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Paramount Global (NASDAQ:PARA) (NASDAQ:PARAA) remains my worst investment. Let’s just get that clear from the start. I said two years ago it was madness not to buy Paramount. That was wrong, wrong, wrong. The fact that I recommended against buying the new Warner Discovery at the same time, and heeding that warning saved a lot of money, makes me feel a little better, but not much.
And no, the fact that Warren Buffett made the exact same mistake as me doesn’t help much, either. Mr. Buffett and I are about to part ways, anyway. He is now completely sold out of Paramount, while I am hanging in. Yes, I am still buying. Get all the ribbing out of your systems, and then read on.
Although a few rounds remain to be played in the game, it is no longer inconceivable that none of the various deal permutations that have been put forward for Paramount will pan out, and that it will continue as an independent company. Essentially, Redstone will block a deal with Apollo Global Management, Inc. (APO) and Sony Group Corporation (SONY) and the ‘B’ shareholders will litigate a Skydance deal to death.
Because so many Seeking Alpha articles are already offering a blow-by-blow analysis of the deal talks – and I absolutely encourage you to read them – I wanted to turn back for just a minute to a more in-depth look at Paramount’s actual operations. If it stays independent, can it turn itself around?
Scale Is Not The Issue
I’m angry. Usually, when an investment goes wrong, I can manage to be philosophical or even dispassionate about it. Risks of the trade, can’t win ’em all, pick your maxim.
But this one is really getting to me. I’m sure part of that is simply the sheer amount of my portfolio that has suffered – I bet a lot more on Paramount than I did on my typical investment, so sure was I that it had the tools needed for success. Fortunately, some of my other media investments have worked out much, much better, or I’d really be hurting. In fact, my Netflix buy has repaired all the damage my Paramount buy has done.
Still, I’m unusually angry, partly because of the sheer amount lost. But it’s also that I still don’t believe there is anything wrong with Paramount, at its core. It has become quite commonplace to speak of Paramount’s “lack of scale” as the reason for its apparent impending demise, or at least subsumption. But I would still argue that that isn’t born out by the numbers. Paramount spent roughly $16 billion on content in 2023, the same total as 2022, when $4 billion of it was spent on streaming. That is only slightly less than Netflix, Inc. (NFLX) which leads the industry in market cap and performance, if not in spending. While the gap with other studio peers is larger, I’m not sure spending at Netflix levels equals a “lack of scale.”
What’s more, a lot of that extra spending by other traditional industry players like Warner Bros. Discovery, Inc. (WBD) and The Walt Disney Company (DIS) is not spending that investors should necessarily cheer. As I’ve explained before, Paramount’s lower spending total is almost entirely accounted for by its far more profitable approach to sports rights; a lot of that extra spending that Disney and Warner are doing isn’t particularly profitable or even sensible.
What then, does account for Paramount’s underperformance?
Stock Performance
That depends on which underperformance you’re talking about. First, the stock price. Paramount cut its dividend in spring 2023. That announcement, with its Q1 earnings, was enough to cause half of the past-year decline in a single day. Paramount went from $21 to $16 with the dividend cut and was still at $16 as late as December.
Since then, the other half of the decline has reflected the increasing evidence that Paramount is more or less ready to throw in the towel, and intends to be a distressed seller to another studio or private equity firm soon. More specifically, it is actually Shari Redstone, who exercises control over Paramount through her 77.3% share of Paramount’s Class A voting stock, who is ready to call it quits. The perception that she has no leverage and will be forced to accept a fire sale offer has driven the stock lower.
Operations
All that, however, merely explains the stock market decline; what is the operational explanation for Paramount’s troubles? The company reported a $600 million loss for full year 2023. How is it that one of the Big Five movie studios, with the most popular of the Big Four broadcast networks, the most popular show on cable (Yellowstone) and the only profitable sports slate in American television, can’t make money?
Accounting Element
First, we need to acknowledge that there are some accounting factors in that 2023 loss. Paramount took a “programming charge,” i.e., a write-down of the value of programming assets, of roughly $2.4 billion in Q1 and Q2 last year. That is money that would ordinarily be amortized over a period of years – it’s mostly streaming originals, which Paramount usually amortizes over a 4-year period – that instead saw its red ink taken all at once. Had it been amortized normally, Paramount would have reported an operating profit of roughly $1.2 billion, more or less identical to 2022, instead of reporting an operating loss of the same amount.
Still, that write-down reflects the fact that the content isn’t performing well, so those losses were always going to happen, and they’re quite real; the accounting change is simply a timing issue. So Paramount is operationally deficient, even if perhaps not quite as operationally deficient as this one-time write-down makes it look. We cannot dismiss Paramount’s operational issues by putting them down to accounting distortions.
