Our Revised 2023 Base-Case Scenario

S&P Global economists recently updated their macro-economic forecast for the U.S. (see "Economic Outlook U.S. Q3 2023: A Sticky Slowdown Means Higher For Longer," published on June 26, 2023). While our base case no longer includes a recession, we now expect a prolonged period of slow economic growth in the back half of 2023 (with less than 1% GDP growth) that will continue into 2024. The balance of risks to our economic forecast are tilted to the downside, with the risk that persistently high interest rates and inflation will deplete consumer savings.

Table 1

A persistent ad recession

Despite a modest improvement in the economic forecast, which no longer includes a macro-economic recession in the base case, we expect advertising trends to remain depressed through the rest of 2023. Based on recent comments by the media companies during first-quarter earnings calls and at industry conferences, we believe that advertising spending, especially by national advertisers, remains weak. Since early last year, advertising has been characterized by general malaise and step-downs related to macro shocks along with brief, but unsustained, improvements. A few media companies have argued that a second-half 2023 recovery is possible, but we remain skeptical as we have yet to see any change in advertiser sentiment. Advertisers continue to delay purchasing decisions until closer to airtime. When they do make a commitment, they are demanding more flexibility to cancel or delay. As a result, transparency into longer-term trends is limited. We are unlikely to get clarity on second-half trends until the end of the summer when the college football and NFL seasons get under way.

A weak TV upfront indicates advertising's current challenges

In practical terms, it's difficult to ascertain year-end 2023 advertising trends as the only advertising that is purchased that far in advance is national television through the annual upfront, TV's advanced sale of its key ad inventory. The 2023-2024 broadcast TV upfront has been under way for nearly three months, and we still await the first major deal announcements. In prior years, especially before the COVID-19 pandemic, the upfront was nearly completed at this point, with roughly 70% of ad inventory committed and CPMs (the cost per 1,000 viewers) higher usually by mid- to high-single-digit percentages over previous year's ad pricing. So far this year, few upfront deals have closed, and the current pacing is for less inventory to be sold and for pricing to be at roughly the same levels as last year's upfront. We believe the upfront is affected by three factors:

A weak economy.  Historically, when the economy weakens, advertisers favor buying ad inventory through the scatter market versus committing early to the upfront. If the economy recovers and demand for ad inventory increases, advertisers end up paying higher CPMs.

Declining audience ratings.  Audiences watching non-sports programming continue to tumble by double digits. As a result, advertisers appear to be increasingly unwilling to pay a premium for non-sports TV inventory.

Writers' strike.  Unless resolved soon, the ongoing writers' strike will hurt the 2023-2024 broadcast season as scripted content will not be available to air. Advertisers are reluctant to buy TV inventory without knowing the scheduled programming.

Weak national advertising constrains all media while local remains healthier

National advertising, whether on television, digital, outdoor, or radio, remains the most challenged ad category. It first softened for digital and radio toward the end of the first quarter of 2022. It then spread to television, through the scatter market, first at the end of the 2022 summer and again at the end of the year. While national appeared to stabilize in the first quarter, it weakened further in March and again in April, most likely due to the regional bank crisis.

Local advertising, on the other hand, has remained relatively healthier compared with national, though it has recently softened for television and radio. What's behind this recent softening is not clear. Historically, local advertising trails macro-economic activity and so it may be just the case that local advertising is finally reacting to a weak economy.

Lowering our 2023 ad forecast by pushing out any recovery in ad spending to 2024

We lowered our 2023 U.S. ad forecast due to weaker national ad trends. We now expect overall advertising to grow 2.4% in 2023 and 8.2% in 2024. Because weakness in national affects all advertising media, we lowered our ad estimates across most media including national TV (broadcast and cable) and the national advertising components of outdoor and digital. While radio also has a frail national component, we raised our radio estimate by 300 basis points to a decline of 7% as local radio is performing better than our previous expectations.

Table 2

Streaming's second-half performance is critical to a path to profitability

We believe that achieving profitability is a function of two key points. One is by boosting revenues by raising ARPU. Two is by lowering per subscriber costs by controlling programming, marketing, and back-office costs. Media companies are pursuing the former through greater pricing segmentation including ad-light options and raising prices of their ad-free options such that the all-in (subscription and advertising) ad-light ARPU matches with the ad-free APRU.

The second half of that path is by controlling operating costs, in particular moderating content spending. Not only does this include scaling back new original content development, it also means reducing the amount of content available on their streaming services. While at first media companies put their entire studio libraries onto their owned DTC streaming services, this has proven to be uneconomic, and we expect companies will reevaluate whether to write-down or license certain content.

We believe these actions can help the legacy media companies in their pursuit of streaming profitability. We think 2022 is likely the high loss year for Disney and WBD and 2023 is for Paramount and NBCU. All four companies remain focused on achieving their goal of reducing operating losses and eventually reaching breakeven soon. Our thoughts on Netflix and the four global media companies are:

• Netflix Inc. has already proven that that streaming can be profitable with 20%+ margins. The next question is how much higher can margins go?
• The Walt Disney Co. has said that its high loss inflection point was at the end of 2022. We expect Disney+ to reach breakeven in 2024 and for the entire streaming segment to be EBITDA positive in 2025.
• Warner Bros. Discovery Inc. (WBD) reported $50 million of segment profitability in first-quarter 2023 and now expects to be breakeven in the U.S. this year. The company expects to generate $1 billion in segment cash flow next year.
• Paramount Global's path to profitability remains a work in progress. The company expects 2023 to be its peak loss year but has yet to offer a breakeven target year. The company launched Paramount+ in 2021, a year behind everyone else.
• Comcast Corp. (NBCUniversal Media LLC)expects 2023 to be its peak loss year as well, but, similar to Paramount, has yet to announce timetable to breakeven.

