Why Warren Buffett Bought Paramount, Not Netflix, Stock

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Older viewers love CBS, but I’m guessing that Warren Buffett didn’t just drop $2.6 billion on shares of network parent

Paramount Global

because he’s a big fan of NCIS: Hawaii. He might be betting that investors have got show business all wrong.

Legacy television and movie distribution are looking like more of an asset than a drag amid the shift to streaming. It’s telling that the renowned value investor didn’t go instead for shares of

Netflix

(ticker: NFLX), which are down from a peak of $700 last November to $190 as of Tuesday’s close. 

Paramount (PARA) combines two legacy television companies: Viacom and CBS, both of which were cash cows. When Bob Bakish took over Viacom in 2016, TV ratings were weak and the company’s storied movie studio, Paramount, was losing money. But Viacom had generated $1.2 billion in free cash on 12.5 billion in revenue in its latest fiscal year. Bakish boosted TV ratings, returned movies to profitability, and grew free cash flow.

 CBS, meanwhile, was then and is now a perennial ratings leader. Back in 2016, it produced close to $1.5 billion in free cash on $13.2 billion in revenue. The two companies merged in 2019, with Bakish as chief, and launched the Paramount+ streaming service last year. The company also owns the Showtime premium channel and streaming service, and a free streaming service with commercials called Pluto TV. 

It’s too early to call Paramount a success. For one thing, the stock has stunk. Even after it bounced 15% on Tuesday following Buffett’s

Berkshire Hathaway

(BRK.A, BRK.B) disclosing a stake, shareholders have lost 27% over the past three years.

The company is also spending gobs of money to bring in streaming subscribers. This year, it’s expected to clear only around $700 million in free cash on revenue of more than $30 billion.

Time will tell what that spending surge does for growth. Last quarter, Paramount brought in 6.3 million subscribers, reaching 62 million. That doesn’t count 68 million regular Pluto viewers that the company said was up by a double-digit percentage from a year earlier.

Note that Paramount’s crimped free cash flow, when calculated against the company’s recent stock market value of $20.8 billion, makes for a free cash yield of 3.4%. That’s not nothing, and analysts who’ve ventured forecasts think free cash flow could reach $2 billion or so by 2026. What makes that appear feasible is that it implies a margin that’s well lower than the one the old Viacom and CBS were achieving. If those forecasts prove accurate, Buffett will have bought into a 10% free cash yielder. 

“This combination of traditional assets and streaming assets is a real advantage, both in our ability to accelerate our business and drive subscribers and create more attractive economics and margins than a pure play streamer would have,” Bakish told me in February. He gave two examples of how old-fashioned distribution can lower the risk of creating streaming content. Paramount introduced a cowboy show called 1883 on cable to fans of its hit Yellowstone before moving 1883 exclusively to Paramount+. And the company has used a 45-day theater window to help make back the cost of movies that end up on streaming. 

At a glance, Netflix is a much bigger fan favorite and better hitmaker, judging by its 221 million streaming subscribers and a big haul of recent awards. But it has also burned more than $8 billion in cash cumulatively over the past six years. Investors have revolted against cash burners when Netflix’s growth has broken down. This quarter, it predicts a loss of two million subscribers. The company plans to launch a cheaper, ad-supported subscription tier, but setting up an ad business takes time. 

We don’t yet know how appealing Netflix will be as a service if the company must bring down content spending to levels that turn free cash flow consistently positive. On the flip side, we don’t know whether future free cash projections will pan out if the company must ramp up spending to rekindle growth. Two analysts have estimated Netflix’s 2026 free cash flow; one says $5.5 billion and the other says $9.5 billion. The midpoint, $7.5 billion, assumes both heady revenue growth and a margin that far exceeds what Viacom and CBS were generating back in 2016.

Bottom line: Netflix has four times the market value of Paramount today, but it’s far from clear that it can produce four times the free cash flow even several years from now. Maybe it will prove to be a technology company that’s unbound by the traditional limitations of putting up cash to try to make hits. But if it’s just a show business company with a head start online, Buffett’s bet is likely to outperform. 

Write to Jack Hough at [email protected]. Follow him on Twitter and subscribe to his Barron’s Streetwise podcast.