Earlier this week AT&T and Hulu announced an agreement for AT&T to sell its 9.5% equity position in Hulu back to the joint venture entity (that is Hulu) now owned by Disney (majority owner) and Comcast. Some care is needed in describing the transaction since the entity of Hulu bought back the equity stake from AT&T as opposed to Disney or Comcast purchasing the equity position. Because of this transaction structure and unless some other understanding is reached between the joint venture partners, the resulting ownership positions in Hulu are 67% for Disney and 33% for Comcast.
The total price of the 9.5% position was $1.43 billion, equating to a valuation of Hulu of just over $15 billion. Our interest in the transaction is to observe the evolution of OTT business models made visible in the valuation escalation of Hulu, and its implications to where technology providers can add value (and get rewarded accordingly) to OTT service offerings.
The story of Hulu’s ownership was an example we cited during last week’s 2019 Devoncroft Summit | Las Vegas (see below slide from the event, updated for the most recent transaction).
It is interesting to reflect on the ownership changes since Hulu’s formation. The original March 2007 press release cited distribution partners such as AOL and myspace, which makes it sound a lot older than 12 years. At its inception ownership, was divided between Fox and NBC Universal, the first content contributors. Well-known private equity firm Providence Equity Partners had an ownership position for the first five years of Hulu’s operations, subsequently selling its position back to Hulu’s media owners in 2012.
Disney’s initial entry into the capital structure began with its purchase of a (reported) 27% stake in early 2009. (One side note on Disney’s original investment: neither Hulu nor the investment in Hulu is actually mentioned in Disney’s 2009 Annual Report.) Comcast acquired NBC Universal’s equity position with its acquisition of NBC in early 2011. (One side note on Comcast’s original investment: Hulu was accounted for using the cost method of accounting. This means Hulu was valued at historical cost. The cost method is used when the investor does not have substantial influence over the activities of the subsidiary and the investment has no easily determined fair value. One of the FCC’s conditions about Comcast’s purchase of NBCUniversal was Comcast’s agreement to have less influence over Hulu for a period of seven years).
AT&T’s equity position stems from its acquisition of Time Warner, which purchased a 10% stake in Hulu in August 2016. The Time Warner investment in Hulu valued the enterprise at $5.8 billion in late 2016.
Disney’s acquisition of 21st Century Fox (or at least a large portion of Fox) included Fox’s 30% interest in Hulu. A June 2018 regulatory filing by Disney provides a bounty of formal literature on the valuation of Fox’s assets. The relevant excerpt of the valuation of Hulu done by Goldman Sachs is highlighted below.
The conclusion was Hulu was worth between 2.0 – 3.0 times forward revenue. No more detailed justification is offered in the regulatory filing on Hulu’s valuation than the professional judgment and experience of Goldman Sachs. (Goldman received a $58 million dollar fee for its assistance on the transaction.)
There is an important nuisance of this valuation of Hulu: it includes a control premium because Disney was acquiring a majority ownership position. The 1% of a business you buy to gain control is necessarily worth more than the first 1% of a business you buy. This matters because the comparison of the most recent valuation of $15 billion to the June 2018 valuation of $9.3 billion is flawed; the appropriate comparison is to the valuation of the 30% interest without a control premium – equating to $8.0 billion.
In plain terms, the valuation of Hulu almost doubled in less than a year after having increased by more than 30% in the previous two years.
My question is then – why? The glib answer is $15 billion was the valuation at which AT&T was a willing seller and Hulu still a willing buyer. A skeptic would then view Hulu’s valuation as the result of a relatively few number of transactions between even fewer counter-parties, having perhaps a motivation to escalate the value of the enterprise. A proponent would point to the stated subscriber numbers (25 million) and early success with an OTT advertising model ($1.5 billion during 2018).
But you won’t find the answer in the financial performance of Hulu. Based in large measure on disclosures in Comcast SEC filings, below is the implied annual losses of Hulu.
At Disney’s investor day in April, CFO Christine McCarthy indicated Disney anticipates Hulu’s operating losses to peak at $1.5 billion in fiscal 2019 (ending in September) and the decline slightly in fiscal 2020, with domestic profitability reached in either fiscal 2023 or fiscal 2024. In other words, Hulu will not have generated a dollar of profit until its 16th year of operation – at the earliest.