An unsettled writers' strike could exacerbate media industry pressures

The Alliance of Motion Picture and Television Producers' (AMPTP) contracts with the three largest Hollywood professional entertainment unions--the Writers Guild of America (WGA), the Directors Guild of America (DGA), and the Screen Actors Guild–American Federation of Television and Radio Artists (SAG-AFTRA)— are renegotiated every three years. The AMPTP represents over 350 U.S. television and film production companies, including Walt Disney, Warner Bros Discovery, Netflix, and Paramount.

To almost no one's surprise, this year's negotiations have been contentious as the many of the terms in the current contracts have not kept up with the significant changes that have overtaken Hollywood in the last few years. On May 2, 2023, two days after the current contract expired, the Writers Guild of America (WGA) went on strike (the DGA agreed to a new contract before its contract expired on July 1 while negotiations between the SAG-AFTRA and AMPTP continue as of July 7, 2023). The key issues for the writers include higher pay, better residuals from streaming, larger writers' rooms, and safeguards against artificial intelligence. The immediate effect of the strike was the halting of most domestic-based productions either because writers were needed to continue the work or because staff (actors, directors, other union members) refused to cross picket lines.

The financial impact of the strike will depend on how long it lasts. If the strike is resolved before the end of the summer, we wouldn't expect a lasting material financial impact. In fact, the media companies may exceed third-quarter 2023 EBITDA and cash flow expectations. That's because while the strike may have only a modest impact on revenues, companies' programming spending will be lower if productions are shut down. If the strike were to last longer, the financial impact could become material. The television networks and DTC streaming platforms won't have new scripted content, especially for the 2023-2024 TV broadcast season. The media companies may then rely on reruns, foreign content, or unscripted shows to satisfy audiences. This would likely cause advertisers to pull back spending and consumers to either drop or not sign up for DTC streaming subscriptions, which will hurt revenues.

A prolonged strike could also delay feature length film development, leaving holes in theatrical release schedules and reducing licensing revenues. From a ratings perspective, we remain focused on the timing, severity, and potential outcome of this writers' strike including the timing of studio revenues and cash flows, impacts on the competitive positioning for studios and producers, and longer-term implications for profitability once an agreement is reached. The last two strikes in the sector were by the WGA in 2007 (lasting 100 days) and in 1988 (lasting 153 days).

An update on our proposed media sector review

In December 2022, we introduced the idea of reassessing our view of the media sector and the possibility of tightening our downgrade leverage thresholds. We had contemplated doing our review sometime in 2023. Since publishing that commentary (see "Media Industry Implications From Our Rating Action On AMC Networks Inc.," published on Dec. 22, 2022), many media companies have made changes to their business strategies, in particular adjusting their streaming models to focus on profitability over subscribers.

We note two updates. The first regards the timing of a possible review. The second update regards how we may reflect changes to the media business in our credit ratings analysis.

Timing of our review

We are more likely to hold our review in 2024 than this year for a number of reasons:

• Advertising spending remains in a stubborn recession, reflecting advertisers' concerns that consumer spending will weaken. Assessing the media sector during an advertising recession would not provide an accurate picture of the company's normalized credit metrics.
• Media companies have begun repairing their studio model. This business used to generate solid cash flow from the licensing of library content to third parties. With the launch of in-house streaming services, this cash flow stream mostly disappeared from the large captive studios. However, many of the captive studios plan to move back to a hybrid model which includes both content made exclusively for in-house streaming and third-party licensing. We want to assess how this development progresses as it could improve our view of the studio model.
• The U.S. diversified media companies are moving with a sense of urgency toward free cash flow breakeven for their streaming services. As discussed above, this includes focusing on both raising APRU and controlling costs. We would like to see how this push to profitability progresses before passing judgement on the entire media sector.

Free cash flow (FCF) to debt as a possible companion credit metric

In previous industry commentaries, we said that we could tighten our downgrade rating leverage thresholds to reflect weaker businesses. Although our historical key credit metric has been leverage, i.e., debt to EBITDA, there are other metrics that we could use. In particular, the secular changes affecting media will likely permanently weaken cash flow metrics. Thus, we could consider adding an appropriate cash flow metric, such as FCF to debt, to our credit analysis. We recently included a FCF-to-debt metric in our Disney outlook statement (see "Walt Disney Co. Upgraded To 'A-' On Improving Leverage; Outlook Positive", published June 5, 2023).

Related Research

• Credit Conditions North America Q3 2023: Risks vs. Resilience, June 27, 2023
• Economic Outlook U.S. Q3 2023: A Sticky Slowdown Means Higher For Longer, June 26, 2023
• SLIDES: U.S. Media & Entertainment Industry: Pouring Recessionary Gasoline On A Secular File, 2H 2023 Edition, June 23, 2023
• Walt Disney Co. Upgraded To 'A-' On Improving Leverage; Outlook Positive, June 5, 2023
• The Ratings Outlook For The Local TV Industry Is Stable Despite Emerging Risks To Retransmission Revenue, May 1, 2023
• U.S. Advertising Forecast Revised In Light Of A Potential Shallower Recession, March 29, 2023
• Calculating Leverage For Large U.S. Media Companies (2023 Update), March 13, 2023
• Media Industry Implications From Our Rating Action On AMC Networks Inc., Dec. 22, 2022