Disney, a powerhouse in the entertainment industry, is known the world over. However, the coronavirus pandemic over the last two years has proven to be a difficult time for the company, with most theme parks and cruise lines shut down or running at reduced capacity, and theatrical releases hobbled by national lockdowns. The reduction in live sports has also impacted Disney’s ESPN service. The silver lining has been the success of their Disney+ streaming service, driven by the increased demand for home entertainment.
The value of Disney’s IP is unmatched in its breadth and depth. As well as its own stable of beloved characters, the acquisitions of Pixar, Marvel, Lucasfilm, and 21st Century Fox have brought even more lucrative franchises under its wing. Disney is able to leverage this IP across all its businesses: theme parks, theatrical releases, home entertainment, toys, and consumer products; each building on each other to satisfy their legions of fans. However, competitors are not standing still and are spending heavily to both create and acquire their own franchises.
The Disney+ streaming service is only two years old but already has 118 million global subscribers. In some ways, it’s been a victim of its own success – subscriber growth saw an unexpected drop in the last quarter, likely the result of rapid early expansion. Growth may also have been spurred by a raft of special offers and discounted prices, resulting in an average revenue per user of $4.12/month in the last quarter, a drop from $4.52 at the end of fiscal year 2020.
A significant portion of Disney’s revenues come from their linear TV networks, the transition to streaming needs to be managed carefully. With Disney+, along with ESPN+ and Hulu, Disney is well-positioned in the transition from linear programming to the new world of Connected TV. Across all the streaming services, they have 179M subscribers, a YoY increase of 48%. They are guiding for 300 to 350 million subscribers across all streaming services by the end of 2024.
Disney is extremely popular with children but has fans of all ages, especially with the Marvel and Star Wars franchises. However, its family-friendly image, while a strength, may also be a weakness as it may need to expand the range of content in its primary Disney+ streaming service to cater for a wider range of interests. It was a surprise to hear that they are considering integrating sports betting into the ESPN services, but this could be successful if it is isolated from the core Disney branding.
The company has returned to profitability following a net loss in fiscal 2020 but total revenue and net income remain below pre-pandemic levels. It may take many years for business performance to return to growth, as the costs of building out its streaming services drag on the bottom line, with Disney+ only expected to be profitable by 2024.
It would not be surprising to see theme parks and cruise line business rebound quickly once the economy fully reopens post-pandemic, and the full Disney machine of theme parks, theatrical releases, home entertainment and consumer products will be at full strength. With no indication of when this will happen, the big question is can Disney navigate the storm and continue to grow?
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Transcript
Albert: Hi, this is Albert.
Luke: And this is Luke.
Albert: Today is Monday the 29th of November.
Luke: Welcome to the Telescope Investing podcast.
Intro
Albert: Thanks for joining us on the podcast and a warm welcome to anyone joining us for the first time.
Luke: We haven’t done a promo intro for a couple of episodes. So before we get into today’s episode, we take a quick minute to thank everyone who’s been listening and supporting the show. Telescope Investing’s for you, and we want to encourage you to drop us a line at feedback@telescopeinvesting.com and let us know if there are any topics you’d like us to cover in future episodes.
Albert: One of the best ways you can show support for the podcast is to leave us a review on Apple Podcasts and also to subscribe on your podcast platform of choice.
Luke: Our goal with Telescope Investing is to provide value to you and empower you to make smarter investing decisions. If you’ve got a friend or family member who you think would also get value from the show, we would love it if you take a quick moment now, spread the word and send them a link.
Albert: Let’s get straight into the show, which is a deep dive into Disney. One of our model portfolio stocks for 2021.
Luke: And it was model portfolio for 2020. This one’s been a core holding for both of us in our real money portfolios for ages, Albert. And actually Alb, I know you wanted to do this one because we’ve covered every other stock in this year’s model portfolio in one way or another, but Disney is the one company we haven’t really looked at hard, at least on the show.
Albert: I think one reason for that is because Disney is so well-known that we think most people would have heard of Disney and know this business inside out.
Luke: I’ve been at Disney shareholder for donkey’s years now, it’s one of my first holdings. But I haven’t really refreshed my due diligence on the company properly until this week. So I’m glad we picked this one up.
Albert: Yeah, me too Luke. And similarly, I’ve been a Disney shareholder since 2010, and I’ve been adding Disney shares every few years. Most recently, just this month. And another reason why Disney is on my mind is because I signed up for Disney+ on the first day it was available in Hong Kong, and I’ve been very busy catching up on all the shows I haven’t been able to watch until now.
Luke: If I just think about my own journey with the stock, I actually bought Marvel back in 2007 and Marvel were acquired by Disney in 2010. I’ve topped up that position a couple of times, in 2015, 2020, and then actually most recently in January, this year on the back of the Disney+ launch. But to be fair, that final position is currently in the red.
Albert: Yes, I think we’ll go through the reasons why a bit later in the episode, but as of the 24th of November, Disney has a market cap of $274 billion, which gives it a price to earnings ratio of 136, and a price to sales ratio of just four.
