Uncertainty, Technology, Content, and Tangible Examples

I'm easily contented in certain scenarios with uncertainty.  DreamWorks Animation, which I recently wrote up, faces an uncertain future in regards to DVDs.  While they have historically been a major contributor to profits, there is a clear change as the digital era gains traction.  I recommend The Black Swan and I consider it a key intellectual text for investors - you can find the same intellectual strains in texts from Ben Graham to Stephen Jay Gould, but Taleb's writing is particularly approachable.  

One of the key points is not to focus on details you can't control, but instead on creating robust systems.  Just-in-time lean inventory is fragile, where as having 2 eyes, kidneys, and lungs is robust.  Most debt free companies are robust.  They can lose a customer or lose production in a natural catastrophe, but bounce back. 

Taleb doesn't like stock pickers, having famously (among the value investing circus) declared that he is much more certain Soros is a better investor than Buffett.  I think a person that genuinely adheres to an empirically rigorous margin of safety approach with investing is implicitly recognizing black swan risk and the limits of their intelligence.

Am I a good example?  No.  I try but I know there are blind spots in my approach.  I write this blog in part to help myself recognize blind spots either in hindsight or with the help of kind readers.  Many people - including prominent "value investors" - do not adhere to this.  I'm sure this is where psychological biases and individual human inclinations play a role, but I have read plenty of stock commentary that is sloppy, self-serving, and nearsighted.  There's no exam to pass to in order to call oneself a value investor or a practitioner of Buffett style investing. 

But an intellectually honest approach to valuing a company, then halving it, discounting it, or handicapping it in someway will make money over time distributed over enough opportunities.  The problem is less the approach and literal activities involved than the person tasked with actually executing them.  The way I read The Black Swan was that there is nothing wrong with the world itself, it's how humans overlay a shoddy and disingenuous perspective on everything.  And alas, investing properly is not about figuring out what a company might be worth tomorrow if they do XYZ successfully, it is about figuring out what it is worth today and paying a lot less.

One aspect of uncertainty is technology.  Technology risk is increasingly pervasive in investing.  The rate of change is increasing across industries.  What effect will 3D printers have on UPS and Fedex in 10 years?  Does Comcast have a viable future physically piping information around the country?  Will tobacco leaf merchants get cut out of the supply chain?  Taleb addresses technology and innovation as evidence for how flawed our thinking can be on occasion.  If we actually knew what technology would exist 10-20 years from now, we would already have it.  Look around today and simply observe all the technology exists today.  Nobody knew the world would exist as it does today 50 years ago. 

So I recently wrote about DreamWorks Animation and have gotten some criticism from readers over casually brushing aside the fact that DVDs are in a terminal decline due to increasingly common digital distribution mediums.  I don't know how you figure out the effect.  I could take a static view, which is that studios have no way to replace the profits from DVDs.  There was once a time when Amazon made a lot of money from selling physical books.  There was once a time when Netflix actually sent movies to people through the US Postal Service.  There was once a time when America used to make things! 

I don't know if there is specific historical insight to be gained from looking at the CD industry's decline, but it's an example of destruction wrought by technology.  The decline of the DVD won't mirror it exactly.  Both reflect the underlying change that occurs when disruptive technology interferes with a good thing.  The decline of the CD means one thing.  When consumers get ripped off for countless years buying 2 songs with 10 other audio clips of half-baked garbage, they will jump at the opportunity to pay nothing.  Were CDs wonderfully profitable?  Yes.  The distributors made off like bandits.

Is music dead?  No.  Revenue for artists has shifted to concerts, the number of middlemen is reduced, and quality content still realizes its ultimate value.  Rappers have not gone from Maybach driving drug dealers to rollerskating crack whores.  Even mediocre bands like OK GO have used technology to their advantage.  Think of their epic single shot Rube Goldberg contraption in sync with music.  One of their band members even outlined what the hell is going in the Wall Street Journal.  They sell albums as a result of this – as in people BUY their music, go to their concerts, and splurge on band shirts.  That Rube Goldberg music video was paid for by State Farm.  YouTube splits ad revenue with the band.  One estimate is at least $2 per thousand views once a video goes viral.  They have a good amount of creative low budget music videos with millions of views.

Just another example of content getting monetized.  Epic Meal Time.  These folks just make gluttonous food while cursing, drinking, and joking around.  They sell shirts, pitch Netflix accounts, and probably have other sponsors (they were in Gymkhana 4, a video sponsored by DC Shoes which is just some dude driving around and doing cool stuff with a car).   

Howard Stern is still making hundreds of millions off of a radio program.  Radio is so long gone from being the dominant content distributor it once was.  Yet here is an example of someone who is able to engage an audience skillfully who is finding a way to be compensated for it.

And one more because I have seen every video on YouTube and ponder the business side – this guy has a sponsor that splits revenue with him to make videos of shooting guns and speaking in a fake Russian accent (he has a shade under 300 million views on his uploads, even if he makes $1/thousand views…).  I've read some stuff that he is sponsored, but this is clearly some type of business venture.

