The Walt Disney Company's (DIS, Financial) stock has been on a tear over the last couple of weeks, and the stock hit a fresh all-time high on Dec. 11 as investors welcomed the outcome of the four-hour long Investor Day event, in which the company pledged to prioritize the streaming business.
Disney's investors are always hoping to hear more news about prioritizing streaming. In October, activist investor Daniel Loeb sent an open letter to the company management highlighting the benefits of focusing more on streaming platforms such as Disney+, Hulu and ESPN+, and soon after, the company announced a major reorganization to do just that.
Even though shares seem expensive at the current market price of around $175 as of the writing of this article, Goldman Sachs (GS) seems to believe there is more upside and has assigned a $200 market price for Disney. This is now the highest target price for the entertainment giant among all the Wall Street analysts who cover the company. In a research note to clients, Goldman Sachs analysts wrote:
"Disney's updated long-term targets for its Disney+/Star DTC streaming services are materially above our prior base case estimates, and we believe well ahead of investor expectations. We believe this outlook is attainable, especially as it broadens the service's content offering to include new programming from Star outside the United States."
An evaluation of the recent developments, the outlook for the streaming business and the valuation implications of prioritizing the direct-to-consumer business model confirm my opinion that Disney is still just as undervalued as Goldman Sachs claims.
Growing in leaps and bounds
Disney+ was launched in November 2019, and at the time, the company planned to bring in 60 to 90 million paid subscribers by the end of 2024. The numbers reported in the last quarter goes on to suggest that the company might have underestimated the power of its brand value. Disney+ has already gained more than 86 million global subscribers, and the company has not even launched the service in many Asian countries.
One of the key pillars of Disney's success has been its strong presence in India. As illustrated below, Hotstar had a dominant position in the Indian streaming market at the beginning of this year, and the likes of Netflix, Inc. (NFLX, Financial) have failed to meaningfully penetrate this lucrative market despite spending billions of dollars on creating content in local languages.
Source: The Atlas
Before the start of this year, many investors were oblivious to the fact that Hotstar is a service owned by Star India, which is a wholly-owned subsidiary of The Walt Disney Company. This relationship has helped Disney+ quickly gain traction in the all-important Indian market, and the company reported that 30% of its global subscribers are from India. The South Asian nation has been identified by many streaming companies as the most important region from a growth perspective because of the rising middle-income society and the increasing internet penetration rate. Disney's edge in this market will help the company report better-than-average subscriber growth in the coming years, which is good news for long-term investors.
Disney recently launched its services in a few Latin American countries as well, and the company confirmed its intention of expanding into many untapped regions around the world in a bid to become a truly global player in the streaming industry. At the moment, service is only available on a limited basis in Asia, whereas its competitors have already established their presence in this densely populated continent.
The price hike will drive sustainable earnings higher
On Dec. 10, the company announced that Disney+ service will cost $7.99 in the U.S. starting from March 2021 instead of the current rate of $6.99 per month. Netflix, the leading player in the industry, has used price increases over the years to improve its profit margins, and Disney seems to be following its lead. Empirical evidence suggests consumers are highly unlikely to ditch the subscription because of this price hike, and earnings will be positively impacted in the long run.
The company should ideally allocate the additional revenue stream resulting from the price increase to creating more original content, which, in return, will help attract more subscribers. A study conducted by The Harvard Business School concluded that original content is a key driver of revenue for this industry. Professor Jeff Prince and Professor Shane Greenstein wrote:
"Our results indicate that if a streaming service wants to attract subscribers, offering content from TV channels is not a sufficient strategy. Building on this insight, we found that offering original content can be one important way that streaming services can differentiate their offerings from competitors'. The firms that most quickly understood the importance of original content stood to gain the most."
In the Investor Day event, Disney announced it will be adding 10 Marvel series and 10 Star Wars series to its streaming service in the coming years, along with 30 series from the Disney and Pixar brands. This confirms that the company management is focusing on the right strategy to drive revenue, and investors stand to benefit from this development.
Valuation implications
The average revenue per user of Disney+ currently stands at around $4.50 according to company filings, and this can be expected to grow in 2021 along with the announced price hike. Disney currently generates close to $400 million in revenue from this service, whereas the company is setting up to bring in over a billion dollars by 2024 assuming the ARPU will increase to over $5 by then.
Source: Disney
Even though this might sound like a drop in the bucket considering the $65 billion in revenue the company has generated in the last 12 months, the key is that Disney will be valued at much higher multiples by Mr. Market because of its new business model in which streaming is the priority.
To put things into perspective, Netflix stock has traded at an average price-earnings ratio of 193 in the last five years in comparison to just 19 for Disney. Going forward, Disney will likely be looked at more as a growth company because of its growing penetration rate in the streaming industry, and this could lead to a significant expansion in its earnings multiples, delivering handsome returns to investors.
Takeaway
Disney is moving in the right direction by tapping into the high-growth streaming industry, and its brand value is proving to be a game-changer. Even though there's a long way to go to become the number one player in this lucrative business segment, there are signs that suggest the company will grow at a faster pace than its closest rivals in the foreseeable future. This will help Disney report stellar earnings growth, and I think the stock is likely to trade at much higher valuation multiples, closer to the norm for pure-play streaming companies.
Disclosure: The author owns shares in Disney.
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