The best way to profit from the television revolution

The TV and video market is changing dramatically at the moment.

One of the biggest changes is the rapid growth of Netflix and its video streaming rivals. These companies deliver content over the internet. So you can watch what you want, when you want to, without any adverts.

Netflix isn’t just growing in the US, it’s doing well in the UK and is about to launch in France and Germany.

This is putting pressure on the established broadcasters and cable companies. That’s one reason why over in the US, two big TV/telecoms mergers are waiting for approval from the regulators.

Where there’s change, there’s usually opportunity – so where should investors be looking for profits?

These defensive mergers could create short-term opportunities

Let’s start by looking at the mergers. The first merger is between the two largest cable TV providers in the US – TimeWarner Cable (NYSE: TWC) and Comcast (Nasdaq: CMCSA).

The second is between AT&T (NYSE:T) and DirecTV (Nasdaq:DTV). AT&T is the largest telecoms business in the US while DirecTV is a satellite TV provider, similar to Sky in the UK (although DirecTV’s market share is far lower than Sky’s.)

Both mergers are defensive moves. All four companies are worried that online streaming is going to inflict serious damage on their businesses.

You see, with video streaming, consumers can get free entertainment from Youtube as well as cheap entertainment from the likes of Netflix (Nasdaq: NFLX). A typical cable TV package in the US costs around $90 a month. A monthly subscription to Netflix costs $8.99 a month.

So it’s no wonder that more and more Americans are ‘cutting the cord’ and cancelling their cable TV subscriptions. Sure, $90 a month may give you access to hundreds of channels but who cares when most folk rarely look at more than 20?

Music streaming services such as Spotify (which basically allow you to pay a monthly subscription to listen to whatever music you want) are also growing fast. And Google has paid $1bn just this week to buy Twitch, a streaming site for gamers.

In short, it’s clear that the internet is going to become the dominant delivery mechanism for everything from music to TV to gaming. That’s very disruptive to the old companies’ current business models.

Of course, the success of these platforms depends on their ability to offer television that people want to watch. That’s one reason why Netflix and other streaming services are now producing their own original content, such as the US remake of the old British TV series House of Cards.

Comcast and TimeWarner Cable are hoping that their merger will enable them to negotiate better deals with content providers and thus compete more effectively with Netflix and others.

It’s a similar story with AT&T and DirecTV. This new company plans to compete by offering combined phone, internet and TV packages.

Assuming both deals get the regulatory thumbs up, I suspect that we’ll probably see an initial boost to profits for the merged companies. We may also see further mergers along the same lines.

So in the short-term, you may be able to make money by investing in takeover targets. Verizon (NYSE: VZ), another big telecom group, is a possible buyer, while potential targets could include Dish (Nasdaq: Dish), another satellite TV provider, or Cablevision (NYSE: CVC), a cable company in which hedge fund manager John Paulson has an 8% stake.

Be careful though. Buying shares in Dish or Cablevison may work out well, but they already look quite expensive, so you could lose out if no bid ever comes.

Should you invest in the revolutionaries?

So is it better to invest in the upstart – Netflix? The company certainly has a lot going for it. It now has 48 million streaming customers around the world, and that number is growing fast.

In the UK, 18% of peaktime broadband traffic is now with Netflix, according to Sandvine’s ‘global internet phenomena’ report. And this week’s move into France and Germany should boost that growth further.

What’s more, Netflix is a business that may benefit from ‘high operational gearing.’ In other words, most of its costs are fixed. So as revenue rises, you may see a big rise in profits.

However, there’s a big caveat to that. If Netflix chooses to invest heavily in more original content – which seems to be the way things are going – costs may rise by more than some people expect.

Another downside is that Netflix already faces significant competition in streaming from the likes of Amazon (which is also producing original content) and Hulu. It’s possible too, that the US cable companies might get their acts together and launch their own Netflix-style services.

The cable companies also resent the fact that Netflix is using so much of their bandwidth capacity (if you imagine the internet as a big pipeline, streaming video is like sending a flood of water through it, compared to a trickle for emails). So they may push for payments from Netflix – like a toll, pretty much. Indeed Comcast has already done that.

Finally, Netflix is far from cheap. It isn’t paying a dividend and it’s on a price/earnings ratio of well over 100. I suspect that Netflix will still be a significant player in 20 years’ time, but I’m not convinced I should buy at this valuation – especially when you remember that Netflix will probably always face significant competition.

Content is king

So how can you profit from this battle? Well, I’m not sure you want to invest in any of the content delivery companies at all.

Instead, I can’t help but think that the best place to be in the long run is with the major content providers. You see, we can’t predict for sure which companies will deliver content to our homes in 20 year’s time. And we don’t know what technology will be used either.

But we can be sure that people will still want to watch great movies and great TV-style entertainment as well. So the companies who already own that content and have a good record of producing high-quality content that people will pay for, should keep doing well.

The Walt Disney Company (NYSE: DIS) could fit the bill nicely. It has a fantastic library of content and the valuation isn’t horrendously high. And unlike many of the companies mentioned here, I find it hard to imagine a media future in which Disney is no longer a big player.

• This article is taken from our free daily investment email, Money Morning. Sign up to Money Morning here.

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