Disney's Lost Decade. What's Next?

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I would sit with money managers, portfolio managers, and I'd say, why do you like Disney? And they're like, oh, it's just a fantastic media conglomerate. And I used to say back, no, it's ESPN masquerading as a well-run media conglomerate.

Hello and welcome to the Barron's Streetwise Podcast. I'm Jack Howe, and the voice you just heard, that's Citibank analyst Jason Basny. He's talking about Disney, which is coming off a lost decade for shareholders, but which most of Wall Street still calls a buy. In a moment, we'll hear from Jason and another bull on the stock, to understand the case for better returns from here. Listening in is our audio producer, Alexis Moore. Hi, Alexis.

Hi, Jack.

Alexis, have you been to Disney World?

Heck yeah.

I went once as a kid, and I went many times when my kids were small. And I have a theory about the Disney parks. You talk with a lot of people who say I used to go, it used to be fun, but then something happened. They closed my favorite ride, they put the movie tie-ins on everything, or the prices went way, way up, or they got rid of my favorite free service, what have you. And a lot of that stuff really has happened in recent years. The prices have gotten up there. But my theory is you've heard the famous explanation from the Saturday Night Live producer Lorne Michaels, how he talked about how everyone always says SNL sucks today. It used to be great in the past and now it's terrible. It's not funny anymore. And when he digs a little deeper, he always finds that people's favorite time period for SNL was when they themselves were young. I forget exactly the age range he gave, but like they themselves were young and healthy and having a lot of fun. And they look at that and they say that was the best period for SNL. What they mean is maybe that was the best period for their lives. I think Disney is like peak fun when you yourself are a young kid or when you as a parent have young kids. But then when the kids get older, it stops being as much fun. And then you say, hey, Disney really jumped the shark. It's not as good anymore. The point is, if you're out there and you're a parent with young kids and you're gearing up for a trip to a Disney park or to any theme park and you're hearing people say, oh, it used to be fun, it's not fun anymore, I'm pretty sure that's not true. I'm pretty sure you're going to have a blast. I think I've mentioned on this podcast about how my family used to get jazzed up for a Disney trip by watching this. There was like a YouTube sort of ad that told you about how great it was staying at a Disney resort. And there was a showman who used to go, he did a song and dance routine about, you know, this and that for free.

I remember that.

We can pick you up with our airport bus.

All those perks are gone. Like they're either gone or they charge for them. So it's like, that was kind of sad, but okay.

Disney stock hasn't been a very happy place for, you investors to be for the past 10 years. I saw it recently at $121. That is where it was trading on August 4th, 2015, decade ago. On that day, the company lowered forecasts for its financial results, citing ongoing subscriber losses at ESPN.

Disney shares are taking a big hit.

It is cutting its forecast for cable TV profit.

Everyone and their mother was a Disney bull going into the number. And then lo and behold, people are dropping ESPN because they're unbundling from their cable deals.

Any media investor who's got some tenure on them remembers the August 2015 Disney Investor Day.

That's Ben Swinburne. He's an analyst at Morgan Stanley who covers media stocks, including Disney.

I remember it because we were not recommending Disney at the time. We were cautious on the ESPN situation.

The cable sports network was easily Disney's biggest moneymaker at the time, even if the public associates Disney more with Mickey Mouse, roller coasters, and superhero movies. The stock back then lost 9% in a day. A lot of other media stocks tumbled too. Discover, Time Warner, Viacom, Fox, Comcast, CBS.

And the industry lost $50 billion of market cap in a day, which at that time was a lot.

This was not nearly the start of cord cutting. Consumers have been leaving pricey cable television bundles for streaming for years. But it's as good a milestone as any for the moment when Wall Street decided in earnest that traditional television economics could no longer hold. If ESPN was vulnerable, so was everything else. Fast forward to now. Three-quarters of Wall Street analysts who cover Disney stock recommend a purchase. That's actually higher than the percentage who like Netflix. Be careful there. Disney was also the more popular of the two stocks on Wall Street a decade ago. Since then, Netflix has returned 955% versus 253% for the S&P 500, while Disney, if you include dividends, has eked out a 10% return. I spoke recently with Jason Basny from Citi about how we got here. Let's hear part of that conversation.

