Disney 2.0: Iger to Reclaim the Magic?
Pivoting a 100-year-old conglomerate towards a DTC-centric model has proven challenging (and costly). Will Iger make a difference? How much might Disney shares be worth? By Sam Fargo and Benjamin Tan
Think about the first time you entered a Disney park. You’re pixie-dusted from the moment you step in. For a brief moment, your inner child comes out and everything feels real — Cinderella lives in the castle and Mickey is no longer a cartoon.
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It’s not just the cast members, the rides, or the scenery. It’s the entire sensory experience. Everything feels happier, it smells better, and your stress melts away. None of this is an accident. It’s exactly the way Walt wanted guests to feel. Escapism at its finest.
In recent years, Disney (DIS 0.00) has lost some of that magic. With nearly $1.5bn in streaming losses in Q4 2022 alone, park guests unhappy, once lucrative networks like ESPN losing viewership, and a 4-year-low stock price, the company has a lot to come back from.
Bob Iger Returns: The Prince that was Promised?
Enter Bob Iger. The former CEO reclaimed his throne, leading a very different company than the one he retired from in 2020. Bringing back Iger, a leader respected by investors and creatives, signals a bold move for Disney—one that has Wall Street optimistically speculating about the company’s future. The media business is undergoing massive secular change and Iger has been tasked with leading Disney through it.
The mere fact that he’s back at the helm has calmed investors’ nerves. Why? They know what to expect from Iger: a focus on excellence and a passion for the brand.
Bob Iger built the Disney behemoth we know today, overseeing the acquisition of Marvel, Pixar, Lucasfilm, and 21st Century Fox. In early 2019, he was asked about some of these acquisitions that became so important to Disney’s success:
"In the case of Pixar, Marvel, and Lucas, none of them were for sale. We were the only ones. Us identifying them as acquisition targets and my going out and meeting with Steve Jobs and Ike Perlmutter and George Lucas.”
He’s a dealmaker. More importantly, he fundamentally understands the brand. Iger recognized that, going back to Walt’s roots, animation was the key to Disney’s success. The company was falling behind its peers and while the content catalogs of Pixar and Marvel were important, the talent Disney acquired gave them a competitive advantage long after.
Iger understands Disney’s DNA in many of the same ways as Walt. In a recent memo to employees, he said, “I fundamentally believe that storytelling is what fuels this company, and it belongs at the center of how we organize our businesses.” This was after he reportedly said Disney was “losing its soul”. That’s quite the statement for a company like Disney, whose success hinges on the portrayal of magic.
Back to Basics: Reclaiming the Brand of Walt Disney
For the Disney magic to return, the passion has to return, and not just a passion for the dollar. In his biography, “Walt Disney: The Triumph of the American Imagination”, Neal Gabler illustrated Walt’s perspective from a conversation with Imagineer Marc Davis:
“You and I do not worry about whether anything is cheap or expensive. We only worry if it’s good.”
While it’s impossible to expect any public company to ignore financials, Disney has become synonymous with a quality product, no matter the expense. Walt poured his soul into Disneyland and guests could feel that passion as they walked down Main Street, USA. He wanted guests to enter his films, not just watch them.
If Iger is to reclaim that magic, he needs to focus on the details. Under former CEO Bob Chapek, lots of little things began to slip. There are Reddit threads of loyal guests “shocked at the amount of cobwebs” as well as complaints of cockroaches and rats, with one guest saying, “I’ve never seen roaches in a Disney park in my life, but this year I’ve seen hordes of them.” These seem like small things for a colossal enterprise, but they are the small things that Walt got right, amounting to the global and multi-generational magic that is refreshingly Disney.
Whether it’s stores, restaurants, products, or places, our favorites become favorites not because they’re great, but because they’re consistently great. They set expectations, and whether or not they live up to them forms your opinion: good, bad, or anywhere in between. Iger once said:
“Walt set a standard early on with the Imagineers. There was a standard that enabled people to come in expecting something and then giving something even beyond that. So they left thinking, how did Disney do that?”
Sum Of The Parts (SOTP) Valuation
Valuing Disney is best approached using SOTP because each of its major business segments is not just distinct but also at various maturity stages. The company is unlike any other, hence difficult to perform direct valuation comparisons on a relative basis.
Parks is Disney’s most iconic and timeless business segment. Even as online entertainment becomes more ubiquitous, people keep flocking to Disney theme parks. Recent price hikes have not dampened demand. The desire to visit the land of Mickey Mouse cuts across all generations and has remained relevant for decades. Valuation of Parks as a segment is also least controversial and most tangible, in term of visibility and predictability of cashflows.
