Hats off to the box office — 2022 has been a good year driven by the return to normal. Now that economies are reopening, top execs at Warner Brothers and other movie companies want back into theaters. Warner’s CEO, David Zaslav, mentioned on a conference call that the company plans to forgo the “streaming first” approach in lieu of fully embracing theatrical. He said that Warner “cannot find an economic case” for releasing high budget films direct to streaming. The facts look encouraging, highlighted by Paramount’s Top Gun: Maverick which cleared $1.38B in global box office revenue over a 17-week run, making it one of the Top 10 domestic movies of all time.
There’s more good news for theaters. Next year, momentum should continue with an increase in ticket sales due to a recession. Economic downturns have historically triggered upticks in box office revenue. Take 1929, for example, when sales jumped nearly 60%. Or, in 2019, when they rose almost 18%. While we expect increasing box office revenue next year, those sales don’t change the revenue bullseye for content producers: streaming.
Even after the pandemic, it’s still all about streaming
Taking a step back, pre-pandemic global theatrical revenue was about $42.3B while global streaming services made up $45.5B of the global market (source: Comscore, Netflix reports, Loup Funds). In other words, theatrical’s 43% of market share was behind streaming at 46%. The pandemic accelerated the transition to streaming with digital eating up nearly half of theatrical’s share in 2020. This was driven by Netflix growing its revenue +47% from 2019 to 2021.
We estimate that in early 2021, streaming subscriptions made up 95% of global entertainment revenue market share (excluding digital downloads). As we exit the pandemic, the digital streaming market share has remained surprisingly high. To get a current read, we compared the first half of this year’s streaming revenue for the top five platforms (Netflix, Prime Video, Apple TV+, HBO Max and Disney+) to total box office revenue, and found that streaming still captures 90% of revenue spend. This excludes the long tail of 95+ other streaming services that would inch the digital market share higher.
The winning formula
Even with the surge in box office revenue this year, the underlining trend remains clear. There is more money to be made selling content for home/mobile and the digital distribution model is near free, in the case of Amazon and Apple. For Disney, Paramount and Warner Bros, making money in Hollywood is simple: take a pre-loved action series, add A-list talent, spend >$100m in marketing, and out comes Top Gun: Maverick.
Apple has an advantage: the deepest pockets in Hollywood
Apart from Amazon Prime sitting on more than 20K titles from MGM’s pre-1986 catalogue, we think it’s Apple that is best positioned to grow share from its fractional 2% streaming revenue share today (30m paying subs). Funded by nearly $100B+ in annual operating income, Apple’s content spend is without bounds. This gives them an advantage in Hollywood development deals and attracting top tier talent. On the company’s March 2022 earnings, Tim Cook said that Apple doesn’t make “purely financial decisions” on its content acquisition—which underscores the company’s commitment to developing quality content. In terms of UI, Apple may also be the only streaming service that can run ad-free in the long term. Currently, Prime Video and Peacock have part of their library supported by ads, while HBO, Disney+, and Netflix are exploring ad-based models. The bottom line: it seems inevitable that most streaming services will show ads in the future, which can become a selling point for Apple TV+.
Apple’s content spend supports its growing list of talent, including a recent deal with Tom Hanks’ production company, Playtone; Natalie Portman’s production company, MountainA; Leonardo DiCaprio’s production company, Appian Way; and Idris Elba’s production company, Green Door Pictures. Not to mention contracts with Oprah Winfrey, Alfonso Cuarón, Ridley Scott, A24, and Sesame Workshop. Separately, Apple continues to develop its sports broadcasting capabilities, with its MLB Friday Night Baseball deal and a 10-year deal with MLS. We believe that NFL and Formula 1 races will follow within the next two years.
The one downside of Apple TV+: While the quality of its content is high, its library isn’t filled enough to compete with the likes of Netflix, Hulu and HBOMax. In the end, we believe quality will win over quantity.
Competition is only slightly intensifying
Over the last six months, we have seen negative headlines from the streaming services with a recurring theme of increased competition and a return to normal headwinds. While Netflix has been tagged with the “biggest loser” label, with shares of NFLX down 60% this year, the business has been surprisingly stable. In 2022, we estimate that the company has lost only 2% market share which amounts to about 1M canceled subscriptions out of 220m total. On Netflix’s June 2022 earnings call, management mentioned “competition” a total of 9 times compared to 4 times in the prior year period. Its competitors (Prime Video, Apple TV+, HBO Max and Disney+) each gained 1% market share, still leaving Netflix with 21% at the close of the June 2022 quarter. Prime Video follows with 20%, HBO Max with 15%, Disney+ with 14%, and Apple with about 2%. This implies that the Top 5 have generated about $100B in streaming revenue globally over the past 12 months.
The takeaway: Streaming is a profitable ancillary business alongside the revenue of Amazon’s retail store, Disney’s parks and merchandise, and Apple’s iPhone. As Jeff Bezos said: When Amazon wins a Golden Globe, it helps sell more shoes.