I used to not be bullish on Disney.. And I would get so frustrated because I would sit with money managers, portfolio managers, and I would say, what do you like? And they'd say, oh, I love Disney. And I'd say, why do you like Disney? And they're like, it's just a fantastic media conglomerate. And I used to say back, no, it's ESPN masquerading as a well-run media conglomerate, because there was almost this misperception. But if you actually looked at the numbers and the return on invested capital, it was all coming from those linear cable nets. It was all driven by people paying, you know, $8, $9, $10 a month for ESPN, up to and including the half of households that don't care about sports at all, right? That were just getting dragged along with this very high pay-TV penetration rate.

Amazing that you could make money off of sports from people who never watch sports. Just exactly. Everyone had to have it included in their cable bundle.

That's exactly right. And so what happened since then? You had the first chapter, I would call it, where Mr. Iger got the IP right and began to actually make it a better-run media conglomerate. That was the acquisition of Pixar, I want to say in 2006, the acquisition of Marvel, I want to say in 2009, and then of Lucasfilm. During that golden period, you had a bad media conglomerate become a good media conglomerate where the studio became more potent. The parks began to do much better because you were putting relevant IP in there, but the ESPN cash cow had not cracked. That didn't crack until 2017. When the cord cutting began, you used to hop on Disney earnings calls and, you know, let's say that there were a million numbers on the press release that would come out and all everyone would listen for was the number of Americans that cut their pay TV subscription. And if Disney said it was flat, the stock was flat. If they said it grew by a million, the stock would go up. And if it fell by a million, the stock would fall. And we lived in that sort of bizarre sort of Twilight Zone of the only number that mattered was the pay TV penetration rate, right? How penetrated ESPN was, i.e., cord cutting, for about 2 years. And that's when Disney said, okay, we need to go out and do an acquisition to have enough intellectual property to stand up our own streaming service. And that's what happened in 2019. From '19 to '21-ish, Disney was playing the same game that Netflix was, which is no one cared about the streaming losses. It was growth at any cost. The tenure was 1%. And that's when Disney stock got to $200 a share. Once COVID ended, the 10-year moved to 4, everyone demanded profits, then it's been sort of a disaster because Disney's had to sort of generate profits while the linear business is shrinking and they don't want to invest so much money to really take on the juggernaut in a full-throated way. And so we're sort of in this tweener spot right now, I would say.

Most of the money now is being made in the parks, right? So there's enough there from these other businesses. For the stock to do well, even if streaming becomes a ho-hum business. Is that the idea?

Yeah, that's exactly the idea.

Thank you, Jason. Disney's parks and its cruise ships are part of what it calls its Experiences division, and that is by far the company's biggest earner today, almost 60% of operating profit. But that wasn't always the case. Disney's been really, I think, 3 different companies during its lifetime. It started as an animated film business with later some theme parks. It became a TV company with all that other stuff too, and today it is solidly a theme park company. You might say that it was theme parks that got Disney into TV. Founder Walt Disney dreamed up Disneyland while sitting on a Los Angeles park bench and watching his young daughters play on a merry-go-round, but his animated films weren't enough to cover what would ultimately be a $17 million construction bill. So in 1954, a year before the park opened, Walt cut a deal with his industry's rising competitor, TV. He would make a show called Disneyland and later The Mickey Mouse Club for ABC in exchange for funding and on-air promotion. Three decades later, Disney embraced TV's thriving new pay model when it launched the Disney Channel on cable. Are you having a moment, Alexis?

I used to love Disney Channel. I mean, it wasn't the Disney Channel when I was watching, but still very important to me.

Favorite show?

That's So Raven.

That's So Raven.

Do you remember that?

No, I'm 100 years old.

If I had watched that, so I don't know how old I would have been when that came out, but I wasn't the, I wasn't the core demographic.

Who did that star? Did that star somebody still famous?

