fuboTV Stock: Constructing A Profit Model (NYSE:FUBO)

As fuboTV (NYSE:FUBO) continues to navigate a rapidly changing TV landscape in the US – another 4.7 million households cancelled pay-TV in 2021 – the latest move is another $5 price hike, in line with the one Hulu Live implemented at the end of this past year. It is roughly half the price increases

I’ve already examined fuboTV, both with regards to what I think is working and what I think isn’t working. I will not repeat those arguments here, but I did want to address one particular point that has often been brought up to me about what people think is missing from my analysis. In a nutshell, fubo bulls argue I should stop analyzing the industry in the aggregate and start considering fubo itself as a subset. In other words, even if the industry as a whole will not profit much from gambling, fuboTV in particular will, they say.

I was not convinced, as an initial matter, that fuboTV really can produce such a superior gambling product to other services that it ought to be considered a unique company within the industry, but it’s certainly true that the bulls argue it that way, and my prior analysis was based mostly on industry aggregate numbers.

In this article, I am going to produce a model to evaluate how an individual service will see gambling revenue and content costs – the lion’s share of total costs for any TV distributor – evolve at different subscriber levels. To do that, we first need to make sure we fully understand how content contracts in pay-TV differ from other industries.

Pay-TV Doesn’t Pay For Most

In the old, old days, cable-TV had a true monopoly on national TV services, with only over-the-air local broadcast networks having any other way of reaching customers. National cable channels like USA Network, TNT and eventually the prestigious premium channel HBO simply had no other way of reaching their customers.

The first major step towards change happened when two major satellite companies, DIRECTV – now owned by AT&T (T) – and DISH Network (DISH) achieved true nationwide distribution. This was good for consumers, since it brought at least some degree of competition; it also fundamentally altered the dynamic between content producers like Disney (DIS) and 21^st Century Fox (FOX) (FOXA) and the cable companies, as one would expect; having more bidders for content gave them and other producers like Discovery (DISCA) (DISCK) (DISCB) more leverage.

Finally, and somewhat less remarked upon, however, was that it also changed the dynamics between cable companies themselves.

Most Favored Nation

Having multiple platforms for the distribution of TV content, including a few that were truly nationwide in availability, meant that different distributors content deals were no longer siloed from one another. Every concession Paramount Global (PARA) or AMC Networks (AMCX) offered a distributor allowed them to offer lower prices to consumers, making them that much more potent a competitor to other distributors. As such, a new provision quickly found its way into the heart of all content deals, the MFN Clause.

The Most-Favored-Nation clause essentially says that any distributor who negotiates a deal with a producer, will get the most favorable terms that a producer is offering at any given time to any distributor – even if those terms are different than the ones in the actual deal a particular distributor has already signed.

MFN clauses are really not that unusual. In fact, they get their name from international trade agreements, which require nations to offer reciprocal access to each other’s markets without discrimination. But TV contracts MFN clauses are a little bit unique, because producers knew they couldn’t and didn’t need to offer the discounts they were giving to top-tier distributors like DIRECTV and Comcast Cable (CMCSA) to everyone.

So TV MFN Clauses are “junior-qualified,” – that’s how one person described it to me, I’m not sure if that’s the official terminology – meaning that they only apply to distributors of equal or smaller size. So fubo, for example, has to be offered terms at least as good as Philo, but Discovery doesn’t have to offer fubo the discount it’s giving Charter (CHTR) or Comcast. Philo, in turn cannot demand whatever discounts Discovery or another producer gives fubo.

Pay-TV Hunger Games

This state of affairs creates a sort of hop-scotch leapfrog game, where each distributor is trying to get their service sufficiently far off the ground as to become bigger than the service ahead of them and thereby secure content discounts that the ones below them on the ladder don’t get – and thereby make themselves more attractive to those services customers and steal them, allowing them to leapfrog the next competitor in turn and repeat the process.

The graduated nature of these content discounts means that content cost on the average customer for a service move downwards only slowly. But depending on the distribution of competitors and what position of the ladder a competitor finds itself on, marginal content costs for additional subscribers can fall much more quickly.

Consider, for example, a service with 1 million subscribers which is 100,000 more away from a 5% discount on content costs. Those 100,000 subscribers will only cost that service 45% as much per subscriber in content payments as adding the first million did, after accounting for the discount that adding them will secure.

Price-Competitive Industry

This can be a long, winding road with many peaks and valleys, in terms of marginal content cost per subscriber. Any stretch where there are no discounts available for a while up the ladder can send marginal cost shooting back up again, only to drop again when another competitor finally comes in sight.

Eventually, the worst parts of the journey up the ladder are behind you, and companies amass enough subscribers to begin to defray some of those extra content costs they accrued at the bottom of the climb. Overall, then, you can almost think of pay-TV as having a sort of “implicit fixed fee” of all the extra content payments they make, while their per-subscriber variable costs actually hit the tier-one level long before their average costs do.

