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The Science of Hitting
The Science of Hitting
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Disney: Storming Out of the Gates in DTC

A look at the media company's first quarter results

February 06, 2020 | About:

On Tuesday, The Walt Disney Company (NYSE:DIS) reported financial results for the first quarter of fiscal 2020. For the period, revenues increased 36% to $20.9 billion, with segment operating income climbing 9% to $4.0 billion. Both results were reflective of the consolidation of Hulu and the assets acquired from 21st Century Fox (the deal closed in March 2019).

Looking at the segment results, Media Networks reported a 20% increase in revenues and operating income, largely due to the inclusion of the Fox assets (primarily FX and National Geographic). As it relates to the legacy Disney business, operating income declined at ESPN, with growth in affiliate fees from rate increases offset by lower ad revenues and higher programming costs. Adjusted for the launch of the ACC Network, the number of ESPN subscribers declined by more than 4% year over year – a big headwind when you consider that the average linear pay TV subscriber is paying somewhere around $10 a month for Disney’s sports channels.

Results in the Studio Entertainment business were solid, with revenues and operating income both growing more than 100% year-over-year. This reflects the strong box office performance of Frozen II (the highest grossing animated film of all time at $1.4 billion) and Star Wars: The Rise of Skywalker, along with a relatively easy comparison in the year ago period. As noted on the conference call, Disney generated more than $11 billion at the global box office in 2019, with seven different movies eclipsing $1 billion at the box office – by far the strongest performance in the industry’s history (the prior record was set by Disney in 2016 at $7.6 billion). As shown below, operating income for the Studio Entertainment business has increased significantly over the past decade.

Following last year’s record result, the Studio Entertainment segment will face some tough comparisons throughout the reminder of 2020. While that’s a short-term headwind to earnings growth, CEO Bob Iger is clearly optimistic about the years to come: “As we look ahead, we're extremely pleased with the long-term prospects for our studio.”

The Parks, Experiences and Products segment reported a high-single digit increase in revenues and operating income, with strength at the domestic parks offset by weakness internationally (most notably at Hong Kong and Shanghai). While the company is currently facing short-term issues outside the United States, I’m very impressed by their domestic results (a combination of attendance growth and a 10% increase in per capita spending, with higher average ticket prices from a “more thoughtful pricing strategy”), and continue to believe that this is one of the real gems in the Walt Disney Company portfolio.

The other major event in the quarter was an update on the company’s direct-to-consumer offerings, most notably Disney+. Prior to the launch, Wall Street analysts were estimating that the company would likely end the year with somewhere around 10 million paid subscribers. On Tuesday, Disney reported that there were more than 25 million Disney+ subscribers at year end (with another two million joining during the month of January). To put that number in context, Disney has built a customer base in three months that is equal to nearly half of Netflix’s (NASDAQ:NFLX) U.S. streaming subscriber base. That is no minor feat.

Here’s what Mr. Iger had to say about that accomplishment on the conference call:

“Thanks in large part to our incredible portfolio of great brands, the outstanding content from our creative engines, and a robust technology platform, the launch of Disney Plus has been enormously successful, exceeding even our greatest expectations…. It is a very unique product. I was asked on CNBC whether I felt threatened by competition. But there isn't any competition that is like our product, because of the investments that we've made in those franchises and the quality of the product that we've made over the years and we're continuing to make. So, we're very differentiated.”


I find it interesting that despite early DTC subscriber gains that exceeded analyst estimates of three to six months ago by a mile, Disney’s stock has not done particularly well. Since Disney+ was launched in November, Disney shares have lagged the S&P 500. (To be clear, I could not care less about short-term moves like this, I just find the underperformance interesting.) I think part of the reason that happened is because investors are somewhat uneasy in terms of the long-term economics of the business as Disney transitions to a new model – particularly as they’re asked to digest some ugly numbers in the short-term. (Consider that analysts at Goldman cut their EPS estimates for the next three years by roughly 10% each following the release of the Q1 results.)

I can understand that concern. It’s something I’ve thought about a lot. The change in analyst estimates for Disney’s earnings over the past year or so tells the tale. And, to be honest, I still do not have a great understanding of whether the long-term economics of the DTC businesses will ever rival what Disney had in the linear pay-TV universe. But what I do know is that Disney has developed a monetization strategy that does not rely on bearing fruits from a single channel. Between the parks, movie theaters, consumer products and TV channels / DTC offerings, I think Disney has - and will continue to - effectively monetizing its IP. That’s why I’m still comfortable holding a material position in the business, despite some short-term developments that will be a headwind to earnings growth.

Disclosure: Long Disney.

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About the author:

The Science of Hitting
I'm a value investor with a long-term focus. My goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio - a handful of equities account for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

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