On the other hand, DTC is a tricky part to value because it is still new. Though it has ramped up to 225mn subscribers across Disney+, Hulu and ESPN - just eclipsing Netflix’s 223mn - the business is a major cash drain. For the quarter ending September 30, 2022, DTC reported $4.9bn of revenue and a record loss of $1.5bn. On the other hand, Netflix reported a record quarterly revenue of $7.9bn with an operating margin of 19.3%. The stark contrast in profitability, despite similarity in scale, calls into question the ultimate viability of Disney’s push into streaming.
Domestic Parks: An Asset Yield Approach
Disney Parks as a business segment is akin to real estate: steady cashflows (except during lockdown) anchored by tangible assets. An asset yield approach can therefore be employed as a valuation tool, and capitalization rates for luxury hotels may be the best proxy for Disney Parks. Both are price inelastic, carry strong branding, and command loyal followings. Disney as a theme park brand is irresistible to many who travel across continents to experience the magic. After all, it is the happiest place on earth.
Focusing on just domestic parks for this exercise, FY 2022 revenue reached $20.1bn, even with some capacity constraints. Operating margin was 26.5% and management promises more to come with additional efficiency measures and technology improvements made. Using that (versus EBITDA to account for maintenance capital expenditures) against a cap rate of 4 to 5%, implied enterprise value of domestic parks averages $120bn. This does not include International Parks, which carry different ownership and profit-sharing structures.
Film Studio: Dominant as a Result of Past Acquisitions
No other film studio has dominated the box office the way that Disney has, with Marvel, Pixar, Lucasfilm, and Walt Disney Pictures producing record-breaking movies. Disney has released five of the top 10 highest-grossing films of all time worldwide, and the two highest-grossing film franchises.
One clue on a potential valuation for Disney’s film division may be the $8.5bn (including debt assumption) that Amazon ($AMZN) paid for MGM Studios. Founded in 1924, MGM offers Amazon a deep library of more than 4,000 movies and 17,000 TV shows, including James Bond, Pink Panther and Rocky movie franchises. Though the studio is no longer dominating the box office like it did back in its heydays, it still accounted for 7.1% of the U.S. box office in 2021, thanks to Bond, James Bond.
In comparison, Disney’s domestic box office share in 2021 was 25.5%. While its film library is much smaller, Disney’s intellectual property is more current with better box office returns. If MGM can command an enterprise valuation of $8.5bn - and I reckon that figure was more attributable to its film franchises than television - Disney’s film division alone should be worth in excess of $30bn, just based on relative box office share in the U.S..
Consumer Products: Highest Margin
Disney toys are expensive and people (not just kids) love them. Similar to how brands like Lululemon (LULU 0.00 ) and Gucci command premium pricing relative to peers, Disney products are in a league of its own. For FY 2022, consumer products raked in $5.3bn in revenue (mainly from licensing) with an astonishing operating income margin of 53.2%. Disney charges toy makers such as Hasbro (HAS 0.00) and Mattel (MAT 0.00) huge fees to manufacture toys based on its movie franchises with minimal downside risk or capital requirements. It is a efficient money-printing machine, thanks to the goodwill generated by big-budget film productions, from Star Wars and Toy Story to Marvel and the upcoming live-action remake of The Little Mermaid.
Applying a modest 15x multiple to its operating income, consumer products enterprise valuation is at least $40bn.
Linear Television: Declining but still Profitable
The writing has been on the wall for quite some time now: television is moving away from linear to streaming. Hence the complex merger with 20th Century Fox was conceived back in 2017 to launch a DTC business backed by a comprehensive library of films and shows through a combination of the two conglomerates.
Declines in linear viewership have been threatening Disney’s linear networks segment, though it still generated $8.5bn of operating income against $28bn of revenue in FY 2022. It is far from dead, but its prospects are not bright either with industry trends as headwinds. In the near to medium term, Disney will continues to pump plenty of cash from affiliate fees and advertising, but capital is redirected towards its DTC business to secure its future in the new media landscape. Linear is still valuable to Disney as long as it continues to generate economic profit, but visibility beyond the next few years is poor. For the purposes of this SOTP valuation exercise, if we assume a perpetual decline of 20% in operating income going forward, enterprise valuation is around $40bn.
Summing Up the SOTP - Without DTC or International Parks
At the current price of around $90 per share, Disney enterprise valuation is just under $220bn, which is more than justified by the summation of domestic parks ($120bn), films ($30bn), consumer products ($40bn) and linear television ($40bn).
