Disney (NYSE:DIS) and Netflix (NASDAQ:NFLX) are two of the most powerful and influential companies in the entertainment industry today, and they have a complicated relationship. While Disney investors are increasingly concerned about growing competition from streaming services and the possible impact they could have on the media networks business in the years ahead, the two companies also have a lot to gain from each other.
Disney and the streaming revolution
Cord-cutting is a growing trend, as many consumers around the world are abandoning their cable subscriptions, or at least shaving them down, and embracing digital alternatives. This is hurting companies in the traditional pay-TV business, and Disney is feeling this pressure in its all-important media networks segment.
Based on financials from the first two quarters of fiscal 2016, Disney generates nearly 46% of operating profits from the networks segment, which grew by a modest 3% year-over-year in the last six months, substantially underperforming the 15% increase in overall company-level operating income.
ESPN is major contributor for Disney in the networks segment, and the susbcriber base has been trending in the wrong direction. According to the company's annual reports, ESPN had approximately 92 million subscribers as of Oct. 3, 2015, down from 95 million in 2014 and 99 million in October 2013.
Disney is enjoying healthy growth and profitability in its other, smaller businesses like studio entertainment and amusement parks, offsetting the slowing performance in media networks. Nevertheless, the fact that such a key segment is facing headwinds from the online streaming revolution is a big reason for concern among Disney investors.
Friend and foe
Adapting to new industry trends often takes time and money. However, there's no reason to believe that the rise of streaming services is going to cripple Disney's network business. Content is king in this industry, and its wide umbrella of Disney, Pixar, Marvel, and Lucasfilm is the source of enormously valuable intellectual property. So while Netflix and Disney are competitors to some degree, the two companies are also important partners when it comes to content production, licensing, and distribution.
In the words of Theodore A. Sarandos, Chief Content Officer at Netflix, during the company's most recent conference call:
So I mean, these have always been relatively complex relationships where you are both supplier and sometimes competitor. So in the case of Disney, they're a major supplier, and they're a producing partner. They produce our Marvel Defenders series. We just kicked off our fifth season of production on the show. It's a very lucrative piece of business for Disney, obviously, and a great partnership in that way. And there's no way to kind of isolate the two sets of businesses completely. So while we -- they're a great producing partner. They're a great licensing supplier, and we're always trying to figure out ways that we don't bump into one another competitively, but sometimes it's inevitable.
Netflix and Disney signed a huge deal in 2012 making Netflix the exclusive U.S. home for films from Disney, Marvel, Lucasfilm, and Pixar released in 2016 and beyond. Netflix subscribers will have access to these movies directly after they leave the theaters, and Netflix will be able to stream this content beginning in Sept. 2016.
Financial terms of the agreement were not disclosed, but according to an article in the Los Angeles Times, "A person close to the matter said Netflix could ultimately pay more than $300 million annually for Disney movies." Whatever the exact number is, chances are that Disney is being rewarded handsomely for its valuable content library.
Netflix has recently raised prices, so adding exclusive Disney content to its offering is a great way to strengthen the value proposition for subscribers. Since the agreement was signed in 2012, Disney has produced enormously successful blockbusters, including Frozen and Star Wars: The Force Awakens. While past performance is no guarantee of future results, Netflix management has a lot of reasons to be happy with the movies coming out of Disney's studio entertainment division.
Disney shareholders should keep a close eye on the company's ability to adapt to the online streaming paradigm, because this is undeniably a crucial trend in the business. However, when taking a deeper look at the relationship between Disney and Netflix, the online TV boom is not only a risk but also an opportunity for The House of Mouse.
Andrés Cardenal owns shares of Netflix and Walt Disney. The Motley Fool owns shares of and recommends Netflix and Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.