Luke: In many ways, that’s pretty good value compared to many other stocks in our model portfolio, but Disney is rather different to our growth stocks. It’s much more strong and stable amongst other growth holdings. But we have to be fair, Disney’s performance in the model portfolio has been a pretty woeful -9% since we launched the portfolio on the 27th of January, and the S&P is up 22.5% over the same period.
Albert: Yeah, that’s quite a disappointment. Overall the model portfolio is only up around 3.8%, so it’s been a very tough year for growth stocks, but I wouldn’t regard Disney as a quote-unquote growth stock. Disney as a company is about a hundred years old and has been a very successful company for many of those years.
Luke: This year has been absolutely disastrous for growth stocks. It’s not been too hard on our portfolios, I think we’ve been quite lucky with our overexposure to companies like Tesla and Shopify, but the model portfolio, we know we went into that with the principle of 15 equally balanced stocks, and more than half of those stocks are in the bin compared to the S&P. So we have done pretty badly this year, but ebbs and flows. Coronavirus has impacted our holdings in particular very hard, and Coronavirus won’t be around forever.
Albert: When we first came up with the model portfolio for 2021, we were expecting this year to be a reopening year, and companies like Disney would resume normal business, but unfortunately that hasn’t happened.
Luke: Do we think next year is going to be that reopening year? We’ve just had the Omicron variant identified and that’s causing many countries to re-institute the controls that they had in place?
Albert: If you had asked me this question before the Omicron variant had been announced, I would have said 2022 would have been likely to be a reopening year, but now I’m not so sure.
Luke: Something for us to think about in December when we start planning out our 2022 model portfolio, but let’s focus on Disney, and we’re gonna use today’s episode to go through each of the Telescope Investing lenses and look at the company to see how it’s performing and what its prospects are into the future.
Background
Albert: So a bit of background, over the past few years, Disney, a literal giant of a company has nimbly manoeuvred into a new business model, one that is fitting for the 21st century. And that is streaming, which goes against the grain of their previous model, which is linear TV.
Luke: In many ways though, transitioning into a streaming giant by launching Disney+ was a natural evolution of the business model, and their timing really was fantastic with the world going into lockdown.
Albert: Ideally Disney+ would have started sooner, given that Netflix started its streaming service in 2007, giving it a 12-year headstart.
Luke: But I think we’re going to see that Disney have done a great job of catching up with Netflix, once that path has been forged.
Albert: And don’t forget this transformation has been happening during the looming threat of a global pandemic, forcing most of the companies parks and cruises to close down temporarily. So Disney+ has provided an invaluable revenue source while these parks and cruises have been shut down.
Tailwinds
Luke: So let’s have a think about the tailwinds that are supporting Disney, which is the main lens we use to look at all of our potential investments. I guess the key tailwind of the last year or so has been the global pandemic and Disney in many ways have been both a beneficiary and a victim of COVID with park closures on one side, but then rising demand in streaming, you need some content to stick your kids in front of if you’re trying to work from home. Disney+ came along at just the right time.
Albert: The demand for home entertainment has risen during the pandemic, it’s both a headwind and a tailwind for Disney. The headwind is cord-cutting, and the bulk of Disney’s revenues is actually from linear TV, and that accounted for 42% of total revenues in 2021, but any potential loss of revenues from linear TV is being offset by revenues from their streaming services, which they report as direct to consumer, and that made up 24% of total revenues for 2021.
Luke: Disney is spending hard to grow and expand their streaming offerings, and direct to consumer’s currently running an operating loss while linear networks are generating the profits. But that’s not unsurprising, it’s still a brand new service and they have to invest in advertising and launching into new markets.
Albert: So as we said, linear TV is dropping due to cord-cutting. So the bad news is that the operating income from linear TV dropped 11% in 2021 compared to the previous year. But the good news is that the operating losses for streaming are lower this year than they were last year. I don’t have an estimate of when they expect the streaming revenue to be profitable, but I think they said they expect Disney+ to be profitable by the end of 2024, but don’t forget they also have streaming services in ESPN+ and Hulu.
Luke: And it’s interesting you mention those because another one of our model portfolio picks Magnite, the ad-tech sell-side platform. They’ve been a key Disney partner for quite a few years now. And in early 2021, they extended the relationship they had with Disney’s Hulu to also include ESPN and ABC and possibly some other Disney properties. So Disney are a key player in the connected TV space, even though Disney+ itself isn’t advertising supported.
Albert: As we mentioned earlier, the pandemic has been a disaster for their theme park business. Since early 2020, Disney parks and cruises have been shut down and these operations have resumed, but generally at a reduced capacity. But I expect the theme park business to bounce back quickly when the economy is fully reopen, but this could be a while away though.
Leadership
Luke: Let’s take a look at Disney’s leadership and this has been pretty consistent, albeit I think Disney have had something like seven CEOs and chairmans over the last hundred years.
Albert: That’s a long time, Luke. A hundred years is a long time, so seven is not that high.
Luke: I agree. I agree. Disney’s current chairman is a well-known chap called Bob Iger. He previously worked as president of ABC Television from 94 until its acquisition by Disney in 1996. Iger was then named COO of Disney overall in 2000, and then he took over as CEO in 2005.