Well, it's Raven-Symoné. That's So Raven.

I thought it might have been like, you know, Billy Ray Cyrus's kid.

Miley Cyrus.

Miley Cyrus. That's how old I am. I call Miley Cyrus Billy Ray's kid. That's really wild. Oh man. I think Miley is wonderful.

I think she's wonderful. Okay. Disney Channel might have been a formative development for Alexis, but there was a much bigger move into television coming for Disney. It surprised Wall Street by announcing that it would buy the parent company of ABC for $19 billion. That was the second largest corporate takeover ever at the time. There had been a recent regulatory change that meant that networks were no longer prohibited from owning their primetime shows. So that takeover brought ABC's 80% stake in ESPN. It also came with ABC head Bob Iger, who would become Disney's CEO in 2005. As we heard earlier from Jason, ESPN was really the cash cow that transformed Disney. Sports are special. Audiences skew young. They watch live. It's a dream for advertisers. And ESPN allowed Disney to outbid rival networks on sports rights. It became a must-have channel in cable bundles, and that allowed Disney to charge by by far the highest rates of any network to cable bundlers. That money provided no small part of the resources for Bob Iger to go out and buy Pixar and Marvel and Lucasfilm, and that brought Disney from an also-ran in the movie business to the top of the pack. It set off one of the biggest booms in box office history. It also allowed for no end of upgrades and expansions at the theme parks, which made the parks the big earner that they are today. Last year, Disney's experience division that includes the theme parks, it turned in a record operating profit. And there's more growth to come there, and Disney announced distant plans for a new park in Dubai. It's important the parks are still growing because like I mentioned earlier, they're more than half of operating profit today. Movies, however, have become meager earners. There was a live-action remake of Snow White this year. It flopped. There was a Pixar release in June called Elio. Have you heard of it? If you haven't, you're not alone. That's a good indication of how it did. Then again, in May, there was a live-action remake of a 2002 animated film called Lilo and Stitch. That was a great performer. Bennett Morgan Stanley has a simple explanation for weak theater results for Disney and for others. Too few releases. The pandemic halted movie production, and then studios diverted films from theaters to streaming., and then Hollywood had strikes in 2023. Now, next year is likely to bring the most releases since before the pandemic, and Ben is predicting $11 billion in North American box office receipts. That is close to the 2019 haul. Disney's current slate features the Fantastic Four in late July, a new Avatar near Christmas, a new Toy Story next summer, and the return of the Avengers near Christmas 2026. Wasn't the last one called Endgame? Avengers Endgame? I mean, it had end right in the title. There's a new one? What's the new one called? Avengers Just Kidding About the End? All right, well, those movies were gigantic earners, so we'll see. Let's take a quick break. When we come back, we'll hear some more about Disney.

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That's hbs.me/breakthrough. Welcome back. I mentioned that last fiscal year brought record profits for Disney's Experiences division, which includes its parks. But what about for the overall company? The high water mark for earnings there was set all the way back in 2016, and it was nearly matched in 2018. That was before the decline of traditional TV accelerated like it has in recent years. The low point for profits came in 2021. Parks were still running pandemic losses, and the ramp up of the Disney+ streaming service that was burning through cash. Here's an odd fact. The high point for the stock around $200 a share came pretty close to the low point for profits. That's because investors liked the idea of burning a lot of cash to build a streaming service until they didn't like it anymore. We'll come back to that. Last year, Disney reported operating profit of $15.6 billion. That was up 17% and very close to its previous record. This year, Wall Street is predicting a further 18% increase to $17.5 billion. That would smash through the record. And over the next 3 years, Wall Street expects Disney to tack on an additional $5 billion in yearly operating profit. And that will come mostly from 2 sources. One is steady growth from a large base of profit in experiences, including parks and cruises. And the other is rapid growth from a small base of profit in what Disney calls direct-to-consumer and what you call streaming. Even with that fast growth, Disney streaming in a few years is likely to produce maybe a fifth of the operating profit of Netflix. That's reflected in Netflix today having more than double the stock market value of Disney. I asked Ben from Morgan Stanley about his outlook for Disney and streaming. Well, where does Disney land in all of this? Does it stay in the middle? Does it fall behind? Does this have a shot of keeping up with Netflix? Can it be something different that's more specialized? What do you view their role as?