However, because they all have to compete in the same market, smaller services often accrue little or no profit on full-service plans, as they charge more or less the same prices as the biggest services, but have far larger content costs they haven’t fully ameliorated yet. fuboTV is not profitable at its current size; neither is Cable One (CABO) TV business or, we think, Verizon (VZ) FiOS. Mediacom won’t say for sure but they probably aren’t generating any TV profit, either.

The Path To Profit

One way fuboTV and others could overcome this problem is to drop some channels and keep others, if it could identify precisely which channels can be dropped from the bundle without losing customers. So fubo specializes in sports, Philo in non-sports, Frndly TV in heartland channels, etc. This is, as I see it, just about the only way fuboTV might be able to get to profit. I stress might.

But fuboTV and streaming TV in general also have advocates who say that they will generate profit by increasing their non-subscription revenues, almost always either gambling/gaming revenues or advertising revenues. I already explained in my last article why that is highly unlikely to be correct on an industrywide basis; the relevant profit numbers are simply too small. As I will show, there is reason to believe that an individual service sees its content cost “delta” peak at around $1.8 billion, for each service.

That number is, in the aggregate, simply too large to be meaningfully ameliorated by gambling revenues. In my original article a year ago, I postulated that the entire sector would generate about $1.8 billion in profit to TV providers and sportsbooks combined. That would mean fuboTV would need every last gambler to bet through its service to offset the “implicit fixed fee,” which clearly isn’t going to happen. Last week I updated my estimates to $2.3 billion, but fuboTV probably can’t get 75% of all gamblers on its service, either. Or even anywhere close to it.

The Proposed Alternative

But what if fuboTV isn’t trying to do that? Suppose that instead of attracting all gamblers, it instead sought only to attract the very heaviest gamblers who spent the most money, and only required, in the aggregate, a relatively small content outlay – since even the heaviest gambler, after all, will only cost fuboTV one household of content payments?

In other words, even if the overall curve of gambling profit runs below the content cost curve, is there some point along the graph where the curves invert, and profits from the heaviest gamblers outweigh content losses for a relatively small number of subscribers?

The interesting thing about this argument is that it turns traditional pay-TV logic on its head. Instead of trying to climb to the top of the ladder, where all the scale-based benefits of lower content costs are, a provider is instead trying to go just right a distance up the ladder and then stop.

Instead of being too small, a provider under this theory is trying to avoid getting too big, and watering down its gambling revenues with less intensive gamblers who will nevertheless require another household worth of content payments.

Building The Model

In order to analyze whether this is possible, in a different way than I did last time, I am going to try to create a model of content costs and ancillary revenue. My last effort, though I still think it was a strong one, incorporated only ancillary revenue. How does laying the two side by side change the calculation?

Three Zones

Rather than trying to map every peak and valley, which we lack the proprietary contract information to do anyway, I am going to create a simplified model with only three phases or “zones” of customer content costs.

In the first zone, extremely high content costs actually increase the “delta” of content costs between first- and bottom-tier providers. In the second, marginal content cost is equal to the average content costs of a tier-one provider, the aggregate delta neither increasing nor decreasing. In the third, marginal content costs drop precipitously with scale, and the delta begins to decline until disappearing entirely.

Presumably past this is a fourth zone where average and marginal costs are once again exactly equal, but given how few companies reach it we probably don’t need to map that one.

Like I said, a lot of this information is proprietary, but from the occasional hints and leaks I think we can create a fairly accurate picture.

Implicit Fixed Fee

Back in 2015, AT&T reported that content costs on its shiny, newly acquired DIRECTV operation were $200 per year lower than those at its U-Verse operation. At the time, U-Verse was reporting a little under 6 million subscribers, while DIRECTV was over the 20 million mark that ensured it got the best rates in the whole country.

This means that U-Verse was losing roughly $1.2 billion per year in higher content costs compared to DIRECTV. However, content costs across the industry have risen since then. In 2015, Leichtman Research had the average pay-TV bill at $99, while in 2020 the cost of a combined Internet/TV double-play was at $217. Obviously, there is a bit of apples-to-oranges here, but the equivalent TV-only 2020 number does not appear to be available, perhaps because of COVID?

Even now, Internet bills usually max out at $85 or so, most often less than that, and there has been two years of additional inflation since then. So I feel very confident in saying that content cost for TV has risen at least 50% since AT&T’s report. Let’s leave it at $1.8 billion for now.

Distribution Challenge

The question now becomes how to distribute it. This one’s a little harder, but we do have one clue. Just a few months ago, Disney and Alphabet’s (GOOG) (GOOGL) YouTube TV got into a major dustup that actually saw ESPN, the crown jewel of pay-TV, get dropped for a few days. Peace was eventually restored, but the cause of the dispute was, according to Alphabet, YouTube TV’s insistence that it be charged “the same rates that services of a similar size pay.”

As I said, there are lots of peaks and valleys in the business, but it sounds like YouTube TV, which we think has somewhere between 4-5 million subscribers, had gotten big enough that it was starting to see meaningful reductions in what it paid per household, and Disney was essentially trying to keep the “small pay more” gravy train going.