Albert: And undoubtedly Iger has been an outstanding CEO during his time at Disney and was instrumental in the acquisitions of Pixar, Marvel, Lucasfilm, and Fox.
Luke: He really has shaped the company in the last two decades or so, I’ve actually got his biography, “The Ride of a Lifetime” sat on my pile of books. I’ve really got to start making progress through these now I’m retired, but I will admit I’m currently stuck on Game of Thrones book three.
Albert: Yeah. That book, “The Ride of a Lifetime” has been on my reading list since last year, and I’m not sure when I’ll get around to it either.
Luke: Bob Iger handed over the CEO role to Bob Chapek in February 2020, and this other Bob has also been with Disney for nearly 30 years.
Albert: Yeah. Bob was the chairman of the Disney Parks, Experiences and Product segment since it was created in 2018, and before that he was the chairman of Walt Disney Parks and Resorts since 2015.
Luke: So the two Bobs who are pretty strong leadership team, they know the company inside and out, and as you say, they’ve navigated a pretty turbulent time quite successfully over the last 20 years.
Albert: Unsurprisingly for a 100-year-old business, the insider ownership is fairly low. I think you pulled up this chart. Bob Iger owns about 0.03% of the company’s shares, and Bob Chapek has even less. I even read this 0.0002% of the company’s shares!
Luke: Yeah, they’re quite small holdings, I agree. I guess most of their compensation is salary rather than stock, which is perhaps a bit different to many other smaller companies. But as you say, it’s a hundred-year-old company. I think the majority of the ownership is institutional. This is held by so many different financial services organizations as part of indexes and various other things.
Albert: The company has around 180,000 employees and we looked at the Glassdoor ratings and they’re not so great, 76% would recommend to a friend, only 69% approve of the CEO, Bob Chapek.
Luke: I saw some quite amusing comments on Glassdoor. The majority of the negative comments seemed to refer to “dinosaurs in middle management”.
Albert: Ah, that’s the worst, Luke. We need to get rid of the furniture in companies to make room for the young blood.
Luke: I guess you’re referring to middle management and I suppose Disney aren’t known for their dinosaurs, Jurassic Park is owned by Universal, right?
Total addressable market
Albert: Moving onto the total addressable market, I guess we look at streaming first and there’s plenty of growth left. Even though they’ve grown Disney+ very quickly over the last two years, they expect this to grow at a further 25 to 35% growth for the next four years. This compares to the industry average of 15 to 20% per year.
Luke: Yeah, I guess they’re starting from a smaller base, which is why they can accelerate. And they’re probably going to catch Netflix up at some point. I’ve got a couple of graphs here where we’re looking at their total streaming subscriber numbers compared to Netflix.
Just looking at these two graphs by eye, Disney’s growing at a much faster rate, as we say, from a smaller base and today Disney are at something like 118 million subscribers compared to Netflix’s 210 million, 220 million.
Albert: I think most people expect Disney subscriber count to exceed Netflix’s at some point, but I’m not so sure about that. Because of Netflix’s headstart, they can keep this momentum going and as Netflix gains additional IP and more content, they may be able to keep ahead of Disney.
Disney have 12 theme parks around the globe, and we have one right here in Hong Kong, and I’ve been twice, I believe.
Luke: And I guess if we’re fair, there’s probably not much room for parks and experiences to grow substantially, but Disney are definitely investing in the IP and the experiences available at these parks, cause they’re trying to keep them fresh and bring back, repeat visitors. One, I know you might be excited to see at some point is the Star Wars Galactic Star Cruiser immersive experience and hotel, which is launching at Disneyworld in March 2022. Fancy coming out for a two day stay?
Albert: I think we talked about this in our model portfolio end-of-Q3 review, and I think we said that it’s really expensive and I probably wouldn’t be that excited at that price.
Luke: How about the Avengers Campus, which opened in June this year in Disneyland?
Albert: Now you’re talking.
Luke: In Hong Kong, you’ve got Frozen Land opening in 2022 apparently. That’s got to be an exciting one for you, you’re an Elsa fan, right?
Albert: Actually, Luke, I haven’t even seen the film yet. It’s on my list of things to see.
Luke: I’ve forgotten the song. I was going to give a burst of song.
Albert: Probably not a good idea, Luke. We do want to keep our listeners.
Luke: I was going to sing you a blast of Let It Go but I can’t remember the tune.
Albert: Yeah, just let it go, Luke. And I was really surprised to read that all of Disney’s cruise ships are sailing again and have a new one called The Wish launching in June next year, and bookings for their first season are already 90% filled.
Luke: That is possibly bad timing. I think if I were boarding The Wish, the only wish I would have is not to catch Coronavirus.
Albert: My only wish would be to disembark at the earliest opportunity.
Luke: We do have to do a poker cruise one day though when the pandemic is fully behind us.
Albert: It’s funny you mentioned that, actually, because at the Thanksgiving dinner over the weekend, I tried to teach some of my friends to play poker and it was an absolute disaster. Just imagine a table with three beginners all trying to learn poker at the same time and even worse, we’re playing for no stakes, so obviously, every hand was all in.
