As disclosed in our Q2 letter, we reinitiated a significant position in The Walt Disney Company (DIS, Financial) when the company retested its Covid lows earlier this year. At the current price, Disney is trading for little more than the stand-alone value of its Parks business and a mere 15x ’24 “street” consensus. The company remains early in its Direct to Consumer (“DTC”) transition with a leading market position, and yet the current stock price ascribes negligible value to the streaming business. We believe this is due to questions around the terminal economics of streaming, given large losses being generated today at Disney (>$1 billion dollars last quarter) and stagnating margins at peers such as Netflix. On the last earnings call, management highlighted three items that could lead to an inflection in DTC profitability over the next 12 months: a 38% price increase for Disney+ in the US; moderating growth in cash content expense; and an advertising tier for Disney+ launching in two months that can drive additional ARPU given high demand for the Disney brand amongst advertisers.
While the company has guided to Disney+ achieving breakeven sometime within the fiscal year ending September 2024, the valuation suggests the market remains skeptical. Disney only trades at ~14x the $7 in earnings generated prior to the Fox acquisition, which implies investors don’t expect earnings to meaningfully exceed this figure in the coming years. Hence, the first value driver we highlighted in our last letter is the opportunity for management to optimize Disney’s cost base to drive earnings growth. We believe Disney has ample means to rationalize costs across its operating platform and deliver targeted content for home viewing that does not entail the same cost structure of exclusive theatrical releases. We have come to agree with Disney’s management team that ESPN belongs with the Company at this time. The cash flow from ESPN funds the streaming losses and supports the balance sheet ahead of the Hulu purchase. In exchange, the scale and diversification of Disney provides aircover for ESPN to experiment through the initial phases of its inevitable “unbundling” from linear to DTC. Projecting a brief three years forward, this backdrop looks very different; in 2025 Disney’s streaming business will be profitable, Hulu will be fully consolidated, and the pay-TV ecosystem will have ~20% fewer subscribers.
DIS shares currently reflect very little value from ESPN. As the best brand in sports, ESPN is well-positioned to become the leading end-to-end DTC distributor of sports content in the US. This upcoming transition is obviously complicated by the asset’s current success; today, ESPN enjoys ~$11 per subscriber in monthly linear affiliate fees across a base of over 70 million households. To replicate these economics in a DTC world, ESPN will have to successfully integrate a multitude of value-added services such as sports betting, targeted advertising, fantasy football-type services, and merchandise.
Finally, as our joint press release with Disney at the end of last month outlined, we have signed a support agreement and are pleased that the Company appointed a new Board member, Carolyn Everson, who will contribute expertise in ad sales, media, and digital technology that will round out the Board’s skills. We look forward to continuing our productive dialogue with Disney’s management team
From Daniel Loeb (Trades, Portfolio)'s Third Point third-quarter 2022 letter.