TV Scripted Content Difficulties
Paramount did not break down the programming charge, but outside reports have about half of it owing to the integration of Showtime in Paramount+ as a single service. It’s not entirely clear which side of the ledger those losses are coming from; one of the less understood things about merging services is that it potentially makes content on both sides less valuable as it is replaced by more popular content from the other side. Showtime’s Q1 2023 viewership was very top-heavy, with just two shows, Yellowjackets and Your Honor constituting 30% of all viewership. Presumably, those two shows reduced the value of some Paramount+ existing content while the rest of Showtime’s library may have suffered from competition with P+ content.
Regardless of the exact source, Paramount’s content is not performing. That’s a little surprising considering that, as I said, CBS content is actually quite popular on the linear side. In fact, in the earnings call following the annual report now-former CEO Bob Bakish reported that CBS had the top 16 scripted programs and 18 of the top 20 in the first week of post-strike broadcasts. Paramount has disclosed in the past that CBS content makes up roughly half of the viewership on Paramount+; and this is despite the fact that P+ isn’t even the sole beneficiary of CBS content; roughly $600 million per quarter of Paramount’s licensing revenue comes from CBS shows as well.
One possibility that I perhaps did not consider sufficiently was the chance that the unique characteristics of CBS would make it harder for that channel to transition to streaming than its other broadcast peers. CBS is the most popular of all broadcast networks, but that popularity owes disproportionately to more elderly viewers; in the demo, it is actually Comcast Corporation’s (CMCSA) NBC which takes the top crown.
With elderly viewers both less appealing to advertisers and less likely to make the transition to streaming, it is perhaps not so surprising that CBS is continuing to perform well on linear but having trouble translating that to streaming.
International Shortfall
The damage isn’t through yet, either. Paramount disclosed that it took another $1.2 billion impairment charge on content in the first quarter. This one has to do with the international side; a few years ago Paramount commissioned 150 new, original international shows and movies to try to boost international growth. Now, Paramount reveals that even international consumers spend no less than 90% of their time streaming Hollywood content; the local originals aren’t doing very much for growth or retention.
About the only good thing that can be said about this complete and utter debacle is that it is a one-off; unlike Paramount’s US content spending, which is ongoing and therefore must be made more efficient if Paramount is to survive and thrive, Paramount is gradually exiting International production. In fact, to help cover the losses on its international originals it is selling its share in Viacom18, the network that formerly served as Paramount’s onshore operation in India, to its partner Reliance for a little over $500 million.
Where Are The Children?
Yet another factor is children’s programming. While many have essentially written off Paramount’s entire cable channel group, and I agree the prognosis for MTV and Comedy Central is rather grim, I have argued that Nickelodeon remains a real asset, as one of the top two children’s channels in linear TV. I believed that would be a powerful subscriber acquisition tool, alongside sports, as the streaming transition continued.
It hasn’t worked out. Surveys consistently show the Big 3 for parents with children are Netflix, Disney, and the third is Amazon.com, Inc. (AMZN) of all things. Neither Paramount+ nor Warner Discovery’s Max make the cut, despite ownership of top children’s linear platforms/libraries Nickelodeon and Looney Tunes, respectively.
The prognosis here isn’t entirely grim. Paramount has reported that half of their streaming subscribers touch kids’ content regularly, so clearly Nickelodeon does mean something to the subscribers. It’s possible it helps with retention, even if it doesn’t drive acquisition. Paramount owns the number one brand for pre-school kids, Paw Patrol.
Paramount has shut down the separate Noggin streaming service and will presumably be amplifying the kids content on P+ as a result, so perhaps this trend will yet turn around. With so many other things going wrong, though, the inability to make kids content more central to the strategy is a painful blow.
The Mismanagement Of Streaming
I suspect, however, that Paramount’s single biggest defect over the past few years has been the competency of its management. In a streaming world, success hinges overwhelmingly on the efficiency with which a content budget is deployed. That efficiency, in turn, requires avoiding the trap of “overload,” something cable doesn’t have to worry about but which can kill a streaming service.
What Is Overload?
In brief, overload is when a streaming service spends money on content that appeals primarily to those subscribers who were already subscribed and intending to remain subscribed, even without that content. Because revenue does not increase with more viewership, such spending is essentially wasted money. I have been arguing for several years that some economic models of streaming profitability fail to take account of this significant element.
Paramount seems to have had a lot of overload in the last few years. Specifically, its single most broadly appealing piece of content is the NFL, which Paramount is an anchor broadcaster for. Because NFL fans are accustomed to spending upwards of $100 a month on cable just to watch the NFL – over 10% of cable subscribers say that the NFL is the only reason they’re still subscribing – Paramount’s $6-$12 a month fee for streaming really doesn’t need anything more than NFL games to attract these 40-50 million fans.