Luke: Okay, at least you didn’t get skinned. That’s cool.
Costs of production
Albert: And as for the costs of production, they going to be fairly high. The cost of creating and running a theme park is not going to be low and neither is the production of content for the streaming services.
Luke: But I think one thing we can be assured of is that Disney are going to wring all the value out of their IP in a way that companies like Netflix can’t right? If you’ve launched, say Frozen, then you’ve got the Frozen movie, you’ve got the Frozen TV show. You’ve got the merchandise. Frozen World, whatever that thing is in Hong Kong Disneyland. Netflix don’t have the ability to maximize their profits on their properties in the same way.
Albert: Yeah, and these theme parks are long-running assets and they intend to run these for many years, and Disneyworld are celebrating their 50th anniversary this year and they are planning an 18-month party.
Brand
Luke: I suppose as we start talking about brand and reputation, that Telescope lens, maybe just to kick things off there, for me Disney is the quintessential story stock. It was actually the second company I bought for my niece as part of her junior ISA investment portfolio. We were doing a family trip to Disneyworld in Orlando. I guess I went as a kid and my brother wanted to take his daughter. So I thought buying her some stock in Disney would be a great way to help her understand what it means to be a shareholder.
Albert: And did she understand what it means to be a shareholder?
Luke: Yeah, like we were spending a fortune on hotdogs and merchandise, and I could point out to her that a tiny fraction of that money was going back into her own pocket as a shareholder. I think she got that.
Albert: Yeah. I love spending money on the companies that I own. In a way, you’re paying yourself. So it’s no surprise that Disney is one of the most valuable brands in the world. And it was number seven in the Forbes list of most valuable brands in 2020, and it ranks highly in most lists of valuable brands
Luke: Kids of every generation grow up with Disney and they’re continually reinventing themselves. The brands only got stronger with the acquisitions of Pixar, Marvel, Lucasfilm and Fox. Their breadth and depth of IP is unmatched.
Albert: Absolutely.
Customers
Albert: Moving on to their customers, we’ll start with their streaming services. And this is a point of contention from their last earnings call. At the end of Q4 of this year, Disney+ had 118 million subscribers, but remember they also have ESPN+ and Hulu, and all those services combined have 179 million subscribers.
Luke: And what was the bone of contention, Albert? Why did the stock price take a bit of a rocking after their recent results?
Albert: Disney+ had 118 million subscribers, but analysts had expected 126 million. The number of subscribers only increased 2 million from the last quarter while analysts had expected it to increase by 10 million.
Luke: Yes, that’s a significant miss, but I guess there’s lots of reasons why that might be the case.
Albert: I think one of the main reasons is that growth was pulled forward by stay-at-home orders. A lot of people started Disney+ last year and early this year.
Luke: We’ve all been expecting the world to reopen, and sadly that looks like that might not be the case just in the last week or so, but maybe it wouldn’t have emotionally felt like the right thing to sign up for another streaming service in the last couple of months, because you really want to focus your energies and excite your kids with the thought of going out, getting away from the TV and doing stuff for real.
Albert: Maybe another reason for the slowing subscriber growth is competition from other streaming services. Over the last two years, competing services, such as Peacock, HBO Max, and Paramount Plus have launched.
One thing to consider when comparing this to Netflix is that Disney+ is only available in around 60 countries around the world, whereas Netflix is available in 190. So Disney does expect to be available in over 160 countries by the end of 2023, and they are guiding for a total of 230 to 260 million global subscribers for Disney+ by the end of 2024.
But you need to remember that the Disney+ service is only two years old and at launch they had expected to take four years to acquire 90 million subscribers and they achieved that within a year, so the rollout of Disney+ has been incredibly successful.
Luke: Yeah. I agree. I think this has been an unbounded success, even given the smaller numbers that they delivered in the most recent quarter, so that doesn’t worry me at all if I’m honest. One thing that does give me a tiny bit of pause for thought is their pricing power when it comes to Disney+, and actually, their average monthly revenue per subscriber at the end of this fiscal year was $4.12 cents. And comparing that to Netflix who are yielding $14.68 cents, at least for their North American subscribers.
Albert: This might indicate that Disney+ have pricing power in that they have a lot of room to increase prices. But I guess this average revenue per user is being suppressed somewhat, by all the free trials and special deals that are available at the moment and also by the lower-priced Disney+ Hotstar service in India where most subscribers pay on average around $4 per month.
Luke: I think Disney recognize how critical it is to their overall mission to build their Disney+ subscribers. And they’re using some strong-arm tactics to boost subscriber numbers. For example, from next month, Hulu + Live TV subscribers are going to be forced to pay additional five bucks a month, but they’ll get Disney+ and ESPN+, so Disney are using tactics to try and bring people onto their streaming platform.
Albert: Yeah, and these subscribers have to pay this additional $5, whether they watch Disney+ or not. Personally, I don’t like this kind of tactic, but maybe that’s what they need to do to get Disney+ out there.