International parks and more importantly, DTC, are not factored into the above SOTP exercise.
DTC: New Frontier and Critical to Maintaining Relevance
Back in the old days, when Walt’s studio was working on feature films, he had his teams produce short films to keep the Disney name in the public eye. Fast forward to present day, Disney+ provides a similar opportunity. Iger oversaw its launch in 2019 and the platform has since allowed for limited series, animated shorts, and more to be produced at a much higher cadence than traditional linear or pure theatrical releases.
But creating a brand new streaming channel to compete with Netflix was always going to be a tall order. For a start, Disney relinquished significant revenues (and even paid penalties) when it terminated valuable distribution agreements with Netflix (and other streamers) on marquee content produced by Marvel, Pixar and Walt Disney Animation to populate exclusive streaming libraries at Disney+ and Hulu. Now we can only stream Avengers movies on Disney+ and nowhere else. It has also spent billions to build new content like The Mandalorian, She-Hulk and Baymax! to attract more subscribers. At the same time, aggressive sign up promotions have kept average monthly subscription prices low for maximum appeal. Consequently, in the three short years since the launch of Disney+ in November 2019, losses are in the billions and counting, even after amassing 164mn subscribers worldwide as of Q4 2022.
So how much is DTC as a business worth? It is noted that Hulu alone is valued at $27.5bn, based on the put-call agreement (signed in May 2019) between Disney and NBC Universal.
In a bear market like today, loss-making businesses do not carry much weight. Even the grand dame of streaming Netflix (NFLX 0.00), which is GAAP profitable, has come off the highs of ~$700 per share by more than 50%. Spotify (SPOT 0.00), another established market leader in streaming but still logging losses due to ongoing growth initiatives in podcasting, has suffered a worse fate, falling from a peak around $360 per share to the current $80 level.
Disney is targeting 300-350mn subscribers across Disney+, Hulu and ESPN by FY 2024. Extrapolating from the current revenue run-rate of $20bn with an average subscriber base of 230mn, this implies a potential annual recurring revenue base of $30bn by end of FY 2024, not dissimilar to where Netflix is today. Will it attain the same operating profit margin of 19.3% at that stage? Unlikely, given the breakeven guidance for the DTC business exiting FY 2024. Profitability will therefore have to depend on additional subscribers above the 300-350mn range guided. That is a lot of subscribers to bridge from the current 225mn to the promised land!
Conclusion: Challenges Ahead but Shares Present Optionality
Soaring costs for streaming services have rattled the entire industry and Iger was brought back to adapt to these new times. Regardless of scaling challenges, Disney must still conquer this new frontier. In the face of declining legacy networks, going direct-to-consumer is the only way to thrive in the digital age.
Balancing growth with profitability is a delicate balance. Scaling a digital subscription business, especially with the unprecedented rate at which Disney+ has grown, requires high upfront cost. Recently, management has launched an ad-support tier of Disney+ to further accelerate subscriber growth and rope in advertising dollars. Iger must demonstrate to the markets that Disney+ (alongside Hulu and ESPN+) can be profitable. If anyone can figure it out, it’s Iger.
Taking a step back, Disney remains a global brand and its franchise value continues to grow with each generation. Returns to Disney from content investment extend beyond box office receipts, advertising sales or subscription fees. They include a gamut of monetization avenues: consumer products, music, park attractions, licensing fees, and more. Take Toy Story as an example: nearly 30 years after the film debuted, the franchise still generate over $1bn in annual retail sales.
Extracting franchise value via traditional means of toys, live shows, and theme park rides, has always been part of Disney’s DNA. In recent years, a new direction is taking hold – franchises giving birth to new franchises. Secondary characters from major films like Frozen, Star Wars and Avengers are spinning off standalone shows and movies like Olaf Presents, Black Widow, WandaVision, Loki, Rogue One, and The Mandaolorian. And The Book of Boba Fett, a recent Star Wars show on Disney+, was spun off from The Mandaolorian. It is the Matryoshka model of franchises: a franchise within a franchise within a franchise.
By keeping its intellectual properties fresh and relevant on the streaming front, Disney retains valuable optionality to reimagine them into multiple formats, via an intricate but highly effective flywheel of monetization opportunities. Investors should look at the expanding franchise universe as a proxy for Disney’s future, rather than just focusing on those headline-grabbing short-term losses.
Sam writes on Money Buff
Ben is on Consume Your Own Tech and this post will be his last for 2022
(Ben is long DIS 0.00)
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