capitalization with a 10% share price correction. So did they become 10% smaller overnight? In basketball you don’t just shrink because the market decides you aren’t as tall. Your size is your size.
(Also, market capitalization ignores debt. Which matters since debt holders get paid first. Really have to use both, which is “enterprise value”.)
Instead, if we want to compare size, we need to go a pinch deeper.
What are other measures of financial size?
When you talk companies, you think of organization designed around making money. The ideal measures could help give insight into how much revenue a company could bring in, how efficiently it brings that in, how many users it has and how much market share it has.
So here’s a table on it. I picked the three parts of the income statement (the top, middle, bottom), free cash flow (profit is opinion; cash is a fact), and some other potential measures of size. But the key–to really get the context–is to find some yardsticks to measure them against. In that vein, I picked four rough competitors: Netflix, the digital only superstar, Disney, the content king, AT&T, the telecom company with dreams of more, and Apple, the tech behemoth.
(For those who don’t know, revenues is all the money a company makes; EBITDA is after most of your non-financial type costs are factored in; profit is the money you make after you pay taxes and stuff. Free cash flow is subtly different because it’s the actual amount you make, which can be different than profit because of depreciation and amortization. The last two columns are the “indexes”. Roughly, anything over 1 is bigger.)
Here’s another example to heap more hatred on market capitalization. Say we’re comparing two companies. One makes more money (line 1), and generates three times more profit off that money too (line 3). On top of that, one company is losing cash every year (though they are profitable) (line 4). Well, obviously, if I asked you, “So who is bigger?” you’d answer the company making more money. But that’s CBS compared to Netflix.
Or take content spending, which is also a pretty good stand in for size. Right? With Netflix, you often see the $15 billion floated out there, but Disney beats that just on non-sports programming. Throw in sports and they’re much bigger. Heck the combined SuperCBS isn’t too far from Netflix on spending, and maybe the $3 billion gap is just the difference between profitability and growth.
Oh, and of course there are subscribers. That’s a measure of size too. The tough part when measuring anything is figuring out what matters. Everyone in the media focuses on digital subscribers, which is line 7. Yep, Netflix is way out in front. But why do linear subscribers not count? I essentially pay ESPN $9 a month. I pay HBO some split of the $15 for my linear feed. Sure, the companies don’t own my relationship–the cable company does–but they still have paying users. To show the “total” between digital and linear, I just added the 89 still around linear subscribers for CBS and Disney, and HBO’s roughly 45 million subscribers. So again, yes SuperCBS on one measure isn’t big enough; on another it is.
Of course, when we’re talking size, really everyone is scared of the last column. Apple makes more in cash than Disney makes in revenue. Yikes. That’s why Apple (and Amazon/Google too) can fearlessly “disrupt” the entertainment industry by losing lots of money to gain a foothold.
Size does and doesn’t matter.
I don’t want to go overboard in counter-intuitive programming here. Obviously, size matters in providing a company leverage to negotiate with suppliers and customers. And the ability to lose billions in free cash flows–as Apple, Amazon and Google can–is a competitive disadvantage. (Though, not necessarily smart for investors.)
Of course, size by any metric only matters in how you can use it, which may be my biggest gripe with the market capitalization metric. It’s pretty easy to understand how revenue through to cash flow gives you an advantage the larger it is. (The more money you have, the more you can spend.) Market capitalization, though, isn’t really a tool you can leverage, unless it is to offer more shares to raise capital. Which is yes a tool, but not one used as often as your own revenues.
Most importantly, size–like M&A as I’ve written before–isn’t a strategy. And we should never pretend it is. Instead, strategy is a strategy. As I’ll write in the future, Shari Redstone and Bob Bakish’s challenge is to take this combined entity–that really is big enough to compete–and develop a competitive advantage in this landscape. That isn’t impossible. But it is so hard to do well.
Long Read of the Week – Good Reads on The Merger
So many excellent articles this week on the big story of the week. Apologies if I left out your take.
Sherman had the best, “What should they buy next?” article after the merger. (Besides mine, of course.) But most importantly he used Enterprise Value instead of just market capitalization. Bravo.
SuperCBS will control 20% of national TV advertising. That’s big. Steinberg digs into the challenges facing the new entity.
Porch wrote this before the merger, but I love his layout for how size will help SuperCBS in some specific areas like distribution.
While we all waited for Viacom and CBS to merge, Amazon had “one of” their most successful TV series launches. “One of” what does that even mean? Well, I took 800 words to take my best guess over at Decider, then followed up with another thousand on this site. (The answer? Yeah, for Amazon, this probably is a hit.)
Data of the Week – No More $200 million Blockbusters