Disney Valuation, Part 2: Intro to Media and DTC

The second article in a series about The Walt Disney Company

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I recently wrote an article that looked at the Studio Entertainment and the Parks, Experiences and Products segments of The Walt Disney Company (DIS). In the conclusion, I wrote, “I think you can make the case that these segments are collectively worth $90 billion to $170 billion.”

In this article, I will discuss my initial thoughts on the remaining businesses at Disney, including the Media Networks segment and the Direct to Consumer (DTC) and International segment. (I intended to address all of Media Networks and DTC in a single article, but that proved impractical.)

Let’s start with the Media Networks segment, which includes the company’s domestic cable networks (ESPN, Disney Channel, FX, etc.) and the broadcast network (ABC). The segment makes money from affiliate fees (what MVPD’s pay on a per subscriber basis to carry Disney’s channels), advertising and TV / SVOD distribution (fees generated by the sale and licensing of programming). The breakdown in segment revenues in 2019 was 54% from affiliate fees, 28% from advertising and 18% from TV / SVOD distribution. Adjusted for the inclusion of 21st Centruy Fox, Media Networks affiliate and ad revenues increased by 5% and 1%, respectively, in 2019.

As shown below, the segment has generated roughly $7.5 billion in annual operating income over the past five years. Note that the results now include the consolidation of 21st Century Fox, as well as the associated headwind from removing International TV channels.


As noted in the annual report, segment revenue growth in 2019 (up 13% to $24.8 billion) consisted of the following: an eight point contribution from the consolidation of 21st Century Fox and a seven point contribution from higher per subscriber rates, partially offset by a two and a half point headwind from fewer pay-TV subscribers. That outcome, adjusted for the 21st Centry Fox consolidation, is basically comparable to what we’ve seen in recent years: mid-to-high single digit growth in per subscriber rates, offset by a low-single digit decline in subscribers. As shown below, the decline in subscribers for Disney has been persistent over the past few years.


That math has worked on the top line, with the growth in per sub rates outpacing the loss of subscribers. But here’s where I think that has started to become a problem. First, the rate of subscriber losses has accelerated in recent quarters, and in my opinion, that could continue going forward. Second, expense growth, which largely reflects the rising cost of sports programming rights for leagues like the NBA and the NFL, has outpaced revenues; as a result, segment operating margins have fallen more than 400 basis points since 2014. At the end of 2019, the company’s sports programming commitments totaled $44 billion.


That’s the big picture at Media Networks. Now, let’s do the same for DTC & International. In 2019, the segment generated $9.4 billion in revenues. Half of that was attributable to Disney’s legacy International channels, as well as the assets acquired from 21st Centry Fox (like Star in India). The other half was primarily attributable to Hulu, as well as early subscribers gained at ESPN+ (note that the launch of Disney+ was in November 2019, after the company’s fiscal year had ended).

Naturally, investments in ESPN+ and Disney+ come with significant start-up costs. In addition, the consolidation of Hulu is a headwind to profitability. Hulu lost more than half a billion dollars for Disney in 2018, and that was when they owned 30% (compared to 67% today). As a result, DTC & International reported a loss of $1.8 billion in 2019, compared to a loss of $740 million in 2018.

The breakout in the annual report provides an even more detailed look at the segment results: profitability from International channels more than doubled in 2019 to $670 million, with the difference accounted for by a $2.2 billion loss at DTC.

That’s a long way of saying that Disney is incurring sizable losses to support the growth of this nascent business, but that investment is already bearing fruit. As noted in the first quarter press release, Disney+ had 26.5 million subscribers at the end of calendar 2019 (seven weeks after launch). Recently, the company provided another update, telling investors that the service now has more than 50 million paid subscribers. In five months, despite being available in a handful of countries, Disney+ has built a subscriber base that is roughly 30% of the size of the global business that Netflix (NFLX) built over 13 years.


In summary, we have a segment that generates substantial earnings, but there are concerns about its durability. Then we have a segment with some nascent businesses (Hulu, Disney+, ESPN+, and Hotstar) that are probably going to lose a few billion dollars this year. As the DTC businesses expand, with Disney+ launching in Europe, Asia Pacific and Latin America over the next two years, those losses may become larger as well. (For Disney as a whole, this will include higher programming and production costs as well as lower TV / SVOD licensing revenues.)

One important point worth reiterating is that the first business described above relies on the strength of the company’s non-entertainment programming, particularly live sports (and clips / commentary about live sports), while the latter is focused on entertainment programming. Personally, I’m of the view that these are two distinct markets, which will come with different risks and opportunities and require different solutions to meet customer needs. This is something I've come to believe and understand from listening to Netflix CEO Reed Hastings. Note that Disney has become a strong player in both markets - the only company I can think of that has done so in a big way.

Collectively, between Media Networks and DTC & International, Disney reported $34.2 billion in revenues and $5.7 billion in operating income in 2019. Within that, we have a business that remains largely dependent upon the U.S. pay-TV universe (“the bundle”), and another that is helping contribute to continued pressure on pay-TV as it moves its best entertainment content to DTC / SVOD (along with the other large legacy media companies who are doing the same).

How should we think about that trade-off for Disney? I think the answer requires a closer look at the company's entertainment and non-entertainment programming and distribution strategies. We'll begin that analysis in the next article, with a look at the company’s namesake DTC offering: Disney+.

Disclosure: Long DIS

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