When DIS launched its Disney+ service on November 12, 2019, the executives expected other segments to be affected in the short-term. Soon after, the pandemic brought forth insurmountable challenges as their parks were closed and sports (ESPN) were halted. Almost two years later, the market is still skeptical, but their streaming initiatives will drive the bulk of DIS’ growth while the other segments recover. Prior to the pandemic, Wall Street projected 60-90 million subscribers by 2024, Disney+ is currently at ~116 million.

 

Disney’s streaming success is no surprise for those who follow the industry:

• Disney is considered the highest quality film producer, reaching all age groups. Disney owns 5 of the top 10 highest grossing media franchises ever[1].
• DIS’ main streaming competitor, Netflix, does not own the majority of its content. 70% of NFLX’s content spent is licensed[2].
• Out of the major film studios, DIS is not only the largest[3], but the best positioned to distribute its content with 174 million subs across its direct-to-consumer (DTC) platforms.
• DIS’ ability to monetize its IP outside of the screen via parks and products.

DIS’ largest income generating segments are its media networks and parks, close to 40% each. Studio makes ~20%, while their DTC initiatives are generating losses.

 

Media Networks

DIS media assets were acquired in the 90s when Disney bought ABC. A couple of years ago, DIS acquired 21^st Century Fox (21CF) and extended their network, while adding deepening their library. While the media networks are suffering due to cord-cutting, nowhere is as acute as ESPN. However, we would like to point out that the situation is not as dire:

• DIS’ sports programming obligations have gone down, from $53 billion in 2015 to $40 billion in 2020.
• NFL ratings have improved mid-single-digits the last couple of years. NFL games typically make 70% of the top 100 most watched telecasts in any given year.
• ESPN networks account for 54% of all college viewership in 2019. Among the 80 games on cable that had >1 million viewers, ESPN/ESPN 2 aired 65 of them.
• We don’t believe ESPN is facing an existential threat simply because of streaming’s technology limitation with regards to live sports; cable/TV has a higher picture quality[4].
• Sports gambling legalization should support viewership; 22 states so far have legalized with more planned in the coming years.

 

Parks

Parks remain either on reduced capacity or closed and their cost structure is largely fixed. However, on the flip side:

• 60% of their Parks’ EBIT are generated domestically, and the US is way ahead on re-opening.
  • 60% of domestic EBIT was generated by the two largest parks, Walt Disney World (FL) and Disneyland (CA). Prior to pandemic WDW (40% of total DIS parks’ visitors) had around 3x the number of visitors of Disneyland, ~60 mm vs ~20 mm.
  • As of Q3, US Parks are profitable. Revenue and operating expenses are 60% and 81% of 2019; the marginal revenue dollar from here on goes to the bottom line.
  • Only 12% of EBIT was generated internationally, where lockdowns are more severe (Japan, China, Hong Kong and France). In addition, losses are capped at these parks because either DIS gets a royalty fee (Japan) or is co-owner in the case of China’s parks.
    • Japan (royalty) – 32 million visitors. The two parks have 50% market share in Japan.
    • France (100% owner) - ~14 million visitors
    • Shanghai (43% owner)
    • Hong Kong (47% owner) – 6.5 million visitors
  • 28% of their Parks’ EBIT are generated from product sales. Over the pandemic, this segment suffered only a minor decline in revenues (-8%) as it is more difficult to disrupt.
  • In addition, DIS has controlled the bleeding through cost management and recently launched Disney Genie, an app that helps visitors organize their day in the park, and in turn managing choke points.
    • There is room to grow margins without cutting into the bone. DIS’ theme park EBIT margins are in line with other park operators (Six Flags/Merlin Entertainment) but is still underperforming Universal Studios, their closest competitor 34% vs 42%.

• This difference exists even as DIS parks’ attendance is 4x higher than Universal Studios.
  • DIS’ parks comprise 8 out of the top 10 most visited amusement/theme parks worldwide[5].

 

Studio Entertainment

Profitability for a studio is tied to international success.

• Of all the Marvel movies made since Iron Man (2008), international box office was ~2x the domestic one. This is a great sign of international reach, but more importantly of DTC’s potential.
• Digital revenues surpassed theatrical for the first time in 2019[6], this is a similar story to what happened in the music industry with Spotify; which is why we believe that controlling distribution is crucial.
• Box office will remain hurt for the foreseeable future until further re-openings. On the other hand:
  • DIS is the only studio that gets 55%-65% of theater revenue[7], while other studios get 50%-60%.
  • Covid-19 has benefitted studios by permanently shortening the theatrical release date.
• 21CF deal was key in getting a global content library. In addition to BAMtech[8] (leader in streaming tech), these deals propelled DIS to the clear leader in streaming with a vast portfolio.
  • 21CF also owned highly complementary and profitable IPs such as X-Men, Deadpoool and Avatar.
• In order to adapt to the post-pandemic world, studios were forced to release more evenly during the year rather than during peak times (holidays). DIS went a step further and successfully released films on their streaming platforms at the same time as theaters[9].

 

Direct-to-Consumer (Disney+, Hulu, ESPN+)

Currently, DIS has 174 million subscribers.

 

DIS is currently maximizing subscriber count not ARPU, although they have been able to raise membership price by a $1/month while still growing above street expectations.

• Disney +
  • 116 million subs
  • Disney+ has already doubled subs relative to what the street was projecting, we believe there’s still more steam in the engine as DIS+ is just entering Japan, Hong Kong, South Korea and Taiwan, a combined 200 million population.
  • While many investors associate DIS+ with kids, Disney+ has more subscribers without children, a sign that this is not a family-focused offering, but rather has broader appeal.
• ESPN+
  • Already at 14 million subscribers, close to recouping all lost cable subs ~20 million since peak in 2015.
  • “ESPN can add a premium tier in order to achieve $15-$20 ARPU, which is double what they were getting from cable at $9. “ – JPMorgan Research
• ESPN+ is the exclusive distributor of UFC PPV events in the US, one of the fastest growing sports for its size.
• Hulu and Live TV
  • 43 million subs
  • Hulu has an interesting strategy.
    • The intro tier is $6/month and includes ads, DIS is able to generate another $6/month ARPU in ads. This matches the ad-free product offering which is $12/month
  • The Live TV bundle – 3.7 million subs
    • For $55/month, consumers can get most of the channels they would get with a cable subscription for almost half the price (cable is ~$100/month). This dual-pronged approach helps control the bleeding by offering an alternative to consumers cutting the cord, but still willing to have a cable-like line-up.
• The bundle
  • For $13 you can subscribe to DIS+, ESPN+ and Hulu intro instead of paying $18 separately. This looks like the early innings of their master plan to have the broadest offering under one roof (sports, adult and children content).
  • “A good chunk of our marketing now is going towards a bundle, and that’s because while we enjoy extremely low churn rates on our individual services, the churn rates on the bundle are even lower. Surprisingly low even for us, and I think what that says is that our customers enjoy the price value of the bundle that we offer. They’re getting an incredible amount of content for a really good price.” – Bob Chapek Q3 call.

 

Most companies tend to be overlooked when their re-investing heavily because financials get murky. We believe DIS’ unique assets mix combined with a successful DTC strategy have increased the value proposition and increased their competitive advantage.