Are Investors Underestimating Walt Disney Co.'s Studio Business?

"Marvel's next wave is just beginning," wrote Vanity Fair writer Joanna Robinson in the magazine's cover story for its holiday 2017 issue. Robinson was paraphrasing Walt Disney (DIS -0.13%) CEO Bob Iger, who noted that the company has rights to 7,000 characters. With another 20 movies already mapped out that are "completely different from anything that's come before," according to film producer and president of Marvel Studios Kevin Feige, the franchise's unblemished track record should have investors betting the next phase of films will impress.

Of course, Walt Disney's studio entertainment business is far more than Marvel. Disney also owns Lucasfilm, Pixar, and its own Disney-branded content. And based on the ongoing success of these other film studios, particularly Lucasfim's Star Wars franchise as of late, investors should be giving significant consideration to Disney's studio business.

Chris Hemsworth as Thor in Thor: Ragnarok. Image source: Walt Disney.

Rapid growth

A quick glance at the performance of Disney's financial results in its studio entertainment segment in fiscal 2017 doesn't suggest the business is doing well. Studio entertainment revenue and operating income during the period fell 11% and 13%, respectively, compared to fiscal 2016. 

This decline isn't due to poorly performing 2017 films. Rather, it's simply a result of the wild success of the Star Wars franchise in fiscal 2016. And herein lies the problem with looking at Disney's studio entertainment business on a quarter-to-quarter or even year-to-year basis: Results are volatile in the near term.

Fortunately, there's a way to zoom out and look at growth in Disney's studio business more objectively. A closer look at Disney's trailing-24-month track record more accurately captures how the segment is becoming stronger over a longer time horizon. Trailing-24-month revenue in Disney's studio entertainment business is up 22% compared to the previous 24-month period. Operating income during the period jumped even more sharply, climbing a whopping 44%.

Or here's another way to look at how things have changed: Consider a snapshot of Disney's studio entertainment business every three years since 2011.

Data sources: company quarterly and annual SEC filings. 

The trajectory is clear. Disney's studio business is growing rapidly. And with four powerful, proven franchises -- Marvel, Pixar, Lucasfilm, and Disney -- showing no signs of weakness, Disney's content engine may be just getting started.

A catalyst

Knowing how important its content and intellectual property is, Disney is positioning itself to better monetize its creative engine. Taking a play from Netflix (NFLX -8.94%), Disney is launching its own streaming services -- one for its studio entertainment content and one for ESPN.

With the service launching in the second half of 2019, Disney management looks ready to do whatever it takes to mitigate the risk that it will flop. Disney's new, direct-to-consumer streaming service will not only stream the latest Disney, Pixar, Marvel, and Star Wars films, but it will also produce four to five films exclusively for the service each year. Further, Disney said it will price the service "substantially below Netflix," raising prices as its content library increases -- a pricing strategy Netflix has successfully executed.

Combining Disney's powerhouse studio with Netflix's proven approach to bringing quality, exclusive content directly to consumers through a streaming-TV service, Walt Disney's studio entertainment business is a force to be reckoned with -- one that Disney's conservative valuation may not be fully accounting for.