Sunday, April 19, 2020

Disney Part 3: The rest of the company, and valuation

The rest of Disney is well known: movies, theme parks and toys.

Disney sells stories that children love.  They take the money, risk and time to craft stories and characters that touch young audiences.  This is a bit of an art - throwing more money into a movie does not make it better.  This makes children to spend money on Disney's other products: merchandise and theme parks- the flywheel effect - buying one service from the company leads you to buying more.  From Walter Disney himself:

Disney recently bought Twenty First Century Fox (TFCF), increasing their debt to 48bn.  Probably for content to put on Hulu and Disney+.

Disney+'s Profitability

Disney+ launched in October and wildly exceeded expectations.  Its going to become an increasingly important part of their business.  How profitable is it, and is it going to burn cash like Netflix?

Disney capitalises film and television production costs, and amortises them over time:

"Film and television production, participation and residual costs are expensed over the applicable product life cycle based upon the ratio of the current period’s revenues to estimated remaining total revenues (Ultimate Revenues) for each production....For television series, Ultimate Revenues include revenues that will be earned within ten years from delivery of the first episode, or if still in production, five years from delivery of the most recent episode, if later."

Not sure of this applies to their Direct-to-consumer segment - could not find it in the 1Q results,  though they amortise TFCF and Hulu content (Search for "intangible assets").  In that quarter, CFO dropped 0.5bn to 1.6bn (top p8), due to "higher film and television production spending".  That may be it.

So Disney+ Direct-to-consumer operating profits do not necessarily translate to CFO.

Since I can't get anything from Disney's results, lets estimate in other ways:

  • If season 1 of "The Mandalorian" cost $120m to make, making 30 series a year comes up to, lets say, 3bn (not all shows will be that expensive).  With their current subscriber base of 28.6bn (revenues of 1.8bn/year), thats a cash outflow of 1.2bn. 
  • In 2019, Netflix had 20bn revenues but still burned 2.9b CFO.  Rough guess, they burn around 18bn/year on production and acquisition of titles.  If Disney+ follows this, they will expand production as they grow bigger, but less than Netflix, since they are fundamentally different.  Netflix's business is to get you watching as long as possible ("We're competing with sleep").  They try to be everything to everyone.  Disney's more focused business is to get children to love their characters and spend money on them. Also, Disney already has a large catalog of movies, plus TFCF.

I expect Disney+'s subscribers and costs to grow, similar to Netflix's past trajectory, but on a smaller scale.  How do you value something like that?


Disney has no video game IP (eg: pokemon, minecraft).  Its a glaring hole in their entertainment business.  They are great at films/movies, but that does not translate into video games.  This essentially means you are ignoring half the population.

2019 was the peak of the movie cycle.  Expect a decrease in movie revenues over the next few years:

  • The top grossing movie of all time, Avengers Endgame, completes a 22 movie arc.  Two main characters are dead.  This year has movies with minor characters, and they will take a few years to "build up" the characters/universe again.   Don't expect another big hit from the Marvel universe for a while.
  • After initial excitement, Star Wars revenue has declined for each of their main movies, culminating in a loss for the 2018's "Han Solo" movie.  They fucked it up by producing bad movies too quickly, and need to slow down.

Disney has been through long bad periods before.  The 60s to the end of the 80's was considered Disney's "dark age", when they did not know what types of movies they were producing.  The company nearly went bankrupt.

There was a second smaller "Dark Age" from 2000 to 2009.  Movie making is a hit-and-miss business.  Despite all the "magic" of Disney's brand and characters, its easy for them to lose sight of what they're doing and get a string of misses.


Lets make a conservative long-term scenario for Disney (while forgetting about the coronavirus).

Assume long term profits in Movie Studio and Parks get back to 2019 levels.  ESPN moves entirely to ESPN+, losing all affiliate fees, but advertising is unaffected.  ESPN+'s price rises to $10/month.  ESPN's sports rights costs do not increase.  Disney's OTT competes with Netflix: they are both different services, so many will subscribe to both.  The key question is, can OTT make up for ESPN's decline?

Basic stats:

  • 128m households in the US.  45m of them have children, 30m of them have both parents with the children.
  • Netflix has around 60m US subscribers and over 100m international subscribers
  • Hulu currently has 28m subscribers
  • 115 million NFL fans in the US.

Lets take:
  • 30 million US households using the Disney+, Hulu & ESPN+ bundle for $17/month (currently $13/month, but expect ESPN+'s price to rise as it replaces ESPN).  So 6.1bn streaming revenue.
  • Another 20m other households are sports fans and subscribe to ESPN+ @ $10/month.  2.4bn revenue.
  • 50m international subscribers to Disney+ only @ $7/month (assume the increase the price a bit).  NFL/baseball are purely American sports, so forget about ESPN.  Gives another 4.2bn revenue.
So 12.7bn revenue.  Minus 5bn annual cash production costs for Disney+.  Gives 7.7bn, to offset against the current ESPN affiliate fees of 9bn.  So thats a 1.3bn  drop in operating profit, or a 12% drop.  This is purely guesswork, but they are reasonable numbers so its the best we can do.  At 15X earnings, you would pay $82 per share.

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