It is important to include the context that these losses are part of the necessary investment to create a new media offering. As important, these losses are driven by payments to the media owners, in form of content licensing and – more recently – retransmission fees for local stations. The circular dependency is then media companies invest funds into Hulu, which are then used to pay for content from those same media companies, and all the future content commitments of Hulu are kept off the balance sheets of those same media companies.
During Disney’s first quarter 2019 call with analysts, CFO Christine McCarthy stated “…that the overall impact of Hulu on the company’s [Disney] results includes revenue from program sales as well as affiliate and advertising revenue. Over the past three years, our aggregate equity losses have largely been offset by these revenue streams.”
Discussions of the cash flows of Hulu make us dizzy. Further, valuations are fickle. Last week, after Disney announced the mid-November launch date (and price) of its own streaming service, Netflix’s market value declined by $7.2 billion in a single day.
Besides, we are less interested in a discussion of Hulu’s value and more interested in a discussion of what is driving Hulu’s value. A narrow view of the cash flows would present Hulu as an empty vessel through which content flows from media owner to consumer, not a framework that arrives at a valuation of $15 billion. Something greater is responsible.
An interesting side-by-side comparison is available within Disney itself. Recall Disney purchased BAMTech in September 2017 for a total valuation of $3.9 billion. (Disney has just renamed BAMTech Disney Streaming Technologies.) Disney’s SEC filings described BAMTech as “an entity which holds Major League Baseball’s streaming technology and content delivery businesses.” It isn’t a perfect analogy since BAMTech does also have a participation in the sports rights, but we feel it is reasonable to view BAMTech as a technology provider dedicated to the mechanics of delivering high value content online. For the year ending September 2018, BAMTech contributed revenue of approximately $300 million with expenses of $700 million to Disney. Post-acquisition by Disney, BAMTech no longer gets to count revenues to Disney, one of its larger customers. This impacts the point below, but not fatally. The original acquisition of BAMTech registered $3.6 billion of goodwill on Disney’s balance sheet and since management has not seen fit to write-down this investment it must mean the business is still viewed as having a value of $3.9 billion or roughly 13 times external revenues.
During the 2019 Devoncroft Summit | Las Vegas we posed the question: how can you value Hulu at 2.0 – 3.0x forward revenues and BAMTech at 13 times trailing external revenues. This question was captured in the below slide. (It may have proved prescient because Hulu was revalued substantially higher just a few days later).
There are multiple ways to read or rationalize the above valuation data points. There is no definitively right answer. Markets are made from disagreement after all. What it does suggest is that Hulu is not being valued based on the technology supporting its delivery infrastructure; otherwise the valuation is inconsistent with BAMTech’s value (though again Hulu was just substantially revalued).
Reasonable people can then disagree on what is driving Hulu’s value. There are lots of acceptable answers. To drive this post to a faster conclusion, let me borrow from Disney’s investor day where Hulu’s Chief Executive Officer Randy Freer described Hulu as “…the stories you love, delivered to you wherever you want, in a curated, personalized user experience.”
The last point on ‘personalized user experience’ was a constant refrain during the NAB Show. For example, MediaKind (just divested from Ericsson) had the entire center of its NAB Show booth dedicated to the topic of consumer experience, and within that technologies used to personalize the user experience.
Adding emphasis to the value of user experience is not a new talking point. During an earnings call in November 2016, then CEO of 21st Century Fox James Murdoch credited Hulu as representing a good example of the importance of user experience. “It’s certainly clear that the user experience is kind of a dimension of competition that is really important” continued Murdoch.
The larger point is personalization is very much a technology driven part of the business, and one could argue that portion of Hulu’s workflow (which is directly tied to advertising) is – at least in part – driving the value of the business. Feel free to disagree.
Below is a schematic of Hulu’s workflow, excerpted from a recent Hulu blog post, titled “The Anatomy of a Live OTT Service.”
Source: Hulu Technology Blog
We have reached out to the Hulu team to better understand which technologies are built internally at Hulu versus sourced from third parties. The layout of image makes it tempting to guess the ‘h’ labeled segments are internal builds.
To sum up a lengthy discussion, if you are looking to follow the money in the media technology industry, then you will have noticed the value escalation of Hulu and – more broadly – OTT services. The flow of investment into the technologies underlying these OTT services is then likely to disproportionately fall into the categories of technologies driving value in OTT services. Again reasonable parties can disagree, but it would appear that technologies for personalization and by extension improving the consumer experience are as good an explanation as the data currently supports.
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