Is Disney's Big Gamble About to Pay Off?
Walt Disney (NYSE: DIS) is arguably the world's most recognizable entertainment company. Despite its size, industry-leading position, diversified media channels, cruise ships, and more, Disney is a very risk-tolerant company. In fact, risk-taking has been a winning move for Disney throughout its history.
Disney's latest gamble is investing heavily in content and expanding its direct-to-consumer (DTC) offerings through Disney+, ESPN+, and Hulu. These three services racked up a staggering $6.74 billion in programming and production costs alone in the first half of fiscal 2022. And Disney expects total fiscal 2022 content spending to be $32 billion.
The DTC segment continues to lose money. And investing in DTC is one of the main reasons Disney can't afford to reinstate its dividend yet.
What's more, the company is shelling out heavy spending while its parks are just a few quarters removed from major coronavirus-induced slowdowns. And the movie business is still trying to get back to its fiscal 2019 form. Here's a brief explanation of Disney's gamble and why it makes sense long term, but why the road could be rocky for the next few years.
Image source: The Walt Disney Company.
Reasons for investing in Disney+
Disney+ launched in November 2019. And with 137.7 million paid subscribers as of Disney's Q2 fiscal 2022, it has already grown to become the second-largest streaming service behind Netflix.
Management expects Disney+ subscribers to balloon to between 230 million and 260 million by fiscal 2024. Subscriber numbers should get a jolt when Disney rolls out its ad-supported tier in North America later this year and internationally sometime in 2023.
Disney's subscriber numbers also benefit from Disney+ Hotstar, a Southeast Asia partnership. But Disney makes about an eighth as much revenue from a Disney+ Hotstar subscriber than a normal subscriber.
The goal of Disney+ isn't to be a profit engine on its own but rather to deliver content to as many people as possible. That way, fans are more connected with Disney's various franchises -- which increases the likelihood they go see Disney movies, take a cruise, go to a resort, buy Disney merchandise, etc. In this vein, Disney+ opens the world of Disney to consumers for little to no cost.
Some risks to consider
Given Disney's track record for producing content that people want to see, it stands to reason that Disney+ should be a long-term winner. Especially as Disney gradually reduces its content spending after its initial three- to four-year ramp-up.
However, Disney's plans could get thwarted by factors outside its control. For starters, it could find an unexpected number of subscribers switching from paid subscriptions to ad-supported subscriptions. The company's revenue per subscriber could fall further if Disney+ Hotstar subscribers continue to make up a large share of total subscribers. Fast-forward to fiscal 2024, and we could easily see total subscribers being in the range of 230 million to 260 million. But many subscribers could generate very little revenue for Disney on their own. Therefore, the total subscriber number shouldn't be taken at face value. Investors should check earnings announcements for a breakdown of Disney+ subscribers versus Disney+ Hotstar and ad-supported subscribers once Disney launches that service.
If an economic downturn or recession occurs this year or next, the timing will sting big time for Disney. Fiscal 2022 and fiscal 2023 are supposed to come back years after a terrible fiscal 2020 and a weak fiscal 2021. If the park numbers reverse trend and begin sliding, and folks show up at the movies less than expected, Disney's bottom line will suffer. Keep in mind that the company's profitability is already strained because of its high content spending and sales, general, and administrative costs.
Keeping a long-term perspective
If a prolonged economic downturn occurs, Disney would find itself spread thin. Its valuation over the short term would continue to look expensive due to weak profits.
What Disney needs more than anything is time. Time for COVID-19 lockdowns to ease, inflation to come down, and a new economic growth cycle to begin. If the economic situation worsens, investors shouldn't be surprised if its takes till fiscal 2024, fiscal 2025, or even later for the company to exceed its record fiscal 2018 and fiscal 2019 performance.
At the same time, it's equally hard to envision a scenario where Disney isn't a much larger company in 10 years than it is today. Disney+ and other DTC services enhance its content engine and provide a valuable archive of easily accessible Disney content and an easy way to watch movies once they leave theaters.
The good news is that no matter how bad things get in the short term, Disney isn't going anywhere. Its big gamble could cost the media company in the short term. But over the long term, Disney should come out on top.
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Daniel Foelber has the following options: long January 2024 $120 calls on Walt Disney, long January 2024 $145 calls on Walt Disney, long January 2024 $155 calls on Walt Disney, long July 2022 $145 calls on Walt Disney, long June 2022 $170 calls on Walt Disney, short January 2024 $125 calls on Walt Disney, short January 2024 $150 calls on Walt Disney, short January 2024 $160 calls on Walt Disney, short July 2022 $150 calls on Walt Disney, and short June 2022 $175 calls on Walt Disney. The Motley Fool has positions in and recommends Netflix and Walt Disney. The Motley Fool recommends the following options: long January 2024 $145 calls on Walt Disney and short January 2024 $155 calls on Walt Disney. The Motley Fool has a disclosure policy.