I’m going to make a small intuitive leap here and postulate that the bottom/middle zone border is right around YouTube TV’s subscriber mark.

Final Content Cost Model

For our present, simplified purposes, I am going to assume that the “delta” maxes out at $1.8 billion at 5 million subscribers, stabilizing from 5-8 million subscribers, and then begins to decline linearly, phasing out completely at 20 million subscribers. So the simplified model looks something like this.

Zone	Subscribers	Marginal Content Cost Per Subscriber
Zone 1	0-5 million	MIN* + $30
Zone 2	5-8 million	MIN*
Zone 3	8-20 million	MIN* – $12.50
Zone 4	20 million+	MIN*

*MIN is the lowest price per subscriber, that the biggest MVPD pay

Assume, for now, that those $1.8 billion in losses are distributed linearly over the first 5 million subscribers – the 5 million subscribers that fuboTV is aiming to hit. At $150 million per month, fuboTV would be paying roughly $30 more for a full package subscriber than a top-tier service like Comcast’s Xfinity Cable if it adopted a “stay small” strategy

Gambling Revenue Model

This is the part that’s harder. We don’t really have good insight into how gambling breaks down between heavy and light gamblers.

I did find some statistics, though they’re a little dated. But it seems that around 60% of Americans gamble at least once in a given year, and about one in seven of those – around 8% – engage in at least one “problem behavior,” suggesting they gamble heavily. Only around 1% of gamblers is considered a “pathological gambler.”

I know, it’s not much to go on. What I’m going to do is divide the market by the old standby, the 80/20 rule. This is a rule of thumb in business which says that the top 20% of customers account for 80% of business. No, I cannot be sure that is an accurate reflection of gambling, specifically; this is my best estimate.

I am going to keep allocating the market in multiple steps until reaching below 1 million subscribers, with a straight-line allocation on the last subset and a progressive shift between the two methods in intermediate steps. So assuming 125 million TV households, only 75 million of which are gambling, we get a gambling profit/revenue breakdown that looks like this:

# of households	% of market	% of total revenue/profit	$ (millions)
60 million	80%	20%	$460
12 million	16%	36%	$748
2.4 million	3.2%	33%	$759
600,000	0.8%	11%	$253

We can lay these figures alongside the content costs to get this projection, again using linear extrapolation:

Subscribers	“Delta” content costs	Gambling Profit	Net Total	Profitable
1 million	$360 million	$380 million	$20 million	Yes
3 million	$1.08 billion	$1.01 billion	($70 million)	No
5 million	$1.8 billion	$1.14 billion	($660 million)	No

Model Analysis

These figures suggest that it is indeed possible to “stay small” and turn a “very small” profit… but only at subscriber levels which fuboTV has already surpassed. fuboTV was at 1.1 million subscribers and growing at last report.

And, according to fuboTV’s CEO David Gandler, he is aiming for fuboTV to eventually amass 5 million subscribers as the old pay-TV system continues to fade away. So fuboTV will almost certainly accrue the full “fixed fee” of higher content costs at the top end of the projection, where losses are still substantial.

We must also consider carefully if fuboTV would really be profitable, even at the low end. The one missing element right now is the lack of granularity in the first phase of content spending. As I said, the plethora of small competitors at the bottom of the ladder probably means that there are all sorts of ups and downs.

However, generally speaking, one would expect that the content losses would slant towards the bottom of the ladder, with services over 1 million subscribers managing at least some degree of cost improvement. So a linear distribution is almost certainly too favorable an assumption for fuboTV. Yes, gambling revenues will probably be weighted towards the bottom of the scale… but so will content losses. And we accounted for the one, but not the other.

Potential fuboTV upside

The good news for fuboTV investors remains what it has always been: fubo is starting to show early signs that perhaps it just could do that. After dropping Turner Networks and actually seeing growth accelerate, rather than slow – something I wouldn’t have believed was possible two years ago – fubo has now dropped A&E Networks and doesn’t seem to have taken a hit from that either. These two by themselves are not large enough savings to correct fubo’s “implicit fixed fee,” but if it can manage further such successes, it may yet reach “the third zone” and start to show meaningful profit.

Other Investments

The model I have built has been applied here to fuboTV, but the same dynamics will govern the content costs and producer/distributor relations of any of the companies mentioned. Investors in Disney, Comcast, or any of the other companies herein mentioned will hopefully find elements of this analysis useful as well.

Investment Summary

fuboTV is building a very interesting sports-utility product, but at the center of that product remains a very traditional pay-TV product. While sports betting should provide a decent ancillary revenue source, it cannot take the place of a real solution to the pay-TV problem, which is a problem of curation. While fuboTV may well succeed with enough of the discipline in bargaining with – and walking away from – content providers that its CEO is always talking about, it hasn’t shown quite enough of it yet… and a gambling rake cannot substitute for it in any meaningful way.