Luke: I’m reflecting on this in the round and maybe that comparison with Netflix, I do think there’s something quite interesting at play here. I think it could be argued that Disney are deliberately operating Disney+ as a loss leader, to enable them to scale up fast. Because they’ve got these enormous network effects from streaming to their parks, their movies, and the merchandising. I do wonder if this is the battle that Netflix might ultimately find quite difficult to fight given that Disney can make so much more money from their IP compared to Netflix.
Albert: Yeah, I think this comparison to Netflix is quite interesting. Remember when Netflix started streaming, actually it took them 10 years to reach a hundred million subscribers, whereas Disney+ took one and a half years. But after that first hundred million subscribers, Netflix only took four years to get the next hundred million, so it appears that the growth of Netflix is accelerating.
Luke: For many households, Netflix might be the first paid streaming service that they have, but once you’re used to that, then it’s very easy to add another service. And these services are quite complementary. There’s actually no reason why a household wouldn’t have both Netflix and Disney+, and maybe Prime and maybe a few others too. Individually, these services are quite cheap.
Albert: I think the restriction isn’t cost but time. Do you have time to watch all this content on all these streaming services? But looking at their market cap, it’s interesting that the market cap of Netflix and Disney are quite similar. Currently, Netflix has a market cap of $295 billion, while Disney has a market cap of $274 billion. And they have exchanged places a few times as to who has the higher market cap. But I like to see them coming at the same problem from two different directions. Netflix is the newcomer using new technology and a new business model to disrupt the entertainment industry. Disney is the incumbent with all the content and the experience, but they need to adapt to this new world of streaming.
So they coming from the same problem from different directions, and I wouldn’t want to bet on which one grows faster from here. But as a shareholder of both of these companies, I don’t really need to, and I expect both of them to succeed.
Network effects
Luke: We’re going to go on to network effects as our next lens, and I think this is one that is truly very powerful for Disney, more so than Netflix. And actually, this is the reason I exited my own Netflix position just last month, whereas I’m holding Disney.
Albert: Do you want to go into a bit more, Luke? Why did you do that? Why did you let go of Netflix?
Luke: Let’s cover it at the back of the episode, cause I did a number of sales in the last few days and I wanted to be a bit transparent about them with listeners.
Albert: Okay. As you mentioned earlier, Disney’s use of IP is across multiple channels. They use the same IP for their theme parks, for the TV shows, for the theatrical releases, for the toys, for the consumer products, each of them building on each other and building this market awareness that appeals to a wide range of consumers.
Luke: And I think no better example of this was their acquisition of Marvel in 2010. They bought Marvel for $4 billion and they turned it into one of the world’s most valuable franchises, which has evidently netted over $23 billion just at the box office, and that’s before you think about parks and merchandising. They have made a ton of money on that property.
Albert: And other studios have tried to replicate the magic of the Marvel Cinematic Universe and have largely failed. For example, Warner Brothers have had some success with the DC properties such as Superman and Batman, but they haven’t performed as well at the box office and neither with the critics or fans.
Luke: And then don’t forget Universal. They tried to launch their Dark Universe franchise, and that didn’t really go anywhere after The Mummy with Tom Cruise failed to break even. I think they’ve abandoned the ideas.
Albert: Yeah. I watched the trailer for The Mummy and said I’m not watching that.
Luke: It’s actually not a bad movie, but I can’t say I’m excited about this monster universe that Universal had planned.
Albert: And even Disney has stumbled in trying to replicate the model with Star Wars. But Star Wars was already a massive franchise when they bought it in 2012. They picked up Lucasfilm for just $4 billion and they had recovered that investment by 2018.
Luke: Yeah, I think it’s hard to say that Star Wars acquisition was not a success. They fully recovered the money and they’ve produced some fantastic movies and they’ve got so many different properties now on their streaming channels, like the Mandalorian and Kenobi. Are you not looking forward to seeing Kenobi?
Albert: To be honest I’m not. But my point was that Disney obviously tried to recreate the same model as the MCU for the Star Wars universe. And I thought Rogue One was great, but they really stumbled with the next film Solo. I can’t even remember anything that happened in that film, even though I watched it.
Luke: Yeah, that was a bit of a snooze fest I agree, but the core final three Star Wars movies were fantastic as a fan.
Albert: I think they declined in quality as the films went on. And don’t forget, Lucasfilm is not just Star Wars, but it also includes Indiana Jones. He’s one of my favourites, but I have to admit it’s not as marketable as the galaxy far, far away.
Luke: There’s a fifth Indiana Jones movie coming out in 2023. Harrison Ford isn’t dead in every Disney universe!
Albert: I’m actually surprised Harrison Ford has agreed to do another Indiana Jones movie.
Luke: I’m definitely looking forward to that one. We actually rewatched Indie one, two and three about two months ago. They are great films.
Albert: And what about the fourth one Luke? What about Indiana Jones and the Crystal Skull? You didn’t watch that?
Luke: If I’m honest, I’ve forgotten about it. You think it’s not going to stand up so well as Temple of Doom?