Well, I think it's important to sort of separate your question into two pieces. There's the, can Disney catch up to Netflix? And then there's the, can Disney+ be a driver of Disney stock price from here? Catching up to Netflix will be very difficult for anybody. And by the way, Netflix is over a half a trillion-dollar company right now. So there's nothing in Disney's stock price that's reflecting anything close to the value of Netflix for Disney+. So we'll put that one to bed. In terms of the opportunity though for Disney+, and obviously that includes Hulu and to a degree includes ESPN, they're profitable today. I think they'll deliver on their double-digit margin guidance, excluding Hulu Live. Revenues are growing in the high single digits. I think the opportunity ahead of them is most substantial and probably most important for the stock internationally. If you look at Disney+ in the US, it's not dramatically smaller than Netflix. Actually, when you add Disney+ and Hulu together, and obviously we'll get ESPN in the mix soon, it's a pretty big business. And Disney+ plus Hulu plus ESPN is a unique offering to the consumer. I mean, there's nothing else in the US like that. Outside the US, it's a small business compared to Netflix. I mean, the international Disney streaming business is probably a quarter to a fifth of the size of Netflix. And to be frank, nobody but Netflix has built a streaming business to scale with meaningful profits outside the US yet. Full stop. Now, can Disney do it? I think that's a big question mark. If they can, I think it's a huge opportunity for the stock. If they can't, it just means you're leaning more and more on the parks to drive the earnings bus.

Jason from Citi has thoughts on why so many of the streaming services that aren't named Netflix are, as you'll hear him put it, half pregnant. It has to do with interest rates.

Here's Jason. I make this chart and update it, you know, every 6 months or a year. On the horizontal axis, it's just how much are consumers using each app per day, and you want an app where consumers use it a lot. And on the y-axis is if you take the price consumers are paying and you divide it by how much they're using it, you get a sense of what the consumers are paying per minute. Where you want to be on that chart is in the lower right-hand corner where you have massive engagement at a very low cost.

I feel like I'm going to find Netflix there.

Is that right? Yeah. And if you are in that lower right-hand quadrant, you are what I would call a pay-TV substitute. If you are in that upper left where you don't have much engagement and the consumer cost per hour is quite high, I describe your app as the equivalent of which HBO was in the old linear days where you'll log into this app and, you know, in the old HBO days, you'd watch Game of Thrones or Sex and the City or The Sopranos, and then you'd turn off HBO, right? And it was a very expensive way to consume content, right, at the consumer level, but people did it because they really wanted to see that piece of content. Most of the other apps, the Peacocks of the world, the Maxes of the world, are in that upper left. People are logging on and they're watching whatever it is, Landman or Yellowstone, and they watch it and then they turn off. And so it's not really a pay-TV substitute. It's just sort of HBO in the digital age. Disney is squarely in the middle. They're not industry-leading and they're not industry-lagging, and they're sort of just stuck. So they have a shot to become a pay-TV substitute. But my fear is that Disney is not going to invest the quantum of dollars that they need to become a pay-TV substitute because the Street is maniacally focused on Disney's aggregate earnings and in particular the DTC EBIT. And this is a bit unfair, and I won't make this too long, but you know, one of the things that people forget is that Netflix Netflix burned money 10 years in its streaming business, and the Street was totally comfortable underwriting those losses because interest rates were close to zero. When the 10-year leapt up to 5%, Wall Street woke up one day and said, we will not underwrite losses anywhere. And every company, every media company sort of responded in kind. And so what that meant is a lot of these streaming services are sort of half pregnant. They sort of didn't run the distance to become a pay-TV substitute, they were sort of interrupted halfway in between. I would argue the move in the 10-year interest rate, which caused the buy side to say they didn't want losses. What that means is that, you know, Disney, I think, is sort of doing what it can to maximize profits on its streaming pivot, but not doing what it needs to do to become a pay-TV substitute.