Now maybe you want to debate whether or not YouTube content will erode the value of television and movies.  If the costs are lowered, the benefits rise, and technological barriers removed, movies and television must be dead if cheap competitors enter the fray.  I don’t view any of these as mutually exclusive.  People still listen to radios despite the medium being old and usurped by technological advances in the minds of some.  As Stephen Jay Gould would say, you are focusing on one outcome that exists in a system of variation.  There is plenty of room in the content ecosystem for different value propositions and mediums – the point is for the content to be sought after.

The issue is that it is impossible for one to prove or disprove the idea that DreamWorks will find a suitably profitably alternative to DVDs.  It isn’t just the content producers that profit immensely form them.  Walmart, Best Buy, and Target love selling these things.  In 2 square feet, you could stack up 4 across, 5 deep, on 10 tiered levels for $10/each (think of it as part of a shelf or a rotating tower).  That’s $2000 or $1000/square foot.  On average Walmart does ~$450-500.  I don’t know exact figures, but I doubt any foodstuff with a similar volume or display cost generates the same profits.

None of this really supports the idea that DreamWorks will find a substitute for DVDs.  I have no idea what it will be.  I was reading the transcript of a Disney investor conference and there is endless discussion about content.  While DreamWorks Animation is not Disney, they face the same opportunities and uncertainty in the future.  There is no IP behind distribution strategies.  Like with any retail operation, if Disney unlocks the trick to making money, DreamWorks Animation will be able to follow suit.

The introduction of Blu-ray and paid video on demand (VOD) has not replaced the overall decline across the Domestic In-Home Entertainment segment.  VOD is not as profitable and Blu-ray, as far as I’m concerned, is just a more expensive DVD that doesn’t really take anything to the next level.  This presentation highlights a few slides in the opportunities.  Electronic sell through, blu-ray, and superset bundles are actually more profitable per unit than DVD according to the presentation. 

This is important for a few reasons.  First, I think blu-ray is dumb.  It’s just a concocted excuse to get people to restock their home entertainment collections.  The reason it hasn’t taken off is because you look at a blu-ray disc and a DVD and you probably really don’t care about the difference.  People aren’t that stupid.  People already have a data container with a movie on it that doesn't require physical rewinding.

The content has control over how it gets distributed.  A Superset Bundle can be a blu-ray DVD combo with an option for a digital copy or an older prequel title.  Increasingly as consumer adoption permits, they will be able to cross sell digital right with a bundle and electronic sell through.  Basically, the 12 oz. mustard is now 10 oz. but the same price.  When you produce desirable content and through trial and error find the value proposition for the consumer that still allows attractive return, you don’t need to worry about the medium.  Perhaps blu-ray is a false dawn and people will restock their digital libraries with film rights once cloud services are introduced or the Netflix deal will make up for a chunk of what is currently thought to be lost revenue.

Everyone knows that the DVD is dead.  Long gone.  Does DreamWorks Animation have an alternative revenue source?  Will people still want to watch a movie again after they see it in theaters?  I don’t like saying things are “priced into” a stock, but Mr. Market is definitely indicating that something in DreamWorks Animation’s future isn’t bright. When faced with uncertainty, there are really only two things you can do: focus on downside protection, and make sure there are intelligent people working on solutions. 

Perhaps this is a self-serving justification for my write up.  All the above is simply identifying content and how it gets monetized one way or another regardless of technological medium.  There is such a variety in mediums that it demands an extrapolation of its effects.  There are new mediums emerging and new strategies to deal with them.  While there is uncertainty as to where profits may come from, these things have a way of sorting themselves out.

If you have examples of the contrary, please share.  Perhaps I suffer from the confirmation bias.

Edit - Naturally, I forgot the newspaper industry.  Are newspapers middlemen of news?  No.  Plenty of newspapers, which produce daily content that many people consider a necessity, have suffered over the recent decades.  Readership is dwindling, free alternatives have emerged, and the classifieds advertising section is obsolete.  Alas, I believe that publications like the NY Times and Wall Street Journal will continue existence in some fashion.  The economic situation at the NYT was much more dire 4-5 years ago when they were flat footed in response to the digital era.

Bill Ackman, in that recent Bloomberg interview, mentioned how he thought Murdoch overpaid for Dow Jones/WSJ and there was a vanity aspect or trophy asset mentality to it.  Well he has successfully transitioned subscribers to an online pay wall, increased prices annually for it, and circulation has been increasing.  People will pay for good content.

Can a like for like comparison be drawn between the death of the DVD and the emergence of craigslist and free classifieds?  Possibly.  Piracy is any issue, which equates free after market content consumption.  The above mentioned Disney presentation highlights increasing bandwidth speeds as a potential source of increased piracy in the future.  As some of Disney's initiatives hinted at though, they are still figuring out ways to maximize their profits in the home entertainment segment.