Albert: Definitely not, Luke. That’s where the phrase, “to nuke the fridge” came from!
Luke: Yes, that’s right. Nuclear bomb-proof fridges. They don’t make them like they used to.
Albert: And don’t forget they also acquired Fox recently. With Fox, Disney now have 30 of the top 50 highest-grossing movies of all time, including number one, Avatar. And I believe there are four Avatar sequels planned.
Luke: Yeah, it seems like everywhere you look, Disney seem to own virtually every bit of IP there is. It’s very hard for companies like Universal to compete with them.
Albert: So Disney have demonstrated an amazing ability of expanding and monetizing IP, and with the Fox acquisition they have acquired franchises, such as Avatar, Die Hard, Alien Predator, Planet of the Apes, Ice Age, and also all those remaining Marvel properties, such as X-Men, and the Fantastic Four.
Luke: Do we know if Disney have got any other acquisitions in the pipeline?
Albert: I haven’t heard of any, Luke, but they’re probably busy trying to integrate Fox into their business.
Luke: They have got the Simpsons as well, I think that’s part of Fox. One thing I do note in the UK, I don’t know how common this is globally, but they’re definitely starting to have more grown-up content on the Disney+ platform. They added something called Star to Disney+ in the UK, oh I’m going to say, six months ago, and it’s just got more thrillers and horror movies and more kind of traditional content that’s not solely aimed at kids.
Albert: Yeah, Star is available in Disney+ service in Hong Kong as well. And I’ve read that Bob Chapek is pushing for more adult content on Disney+ because he thinks it’s needed to appeal to a wider audience and to compete against these other streaming services such as Netflix and Amazon, which do not have these strict restrictions on their content.
Luke: Yeah, I think that makes sense. I guess they gotta be really careful about sullying the brand, but if they can do that by protecting the core Disney brand as the kid’s content and then use brands like Star for their more grown-up stuff, maybe they do keep that separation.
Albert: And they do have Hulu in the States for more adult-oriented content. And I think I agree with Chapek in that they do need to include a wider range of content to maintain the subscriber growth. Not everyone has kids, and not everyone is a Marvel and Star Wars fan.
Luke: But what did you make of Chapek’s other recent announcement just a couple of weeks ago that Disney would be exploring how they can leverage their IP in the metaverse!
Albert: Yeah. I think this was more hot air than anything else.
Luke: Definitely feels like jumping on a bandwagon.
Albert: I do suspect that Disney, Marvel and Star Wars themed NFTs would sell out immediately though.
Luke: Would a Mickey Mouse Twitter profile pic be more appealing than a Bored Ape?
Albert: Depends on who you are, Luke, but I think there are a lot of Marvel fans out there who would pay a lot of money for an exclusive Ironman avatar.
But one thing that I read that was quite surprising was that Disney are exploring adding sports betting to the ESPN service. This is surprising because Disney has a very family-friendly image, one that does not really suit gambling, but as you said Disney are exploring, adding more adult content to the Disney+ service and maybe gambling is becoming more acceptable. I’ve read that they’re looking for a partnership to introduce sports betting into ESPN service, and they do have an investment in DraftKings, so they are a likely candidate.
Luke: Yeah. Disney is such an enormous empire of different brands. Again, I think if they can keep that gambling thing isolated to the ESPN brand, most consumers don’t even know that ESPN is owned by Disney.
Competitors
Luke: What should we talk about competitors before we wrap it up with financials?
Albert: Yeah. So I don’t think there’s a direct competitor for Disney. I think the closest one would be say, Universal, which has theme parks, movies, TV, and its own streaming service in Peacock. I had a look and Universal do have some valuable franchises. For example, you mentioned Jurassic Park earlier, but they also own the Fast and Furious franchise and the Despicable Me franchise, and a personal favourite of mine, the Back to the Future franchise. But I think it’s fair to say that they are firmly in second place when compared to Disney.
Luke: By the way, I’m hearing really good things about the Back to the Future musical in London’s West end. I’m definitely gonna try and see it in the next couple of weeks.
Albert: Oh really? I had no idea there was a Back to the Future musical. Who’s playing Marty McFly?
Luke: I’ve got no idea, but apparently the acting and the singing and the story are great. They do a really good job of bringing the movie to life on the stage.
Albert: Maybe I’ll catch it next time I’m in London.
Luke: If I thought that was going to be any time soon, I’d wait for your arrival and we can see it together, but you’re not leaving Hong Kong for at least another six months!
Albert: Yeah, I think so, unfortunately. But looking at their competitors in each of the segments: in theme parks, they have competitors in Six Flags Entertainment, Cedar Fair, as we said, Universal Studios, and I guess the main competitors will be in the streaming sector and they have some big competitors there with Netflix, Amazon, HBO, Peacock, Paramount, and also Apple.
Luke: And Netflix and Amazon are no slouches, they’re also busy acquiring other properties and IP as well as developing their own. One that caught my eye was the Amazon acquisition of the rights to the Lord of the Rings franchise from the Tolkien estate. Bezos famously bought this for $250 million a couple of years ago.
Albert: And I believe they recently launched a TV series based on the wheel of time books.