DTC EBIT, that's direct-to-consumer, in other words streaming, and earnings before interest and taxes, in other words Profitability. So investors are really concerned about that streaming profitability. That's like half my job is to spell out acronyms.

So I just try—

sorry, sorry. Oh, it's all right. It's all right. That's why I'm here. I try to stay on top of it.

So that's interesting to me. It feels like Netflix has reached such a level of cash flow to enable such spending on content and producing shows and movies, they say, in 50 countries. It just feels like a show business Death Star. It feels like, who's going to be able to compete against Netflix? And I know that Disney has these beloved properties and franchises and lots of family things, but I mean, is the landscape that Disney is the only one with a shot right now and it's not a terrific shot, or how would you describe it?

Well, you, you, I think you've characterized it perfectly, Jack, but I, I would say that, you know, there's sort of bad news for traditional media, and there's really good news for traditional media. The bad news for traditional media is you have one Death Star in the ecosystem, and they look like they're unassailable. What I would say is the good news is, particularly Disney, they've sort of done the hard part, right, which is cultivate these iconic franchises that will at least give consumers a reason to try the app. And I think where they've fallen short is really on the easy part, which is you just need to make a ton of content that's actually undifferentiated. And I think this is where Disney sort of gets a little bit confused maybe in that if you think about this company 20 years ago, 15 years ago, Disney was really a broken studio. If I ranked all the studios, it was number 7. The theme parks were sort of tired, right? And I think what one of the things that made Mr. Iger such an iconic executive is he went out and very carefully bought the right pieces of intellectual property, released very few pieces of high-quality content, which enabled the studio to become more formidable. And then all of that content ended up benefiting the theme park business. So it was the right strategy at the right time. Where Disney is now is they need to do the thing that they would call antithetical to who they are, which is, how about you just make a bunch of undifferentiated content? Because what they have is consumers will log into Disney because it has a good brand, and they'll want to see that one show. But they won't stay in Disney because there's not enough diversity of content to appeal to everyone.

What kind of company or stock is this? Is this a turnaround or is this a company that has growth potential going forward? When I think of the parks, I just always hear about every park being packed, and I know that Disney has ramped up ways to make more money from each visitor. And so I think, how much growth potential could there really be at the parks? I know that they're planning a new park in Dubai, and that sounds like a big opportunity, but How many other opportunities like that around the world could there be? So is this a growth business at this point?

No, I would not characterize Disney as a growth stock. I'd call it low to mid-single-digit top-line growth and call it double-digit earnings growth, something like that. That's certainly not a growth stock. And that's why, you know, the multiple has come in. Could it be a growth stock again? Yeah, your best vector to get growth going is really to sort of supercharge the DTC business. My suspicion is that if that happens, it's probably going to happen after Mr. Iger's tenure as CEO expires. My sort of soft hypothesis on Mr. Iger is he wants to go out as the hero, right? The guy that was brought back to sort of turn Disney around and sort of through that lens, you could imagine him wanting to maximize earnings, to maximize the share price in the near term. And then I could imagine whoever comes in behind Mr. Iger, we have sort of this reset moment where they say, well, We've sat down strategically and decided we're really going to go after the Death Star, and that's going to require another— I'm making a number up— $5 billion of investment in content. And therefore, our direct-to-consumer business will retrench and go back to losses or generate half the profits. And there'll be this sort of frustration among the owners and this reset, but that will sort of lay the foundation for longer-term growth.

Thank you, Jason and Ben, and thank you all for listening. If you have a question you'd like played and answered on the podcast, send it in. It could be in a future episode. Just use the voice memo app on your phone, send it to jack.hough@barons.com. Alexis Moore is our producer. You can subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcasts. And if you listen on Apple, you can write us a review. See you next week.

Data is everywhere. When orchestrated properly, it sings. At Morningstar, we analyze and enrich data, making it actionable and powerful for you. Morningstar, where data speaks.