Everything is cost of capital all at once
The topic of interest rates and their impact is hard to avoid these days, including in the media industry, as participants learn that uncorrelated cash flows do not necessarily mean uncorrelated asset values. However, it was recent reading on a completely unrelated sector — semiconductors — that for us brought to the forefront just how massive and lasting of an influence cost of capital can have on reshaping entire industries and countries.
In the 1970’s, the US was the dominant force in semiconductor design and manufacturing, effectively creating this commercial market and enjoying ~70% global market share. Intel’s revenues, for instance, went up ~90x during the decade. With the start of the ’80s, exactly as US inflation was reaching ~15% and the Fed drove its aggressive tightening policy towards ~18% interest rates, Japanese semiconductor firms were quietly using low-cost local bank financing to ramp up manufacturing of a largely identical product. By 1990, US lost approximately half of its global market share as domestic companies could not compete with Japan’s capital advantage which translated directly into market pricing. The ramifications of this shift spilled far beyond the chip industry itself and are, arguably, to this day reshaping meaningful elements of technological and geopolitical realms.
As credit investors, we’re taught to always be able to answer the classic question — “does the business need to exist?”. In today’s environment, we must extend this analysis to answer “could this business exist with a much higher cost of capital?”. A great test case in the media industry will be businesses that aggregate others’ content, particularly in the highly dynamic video subsegment. Some of these business models are built around offering valuable services while others operate primarily by dispensing cash. Those that indisputably add value to the IP and its owners through better reach, better monetization, better production, etc can typically withstand periods of expensive capital and closed markets. The others, relying purely on dealing the drug of capital, can quickly find themselves out of both buyers and suppliers. At the right price and with the right structure, there will be investment opportunities on both sides of the spectrum.