Yeah. But just by these franchises doesn’t mean automatic success though. It’s hard. It’s hard building these franchises. For example, Netflix bought Millarworld, the comic book publishing company created by Mark Millar to create his own comic book franchise in a streaming service, but its first series Jupiter’s Legacy was pretty much a flop, and I don’t think Millarworld can match the history of DC and Marvel.
Luke: I get the sense that companies have seen the success that Disney had with Marvel, and they’re trying to do it too quickly like Universal with their Dark Universe series, where it’s just a bit blatant where they’re setting up this whole universe in movie one. Let’s not forget, the Disney Marvel properties, they started out as just kind of individual movies or like trilogies, and then it all came together over more than a decade. I think it’s very blatant to fans when you’re trying to build that universe right from the start. You could easy to get cynical about that sort of thing.
Albert: I think Warner brothers made a mistake when they brought out the Justice League way before films for the individual characters. I think they rushed it.
Luke: Yeah. Great example. Yep.
Albert: I think we’re trying to say that the value of Disney IP is unmatched and I would say the closest competitor in terms of IP is probably Nintendo with their Super Mario franchises.
Luke: That wouldn’t have come to my mind. Do you want to justify that?
Albert: I guess you’re not a games player, but if you grew up with Nintendo, you would know all about these Nintendo characters, such as Mario, Donkey Kong, Zelda, and Nintendo are starting to expand this IP into movies and theme parks. And they worked with Universal to open a Super Nintendo World in Japan, in March this year, and they’re planning on opening similar theme parks in the US with one in Orlando expected to open it in 2025. And don’t forget they have a Mario movie coming out with Mario being voiced by Chris Pratt.
Luke: I remember the Mario movie from a couple of years ago with Bob Hoskins, you’re not talking about that?
Albert: Luke, that was a lifetime ago. That was like 30 years ago. I’m talking about a new Mario film, probably animated, coming out next year or the year after. And this was quite a big story a few months ago. Apparently, there was a lot of ridicule about Chris Pratt, a non-Italian, playing Mario, an Italian plumber.
Luke: He didn’t make my Twitter timeline.
Albert: It was all over mine, Luke. And to make it even worse, Chris Pratt is also voicing Garfield in the next Garfield film.
Luke: Ah, I used to be a Garfield fan, that’s a franchise I could buy into
Albert: I hope you’re a Chris Pratt fan.
Financials
Luke: Let’s round it out and look at financials, which is always the last Telescope Investing lens.
Albert: Disney has changed the way they report their earnings as of October 2020. And now they report their earnings as two main segments. First is Media and Entertainment Distribution, which accounts for 75% of their revenue, and this segment includes their linear TV business and also the streaming businesses, which they term as direct to consumer. And the other main segment is Parks, Experiences and Products, which unsurprisingly made less revenue this year and only accounted for 25% of their revenue for 2021.
Luke: So Disney released their Q4 and fiscal year 21 earnings on the 10th of November. Their total revenue for this year was $67.4 billion, which was a year over year increase of just 3.1%. However, that was 3.1% lower than the total revenue from fiscal year 2019, which was $69.6 billion.
Albert: But their net income for 2021 was $2 billion compared to a net loss of around 2.8 billion last year. But the net income for 2019 was $10.4 billion. So while it’s good to see Disney returned to profitability in just one year, there’s still a way to go to return to their previous levels.
Luke: Yeah, it’s definitely going to need Coronavirus to end, parks to fully reopen, and for them to start really smashing it on every front. It’s not enough that they just have streaming as their revenue generator.
Albert: But I think 2020 was always going to be a transition year for Disney, as they roll out their Disney+ service. But rolling out a new streaming service is going to be quite expensive and incur additional cost. And I assume their original plan was for these costs to be offset by the revenue from other business segments. But unfortunately, COVID happened and it decimated their revenue from theme parks and cruise lines.
Luke: And let’s not forget what we talked about earlier with subscriber growth only growing by 2 million in the last quarter, and that really tanked their stock price.
Albert: It was quite a big hit to their share price. I think their share price dropped about 10% the day of their earnings release, and it has continued dropping since then and is now 15% lower than it was the day before the earnings release, and to make matters even worse it’s about 25% lower than it’s all-time high of $197 achieved in March of this year.
Luke: So arguably the whole value of Disney increased massively when they launched Disney+ so it makes sense that their market cap is damaged by a slowing in subscriber growth. But look, let’s be honest, do we really think that Disney are not going to catch Netflix up? They still have so many countries to enter and they still really only have around half of the subscribers that Netflix do. There’s no reason on earth why they’re not going to catch up or even perhaps surpass Netflix over the coming years.
Conclusions
Albert: Luke, I’ve been a Disney shareholder since 2010, and in that time the stock has returned 363% or a CAGR of 13.7%, even with the decline of the share price this year. And this compares to a CAGR of 12.5% for the S&P 500 in the same time. And don’t forget that this return is also ignoring dividends. Disney has historically had a dividend yield of around 1.5%, but they stopped paying a dividend last year, and they said that they don’t plan on resuming dividends any time soon. I understand why they suspended the dividend, but I’m hoping that they will restart paying dividends sooner rather than later.
