Disney is taking the mickey

My Disney position is going from bad to worse. For some reason, the management team is tone deaf to macroeconomic conditions and is prepared to make incredible losses in streaming.

As I shake my head in disbelief at the Disney share price drop, Toddler Ghost is asking me about the “tractor” scene in Cars. It’s an improvement on Cocomelon, I’ll tell you that much.

Cars came out in 2006 and is just as brilliant today as it was back then. After three movies, multiple spin-offs and endless merchandise, Disney made plenty of money from Lightning McQueen and deservedly so.

Of course, he’s watching it on Disney+ on our TV, so Disney is still using the movie to generate revenue, this time through the power of distribution. The trouble is that a generational hit like Cars is hard to come by. In the content game, the costs just keep on coming.

The content treadmill

If you can imagine setting a treadmill at your local gym to the steepest setting and putting it at 15km/h, then you’ve got the right idea of how it feels to be running a streaming business in this environment. Every single month, there’s someone else releasing new content and trying to steal your subscribers.

Netflix. Disney. Amazon. The list goes on and the budgets are huge.

The winner in all of this? Undoubtedly the consumer. We have more choice than ever before. We can have an entire bouquet of streaming platforms and still be spending far less than a full DSTV subscription. Of course, live sport remains a competitive edge for MultiChoice, as does the strong slate of regional content. Broadband affordability is another challenge for the streamers.

With Disney’s share price down over 40% this year, the blame can be laid squarely at the feet of the streaming business and management’s insistence on throwing the kitchen sink and all the fairy tale creatures at the problem.

They better be right

Management is promising that the streaming business will be profitable by 2024. If it isn’t, the market is going to punish Disney even further.

With Q4 and therefore full year 2022 results now in the wild, we know that Disney’s streaming operations (called Direct-to-Consumer) lost a spectacular $4 billion this year. That’s a whole lotta money.

This drove a 42% drop in operating income for the broader Media and Entertainment Distribution segment, which includes all the other media businesses in the group (and there are many). The Q4 result is even worse, with a 91% drop in operating income in that segment.

The parks did well – but shareholders didn’t benefit

The thesis in Disney was a recovery in the theme parks as Covid retreated into the shadows. When I invested, I knew management would invest some money in the streaming business. I just didn’t expect them to pull a Zuck on me and build their own version of the Metaverse.

The recovery in that segment came in with a vengeance. Operating income recovered sharply from just $471 million last year to $7.9 billion this year.

This was enough to achieve a 56% increase in group operating income, which would’ve been MUCH higher if any degree of sanity prevailed in the media business.

The Q4 growth (or lack thereof) is what has really spooked the market. Group operating income is flat year-on-year despite a 9% increase in revenue, so the margin is collapsing as losses mount in the media business.

Where to from here?

I’ve been wrong on Disney’s short-term capital allocation decisions. Much like at Meta, I’m hoping that they will start to tone it down now.

If the company is right and the streaming business turns profitable in FY24, then Disney remains interesting and I’ll consider adding to my position once I’ve had time to fully unpack these results.

If it doesn’t work out, the pain in the share price will get a lot worse until management abandons the investment in Direct-to-Consumer (a very unlikely outcome).

For now, I’m holding. I think we might see another drop after the next quarter, which could be a catalyst to add to the position.

Magic Markets Premium

We’ve covered Disney twice in Magic Markets Premium.

Our approach is always to present a bull case and a bear case, empowering our subscribers to trade and invest with more confidence. A market is all about people reaching different conclusions with the same information, which is why we give a balanced view.

In our most recent work on Disney (August 2022), we noted that management is accelerating the investment in streaming and that this looked bearish over the short-term. We were right (sadly). I opted not to add to my position, as I felt things could get worse before they get better.

Well, they got worse alright.

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