Needham & Company analyst, Laura Martin, published a note discussing the implications of content creators going direct and essentially cutting their own throats. She uses WWE (NYSE: WWE) as an example where in 2013, WWE received $6.37 per viewer per hour from pay per view. However, after rolling up the PPV content and going direct, the company only received $0.67 per viewer per hour for Over The Top content. Viacom (NASDAQ: VIAB) and Time Warner (NYSE: TWX) could follow suit if they pursue recently announced lower ad load strategies. If the shift occurs, it leaves Netflix (NASDAQ: NFLX) as the winner. No change to Buy rating or $125 PT.

For decades, WWE had a Pay-per-View (PPV) business whereby it charged $40-60/month for 3 hours of programming each month. WWE split this revenue 50%/50% with the cable/telco/satellite operator. In 2013, WWE reported PPV segment revenue of $86mm at a 33% profit margin, or EBITDA of $28mm. In late 2013, WWE decided to fold all of its PPV content into a direct-to-consumer (DTC) OTT service, for which it charges $9.99/month. In February 2014 WWE launched its OTT Network and after nearly two years in the marketplace it has 1.2mm subs globally (about 1mm US + 200,000 offshore) and reported $140mm of revenue and $40mm of EBITDA (larger than its PPV business), implying $100mm of direct costs of the OTT Network (TTM).

The net effect of the shift in strategy is a revenue drop from $6.37 of revenue per hour of viewing for its PPV content to $0.67 of revenue per hour of viewing on its OTT Network. In addition, the OTT Network has added costs of about $100mm annually to the WWE income statement, lowering near-term ROICs to WWE shareholders.

When a content company puts identical quality content on Netflix, it teaches consumers to pay a lower price for the same quality of long-form premium content. They believe the recent comments by VIAB and TWX that they will experiment with lower ad loads is based in part on consumers comparing their viewing experience on Netflix to Linear TV. By implication, content companies that put identical quality content on digital platforms with low or no ad loads are undermining their most valuable asset, the dual-revenue stream business model of linear TV, because they retrain a consumer to expect high content quality at a significantly lower cost to that consumer.