Fiery Flash: The Walt Disney Corporation
Can Disney make a comeback on the stock market?
"The Walt Disney Corporation" or Disney is an iconic American company. It was founded nearly one hundred years ago by brothers Walt and Roy Disney. Since the creation of Mickey Mouse, the group's first animated character, Disney grew into one of the largest entertainment companies in the world with annual sales of more than $82 billion. Since March 2019, Disney's share price has roughly halved as the company faces one of its biggest challenges: turning the commercial success of its streaming division into a financial success. Whether it will succeed remains to be seen, but competitor Netflix is already leading by example in this regard.
From animation studio to a global entertainment group
Several decades after its founding, Disney broadened its horizons by adding action films and theme parks to its palette of activities in addition to animated films. After the death of founder Walt Disney in 1966, the group struggled, but starting in the mid-1980s, the company experienced a new period of glory under top executive Michael Eisner. Also under top executive Bob Iger (from 2005 to February 2020), the company set a strong course. In addition to the success of its own (animated) films and parks, Disney's growth was also due to a whole series of large and small acquisitions. Especially from the mid-1990s onward, the company went on the acquisition trail, buying TV channels, animation studios, film studios and parks including ABC Inc., Pixar, Marvel Entertainment, Lucasfilm and Eurodisney. Disney's last major deal was its acquisition of 21st Century Fox in late 2019. This acquisition included the film studio 20th Century Fox, several cable channels and the Indian TV channel Star India. This deal had a price tag of more than $71.3 billion and saddled the group with a high debt level.
Covid19: a curse and a blessing
The Covid19 crisis proved to be a double-edged sword for Disney. On the one hand, the group's results plummeted as cinemas - the clients for Disney's films - and theme parks had to close their doors or run at reduced capacity for long periods in 2020 and 2021. On the other hand, the group's streaming business grew like crazy during this period. A few years ago, Disney decided to stop making its content (movies and series) available to Netflix and set up its own new streaming platform called Disney+. This platform was launched in November 2019. In retrospect, the timing of the launch was ideal, as the global outbreak of Covid19 made online movie and series viewing more popular than ever. As a result, the number of subscribers to Disney+ grew dramatically. At the end of last year - 2 years after the platform was launched - Disney+ had some 104 million subscribers. In addition, the group also had 58 million subscribers in India (Disney+ Hotstar), about 25 million subscribers to its ESPN platform (sports channels) and about 44 million subscribers to streaming platform Hulu (movies and series). Altogether, the group thus had about 230 million streaming customers at the end of last year or slightly more than Netflix which had about 222 million subscribers at the end of March this year.
Streaming losses pushed top executive to exit
As the Covid19 crisis was resolved, Disney's results recovered strongly. Only the streaming business continued to pile up losses, leaving net profits in 2022 at only a third of those in 2019. The hefty losses in the streaming business were due to the focus on creating expensive content to attract as many new subscribers as possible.
However, the end of the Covid19 crisis marked the end of the era of free money. Central banks were forced to raise interest rates sharply to curb derailed inflation. This shifted investors' focus suddenly from growth to profitability. Specifically for Disney, this meant that investors no longer accepted that Disney's Direct-to-Consumer division (which primarily includes the streaming operations) continued to pile up monster losses. The accumulated losses in this division rounded up to about $10 billion since the launch of Disney+.
To turn the tide, Disney intervened. Bob Chapek – who had only been CEO since February 2020 - was ousted in November 2022, and former CEO Bob Iger (now 72) made his comeback. Along with pressure from activist shareholder Nelson Peltz, Disney implemented a restructuring plan. In addition to reorganizing operations into 3 divisions (Disney Entertainment, ESPN, and Disney Parks, Experiences and Products) and giving more freedom and responsibility to creative talent, Disney wants to save $5.5 billion including $3.5 billion on content. Iger additionally indicated that making the streaming business profitable by 2024 is a top priority. For this, in addition to cost savings, the company is also betting on price increases and the further growth of its subscriber base through low-cost subscriptions that are no longer ad-free.
Turning Disney+ profitable poses the big challenge
Turning around Disney's streaming business is no easy task, as in the last two quarters Disney reported losses of $1.5 billion and $1 billion, respectively. Moreover, the streaming market is very competitive. In addition to Netflix and Disney's various platforms (Disney+, Hulu), Apple TV+, Amazon Prime Video, HBO Max/Discovery, local players (such as e.g., Streamz in Flanders) and linear TV channels that also developed streaming applications also compete for the favor of the (streaming) viewer.
For Disney, it comes down to investing smartly (more targeted) in new content while at the same time at least maintaining its subscriber base. Moreover, the company needs to increase revenue per subscriber (read: higher prices) because today they are too low ($5.95 per month in the U.S. and Canada versus $14.91 for Netflix in the same region). In India, revenue per subscriber is extremely low ($0.74 per month), but given the low average income in this country, hefty price increases there are not evident.
Netflix shows the way
Netflix is the pioneer in the streaming world. There were long doubts whether the company could ever become nicely profitable, but Netflix proved otherwise. The group reported its first positive net profit back in 2003, but it is only since 2017 that the company has been posting meaningful profit margins. However, free cash flow did not become significantly positive until 2020 (high depreciation on created content weighs on cash flow). For the first quarter of 2023, Netflix reported an operating profit margin of 21% and a net profit of 1.3 billion dollars (net profit margin of just under 16%). Although Netflix's short-term profit is under pressure (-19% in 1Q23), the group proves that a streaming platform can operate with a decent profit margin.
What to look forward to at Disney?
On May 10, Disney will open the books on its past second quarter (the group's fiscal year differs from the calendar year). Investors mainly want to know how much progress the group made in reducing losses in its streaming business and whether the group will not lose subscribers in this process. Of course, investors are also looking forward to the evolution of the results in the other activities (film studios, parks, etc.).
In addition, the evolution of the debt position is not unimportant. At the end of last fiscal year, the group carried a net financial debt of more than 40 billion dollars. This is not problematic compared to the company's cash flow (the net financial debt/EBITDA ratio amounted to some 2.4 at the end of fiscal year 2022), but it does limit the management's room to maneuver. Moreover, Comcast may require Disney to buy out its minority stake in Hulu in January 2024, for an estimated cost of about $8.6 billion.
Conclusion
Today, Disney is a turnaround story, with the streaming business being the company's Achilles heel. Should top executive Iger succeed in achieving a real financial turnaround in these operations, this could translate into a sharp share price recovery and Iger would deserve a statue in one of the Disney parks.