Paramount and Universal have a chance
There are four major film studios (Universal, Paramount, Disney, and Warner Brothers) that made up 76% of the $5B in box office sales this year. Disney is already a cornerstone of streaming, leaving two studios that stand out as streaming laggards: Paramount and Universal.
Good news for them: There is still time to change course, and return to a “streaming first” approach.
For any given topic — financial markets, individual stocks, entrepreneurship, politics — people fit into four categories: apathetic, interested, extremist and transcendent.
These mindsets fill the pyramid in inverse order:
The apathetic always make up the majority. Most people don’t care about most things. They don’t even factor into the game. They’re in the background as non-player characters (NPCs). If you care about something, you can’t be an NPC. If you are an NPC, you don’t care about the game in question.
The interested are interested. They take some initiative, but they’re not subsumed. They’re in just enough to matter to them. The interested don’t know enough to truly think for themselves; they look to the extremist and the transcendent to tell them what to think.
The extremist holds an unyielding view about a certain topic. Extremists are loud about and often get attention for their views. They will not change their minds nor will they capitulate to ideas that don’t directly support their view. Constant extremity gains attention and pushes edges. The extremist convinces the interested to follow them, since the interested aren’t often looking for complex thought or truth. They’re looking for tribes. Extremists are natural tribal leaders, religious leaders.
The transcendent mind operates with the ultimate mental flexibility. They can embrace extremes, but they’re also capable of changing their minds—often rapidly—upon new information. Unlike the extremist, the transcendent seeks truth where the extremist seeks allegiance to a cause. Transcendents have the most flexible minds. Extremists the least.
It may seem that transcendence is the best mindset because it’s at the top of the pyramid, but there are times when the extremist mindset may be better. There are more “successful” extremists than transcendents — if success involves money, attention, or power. That’s how most people define success for better or worse. Extremists make the best entrepreneurs, creators, and politicians (if the goal is winning votes). Transcendents make the best investors.
To start a business and dedicate a career, that takes an extremist. You need to land on a new island and burn the boats. There’s no going back.
A belief that people would want to buy cloud software in 2000 or electric cars in 2004 or ride sharing in 2008 or room sharing in 2009 or digital assets in 2012 or NFTs in 2018. All those ideas seemed crazy at the time. There is something in 2022 that we will look back on and say, “that was crazy, but it worked.” What will it be?
Because of his impassioned belief in the unreasonable, the extremist entrepreneur can convince the interested to work with him. He can also attract investors. The extremity of an entrepreneur is an underrated signal for the potential of extraordinary returns that make great venture funds, and in some cases, great public market investments.
Audience is becoming the most valuable asset in the digital era. Audience builds influence, influence gives power, power builds more audience.
Audience is most easily won through extremity, per the pyramid. Extremists attract the interested. In some cases, they might even get the apathetic interested. Like the progression from audience to influence to power, extremity sparks audience. When audience is gained through extremity, it is extended through more extremity. If the audience doesn’t get the extremity that attracted it, they will go elsewhere to find it.
All attractive extremity is ideological in nature. It lends itself to cults. It requires faith in certain beliefs that may not be true. Obvious truth is never extreme because something everyone must accept cannot be extreme. Gravity is not extreme. By contrast, undiscovered or unaccepted truth and untruth must always be promoted in the extreme to gain any believers.
Politics is necessarily the domain of disputed truth. If politics were only about undeniable truth, we wouldn’t have anything to argue about.
One of my favorite quotes is:
If you say you’re a unifier, you expect and usually get applause. I’m a divider. Politics is division by definition, if there was no disagreement there would be no politics. The illusion of unity isn’t worth having and is anyways unattainable.
- Christopher Hitchens
The best politicians attract the most attention, grow the biggest audience, and thus gain the most power. This may be axiomatic to anyone paying attention to modern politics on either side. It also means that the “best” politicians must be the ones who most effectively employ extremity.
The Hitchens quote could just as easily be about investing with a nuance: Unity is possible to attain in investing. One of my partners has a saying that successful investing is having everyone agree with you later.
The best investments eventually become consensus. Investing in Apple when everyone hated it in the early 2000s or doubted it in 2016 was non-consensus. Now everyone loves it, and the investment has been a great one.
The best investors are not ideologues but truth seekers. They must be flexible enough to change their minds lest they lose all their money by being wrong, particularly when exploring the non-consensus. Flexibility is an asset for the transcendent but a liability for the extremist where changing minds means losing power.
Consider the two classes of extremist investors: The permabull vs the permabear. Permabulls are right for long periods but when things get bad, they blow up. When they’re wrong, they can be really wrong. Permabears are the opposite. They’re wrong for long periods of time with occasional events of apparent genius. Early 2022 was permabear heaven and permabull hell.
The thing is that both permabulls and permabears can eventually find great success if they live long enough. And, most will also find painful decline if they keep living beyond that success. The optimal investor mindset is to accept when markets are dangerous and when they are opportune. They aren’t always one or the other. Or, forget markets and just look for the contrarian company or idea where everyone will agree with you later.