Luke: I’ve not been a fan of dividend stocks, albeit I’ll admit that maybe my mind is changing on that a little bit, now I’m in retirement, but similarly I’m really appreciating the stability that Disney offers in my largely growth portfolio. If it’s matching the S&P growth actually I’m pretty comfortable with that because I’ve got the rock-solid stability of that Disney empire and its hundred-year history.
Albert: I think it’s doing slightly better than matching the S&P. It’s not a blow the barns doors off kind of stock, and barring in the last two difficult years it has been a steady outperformer. And as you said, this does have its benefits because I see Disney as a foundational stock in my portfolio. One that limits the portfolio’s volatility and also gives it a base on which to grow. My other foundational stocks would be Starbucks, Alphabet, and Amazon.
Luke: And maybe I would add Intuitive Surgical to that list. A company that’s got a long history, is miles ahead of its competition, and it’s just going to be a solid grower for the years to come.
Albert: I still see Intuitive as a growth stock, but I see your point, and I did see the recent price drop in Disney as an opportunity to add more shares. And my reasoning was that Disney+ does appear to be on track to become a major streaming service globally and combined with their other streaming services would enable Disney to transition from the linear TV world to the world of connected TV. And although it’s declining, linear TV is likely to be with us for a while yet.
Luke: Yeah, I’ve bought Disney on four occasions now over the years, most recently this January. Maybe it is time to add a fifth position to that. It’s still quite a small part of my overall portfolio because it’s grown a little slower than most.
Albert: Yeah. It’s around 3% of my own portfolio, so it’s not a huge holding.
Luke: Maybe that’s a decent opportunity for me to jump in with a change in my own strategy. Just to be totally transparent with listeners. I’m pivoting a little bit out of growth and I think this is just the fear of now being in retirement and no longer drawing a pay packet. You’ve been lecturing me Albert over the years really about my heavy growth strategy and the fact that I’ve got very few of those foundational solid stocks and certainly no dividend payers in my portfolio. Those years of nagging, plus if I’m honest, the Simon Erickson comment about his own barbell strategy for his own investments a couple of episodes ago when we interviewed him, that’s really challenged me. And I think it’s now time to build a bit of a solid foundation, just so I don’t have the disaster of having to go back to work one day in the future.
Albert: We had a joke about this, didn’t we Luke? Cause you started getting nervous about growth stocks around six days after leaving your job.
Luke: Yes, that’s right. I’ve got to be sensible. And I suppose I was, if nothing else, I was thinking about the potential embarrassment of retiring and then having to unretire. So maybe it makes sense to put a little money on the sidelines. So maybe just for transparency, what I’ve done in the last, really, couple of weeks is I’ve exited a number of companies that I just no longer felt were aligned with the objectives in my portfolio. And I’ve trimmed a couple of companies that I love and believe in, but they’re just a bit overexposed. So I’ll be posting all of that on Twitter with my end of November update in the next couple of days.
Albert: I’m fully supportive of your changes Luke, you shouldn’t be all growth all the time. But getting back to Disney, I do see Disney rebounding quickly after the pandemic.
Luke: Yeah, I agree. I think I’m probably going to top it up actually on the back of our due diligence today. I’m currently nearly 20% cash, and now I’m starting to figure out what I’m going to do with that cash. So possibly some of it gets reinvested into Disney.
Albert: You have to imagine the full Disney machine of theme parks, theatrical releases, home entertainment, and consumer products, all working at full strength. And I don’t see any reason why they won’t return to pre-pandemic levels.
Quote
Albert: Anyway, Luke, do you have a quote to round us off?
Luke: I do. I dug up a quote from Walt Disney himself. Walt said years ago, “The difference between winning and losing is most often not quitting”.
Albert: I guess you can apply this to investing. Most of the gains you get is just from staying in the game.
Luke: Yeah, exactly right. And I suppose that’s why I’ve also started to disinvest a little bit out of my growth stocks because I need to stay in the game. Could also apply it to the podcast, we’re 67 episodes in and the secret to winning is not quitting.
Albert: You’re right. Luke, I think when we first started doing this podcast, we saw some stats saying most podcasts don’t make it beyond one episode!
Wrap
Luke: Yeah. So we’re in it for the long haul and hopefully, we’ve got a good number of listeners who are enjoying the journey. We certainly hear from our listeners from time to time, but we definitely enjoy the interactions, don’t be afraid to drop us an email feedback@telescopeinvesting.com, if you’ve got a question or there’s something you’d like us to pick up on a future episode.
Albert: Or you can contact us on Twitter. I’m at @AlbertTelescope.
Luke: and I’m at @LukeTelescope.
Albert: As we said earlier, one of the best ways you can support the show is to leave us a review on Apple Podcasts.
Luke: And of course, if you’ve got a friend or family member who you think could get value from Telescope Investing, we would love it. If you take a moment to spread the word and send them a link.
Albert: Thanks, Luke.
Luke: Thanks, Albert.
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