The Earnings Jaw-Dropper
And yet, it seems that’s where a lot of the extra streaming money has been going. On the Q2 earnings call last year, CEO Bob Bakish, watching the stock price steadily decline, seemed to be eager to reassure he had a handle on the situation and began describing some of the changes he’d be making. It started out well enough, really; he told investors that NFL viewers churn drops dramatically if they also engage with entertainment titles, which is what you’d expect.
But then, he stunned me and I expect just about everyone listening when he said, “we probably need to do less for [the NFL viewer] in the fall, and more outside the fall because we can rely on the NFL.” Compounding the almost Looking Glass-feeling, he then went on to reassure everyone he would be “fine-tuning” the content strategy to address that point in the years to come.
It was, frankly, stunning. Both me and I suspect just about every analyst who was modeling Paramount had just assumed it went without saying that of course, any entertainment content targeted at retaining NFL viewers should drop in the other half of the year when the NFL wasn’t playing on TV. My own calculations of the profit margin on CBS’s NFL deal had always incorporated that.
And while that was bad enough, it also raised the concern that a management team that didn’t understand that going in might have put a lot of other overload in other categories as well. Suddenly, it wasn’t so hard to see how the best-scripted shop with the most profitable sports contracts was having trouble making money. Double-loading for 50 million households would be a major drag on the financial performance for streaming.
Light At The End Of The Tunnel
Despite all of this, I still think there are bright spots in the Paramount picture, even without a merger. Its operations, as well as its merger discussions, don’t seem to lack potential.
#1: My Usual Paramount Bull Argument: Sports Profits
One thing that continues to go right is sports content. A few years ago, I wrote that Paramount was a strong contender to become a sustainable streaming business because it had the only profitable sports slate in the business. The stock hasn’t gone where I wanted it to go, but that is the one part of my thesis that has been definitively borne out. In fact, many now say that it is CBS’s sports deals, at least as much as Paramount’s film/TV studio, that the prospective buyers of Paramount are after.
I’ve covered these in other articles already. The March Madness deal runs until 2032 and the NFL deal runs until 2033, although the NFL has an opt out after 2029 that it will probably exercise given the utterly ludicrous bids the NBA is receiving, so the last four years of that deal might have to be chopped off the profit projections. Even so, Paramount can probably generate $1.25 billion a year in profit just off of those two deals for the next six years.
Those are probably the biggest, but it doesn’t stop there. Almost every sports deal Paramount has is profitable. For all the flak management has deservedly taken, Paramount continues to show discipline and focus on sports. You won’t find Paramount throwing $2.5 billion a year at the NBA’s ‘B’ package, which is more money than the NFL gets for its ‘B’ package despite having 10x the viewership.
For all its many, many missteps, a Paramount that can just manage to stay afloat long enough for some of these ludicrous sports bets at other companies to blow up may yet find itself with cards to play later in the decade.
#2: Recouping Write-downs Via Preferred Conversion
Another small boon has been the official conversion of the preferred shares. The Paramount mandatory convertible formerly trading under the PARAP ticker was capped at 0.85 shares per common share. Given the initial price of the convertible at $100 per share, that effectively means that a preferred share that was carrying a $100 liquidation value has just been converted into 1.1765 shares of a common stock currently trading around $12. A total value per preferred share of around $14.
And they sold for $1 billion, so that’s basically $860 million back into the common equity that management was able to get at the peak of the boom. That actually repairs almost all of the red ink from Paramount’s doomed international originals push on its own.
#3: An End To Streaming Waste
Finally, a lot of the waste in streaming may soon be ending. Bob Bakish was finally fired a few weeks ago, and while I never want someone to lose their job, he frankly had looked overmatched for a while. Bakish was a lifetime cable executive who seemed to be having trouble making the transition to a streaming-world mindset. Frankly, if I knew about it in 2021, the CEO has no business fine-tuning it into the strategy in 2023.
With international originals no longer draining the coffers and overloaded entertainment programming shifted to months of the calendar where it can be more productive, streaming may yet turn the corner.
Investment Summary
I recognize fully that each fall in Paramount stock makes my bullish optimism seem ever more out of step. I do believe, however, that Paramount’s failures are more failures of execution than lack of scale or structural disadvantage. Paramount CEO Bob Bakish simply wasn’t up to the job. Ironically that wasn’t what got him fired; Bakish was almost certainly fired for opposing Redstone’s plan to enrich herself at the expense of other shareholders, probably the most competent thing he did in the last few years of his whole tenure.
Paramount has everything it needs to be successful; profitable sports contracts, which is just unbelievable in this day and age, a thriving scripted TV operation, and a viable, if recently somewhat mismanaged, streaming service. An end to overload waste, the continued exploitation of its favorable sports slate, throttling back unhelpful international originals and boosting kids content engagement may yet produce a different streaming picture going forward. Should older viewers start to get more comfortable with streaming going forward and following their favorite programs to Paramount+, that would just be icing on the cake.
It’s been a depressing ride the last few years, but I’m sticking with Paramount.
