We believe the move that teams Discovery (DISCA) with Warner will create a stronger media business, putting the combined firm on much better footing to compete with Netflix (NFLX), Amazon.com (AMZN), and Disney (DIS) in the streaming market. 

Additionally, moving under a purely media-focused management team should make it easier to unlock the value in WarnerMedia's strong studios and content library. We believe the shares of both AT&T and Discovery are attractively valued. 

On the other hand, we still believe Netflix is substantially overvalued. The firm has performed exceptionally well in recent years in terms of subscriber growth, but we see increasing hurdles to that growth. Competition for streaming audiences is increasingly intense as Amazon, Disney, WarnerMedia/Discovery, and even ViacomCBS (VIAC) continue to invest in new content. We expect Netflix to keep its content-spending elevated, limiting its ability to generate cash flow.

ViacomCBS remains our favorite media stock, as the firm is well poised to capitalise on the trend toward increased consumer adoption of streaming services with the relaunch of Paramount+ in March 2021 and the success of its other streaming platforms like Pluto.

Here's how we view the main players in the streaming world:

Netflix 

Netflix remains the undisputed leader in the race to win streaming video customers. Excluding China, where the service isn't available, Netflix is now in about one of every eight households worldwide and likely significantly more if shared accounts are included. The firm's customer additions disappointed during the first quarter, falling short of management's forecast, but we don't believe it's wise to read into one quarter's numbers, given the impact of the pandemic on consumer behaviour. That said, we expect Netflix's customer growth will continue to slow and become increasingly lumpy around the launches of high-profile content.

Disney+ 

Delivered solid customer growth during the first quarter, but it fell short of expectations, too. We suspect the surge in Covid cases in India hampered growth, as the Indian Premier League was forced to suspend play. The Indian service, dubbed Disney+ Hotstar, now accounts for about a third of total Disney+ customers. Also notable at Disney, ESPN+ continues to steadily add customers, though the service remains relatively small.

HBO 

Has impressed us with the momentum it has built in the US, thanks in part to its decision to put new movies on the platform the same day they open in cinemas.

Comcast 

Has attracted sign-ups to Peacock by offering a free tier, but we're worried engagement among many of these accounts remains very modest. 

We've long held that traditional media firms will ultimately prove adept at competing with Netflix. Existing content libraries, franchises that can be extended into new programming, and existing customer relationships provide the elements needed to grow streaming businesses. We also expect these firms' willingness to use both traditional and new content distribution mechanisms will ultimately prove highly beneficial. Among the big media firms, we're most concerned with NBCUniversal's slow progress in delivering meaningful streaming revenue. 

2 promising entertainment stocks

We're keeping an eye on the potential of these two companies in the streaming space:

ViacomCBS

Morningstar Rating: ★★★★
Morningstar Economic Moat Rating: Narrow
Fair Value Estimate (as of June 30, 2021): $US61

With the recombination of Viacom and CBS, the new firm has the content breadth and depth to ensure that its roster of channels remains entrenched in any traditional television offering while also providing plenty of material for Paramount+. ViacomCBS' roster of paid streaming services, which also includes Showtime, has posted strong growth recently, even though the shift from CBS All-Access to Paramount+ only happened in March. The free Pluto TV platform is also growing rapidly. Finally, as movie theaters reopen, the firm's film studio should benefit nicely.

Discovery

Morningstar Rating: ★★★★
Morningstar Economic Moat Rating: Narrow
Fair Value Estimate (as of June 30, 2021): $US42

Discovery has long been known as a firm that produces and owns unique content with proven appeal to audiences across cultures and languages. As a result, its traditional networks have wide distribution, reaching 85 million US households and more than 200 million internationally. The launch of Discovery+ earlier this year leaves the firm a bit late to the streaming game, but it now has an outlet for fans who don't want traditional television service. The plan to join forces with WarnerMedia should provide opportunities to accelerate streaming adoption as the new firm crafts bundled offerings.