The US-China dynamic has worked in Apple’s favor on both the production and the demand front, and I expect this trend to continue for the next couple of years. That said, since February, I’ve been bugged with the question — What would happen to Apple if the relationship between the US and China rapidly deteriorated? While I don’t believe that the superpowers will be at war within the next couple of years, the conversation is one worth having given the increased Taiwan-related rhetoric coming from the PRC.
China makes its case for Taiwan
Outside of its recent military exercises, China published a white paper on Aug. 10 titled The Taiwan Question and China’s Reunification in the New Era. It’s the first paper in more than 9 years since Xi Jinping rose to power, and opens with the statement: “Resolving the Taiwan question and realizing China’s complete reunification is a shared aspiration of all the sons and daughters of the Chinese nation.” The punch of the white paper: China “will tolerate no foreign interference in Taiwan.” I can feel the pressure building, and I believe Cupertino can too.
Apple has meaningful China exposure
Apple’s business is more sensitive to the topic given our estimate that 75-80% of the company’s product sales, or 60-62% of overall sales, are “Made in China.” On top of that, 18% of Apple’s annual revenue comes from Greater China, essentially equal to the size of its Services business. Compared to other big tech companies, I believe that Apple has the most China exposure. But, it’s worth noting that Amazon also has significant exposure based on the number of its products that are made in China.
Where Apple stands today
On Apple’s March 2022 earnings, Katy Huberty asked a key question related to China: Are you starting to rethink your broader supply chain strategy or the manufacturing footprint? Are you happy with the overall geographic exposure that you see in the supply chain? Cook’s response was: I think our supply chain does very good because it’s a fast-moving supply chain. The cycle times are very short. There’s very little distance between a chip being fabricated and packaged and a product being – going out of factory.
I have two takeaways from the exchange. First, the working relationship between Apple and its China partners is running smoothly today; an incredible statement given the headwinds from COVID and supply chain disruption. Once these headwinds ease, I believe that the Apple-China flywheel speed will increase which should benefit earnings. Second, Cook did not answer an important part of Huberty’s question: Are you happy with the overall geographic exposure? I believe Cook did not answer that because he’s thinking about supply chain diversification.
One of Cook’s next chapters: supply chain diversification
While it will take years, I believe that Apple is in the process of reducing its reliance on China. Apple thinks about its business in terms of decades, and in the end, I believe the company will be successful in building production and a strong user base outside of China. My confidence stems from a belief that one of Apple’s core competencies includes production and supply chain management. Of course, Tim Cook has decades of experience in navigating the political landmines that come with relying on a global supply chain. Based on that experience, I believe he sees the writing on the wall and the need to lessen exposure to the region.
Separately, I believe that Cook will write two more chapters as CEO of Apple. One on the new product category side, which will most likely be something in AR, health or auto. Second, a chapter on supply chain diversification. If you’re wondering, my guess is that Cook will retire between 2026-2028, based on his age (61 y/o) and option package. This would mean he has plenty of time to position the supply chain for the next decade.
Apple is serious about diversifying to the US
In January 2018, Apple announced a commitment of $350B for US-based development and job creation (+20K jobs). In part, this was done as a response to political pressures imposed by Washington to bring jobs to the US. Nearly a year later, Apple announced its plans to build two $1B campuses — in Austin, TX and in North Carolina’s Research Triangle Park (RTP). Then, in April 2021, Apple announced that it would add $80B and another 20K jobs to its original $350B investment, bringing the total investment to $430B over a five year period. It’s worth noting that while there’s less pressure from Washington, Apple still upped their investment in the US by $80B — a 23% increase.
While the numbers are impressive, Apple’s incremental investment is likely less, ~20% of the $430B. That still means the company is investing $86B over the next few years in the US, a huge sum when considering that Intel and TSMC believe building a new chip fab in the US costs between $10-20B. After the current investment commitment ends in 2026, I expect the company to invest within the US at a similar incremental pace of about $17B per year.
Outlining Apple’s supply chain
Based on Apple’s 2021 Supplier List (which was the last time the list was made public), we took a deeper look at the company’s suppliers, supplier locations and refiners of raw materials. The bottom line is 75-80% of Apple’s product production is tied to China. Here are our findings:
- Of the company’s 395 global suppliers based in 572 locations, 40% of those are based in China.
- Of the most common elements found in Apple products, 34% of the company’s refiners are based in China. And, virtually 100% of the Lithium used in Apple products is sourced from China.
- The iPhone makes up 52% of Apple’s annual revenue. And, production relies on four companies for final assembly: Foxconn, Pegatron, Luxshare Precision and Wistron. Those companies are predominantly based in Juangdong, Jiangsu and Shanghai. We estimate that nearly 77% of iPhone assembly occurs in China-based factories.
- Separately, when we look at the companies assembling the MacBook, iMac, MacBook Air, Watch, AirPods and iPad, and estimate that 75-80% of all Apple products are “Made in China.”
Source: Loup Funds