Walt Disney (NYSE:DIS) had a great run between 2012 and 2015, notching lots of box office blockbusters and big business wins. Share prices surged 180% higher in four years. The last two years didn't work out that way, and Disney's stock has been trading sideways since the start of 2016.
Will the slowdown continue in 2018, or is Disney about to restart its stalled rocket ride?
What went wrong in 2017
This year, Disney shares gained 12% while the S&P 500 market benchmark rose 38% higher. The company beat Wall Street's earnings estimates in three out of four reports published during the calendar year, but they fell short of revenue expectations in all four instances.
The core of Disney's troubles lies in its broadcasting and cable TV networks. Rising broadcast affiliate fees failed to make up for dramatically lower advertising sales, while higher programming costs for major sports contracts drove operating profits even lower.
Other operations pulled their weight, from theme parks and cruise lines to silver-screen movie releases and licensed consumer goods sales. In every conversation, TV networks turned out to be the chief culprit behind Disney's business challenges.
In a bold attempt to right the broadcasting ship, Disney is shaking up its TV business in a big way right now.
The company is preparing a streaming video service of its own to replace the expiring multiyear partnership with Netflix (NASDAQ:NFLX). The new solution will be fully implemented at the start of calendar year 2019, after a smaller rollout of an ESPN-branded sporting content version in the spring of 2018. That split-step approach makes sense, given that Disney's streaming technology comes from the BAMtech platform that started out as a streaming solution for Major League Baseball.
The long-term viability of Disney's TV-based content will depend on these new streaming services. I agree with management's analysis, which shows that Disney's powerful brand name should help these services hit the ground running.
Furthermore, Disney is attempting to buy out Hollywood rival 21st Century Fox (NASDAQ: FOX) (NASDAQ: FOXA) in a $52 billion takeover deal. That deal excludes a handful of Fox's TV assets such as Fox News, Fox Business Network, and the good old Fox broadcast service. Regulators would not let one company own both Fox and ABC, after all.
So, the Fox deal would focus on that company's movie and TV production studios, along with a few regional sports networks and cable stations FX, FXX, and National Geographic. If this buyout passes muster, I don't expect it to do much for Disney's top-line TV ad sales. Instead, it should unlock backlot efficiencies between the Fox and ABC production crews, lowering Disney's overall operating costs to unlock higher profits. The companies expect to see annual cost efficiency savings of $2 billion, just not right away.
And the Fox deal will give Disney a 60% ownership stake in streaming media service Hulu. I'm curious how that will affect Disney's BAMtech-based streaming efforts. The company might even want to buy out the 30% and 10% minority interests of Comcast (NASDAQ:CMCSA) and Time Warner (NYSE: TWX), respectively, and then consolidate the established Hulu platform with Disney's in-house solution. Food for thought.
The Fox buyout is scheduled to close by the middle of 2018, assuming favorable outcomes in regulatory challenges and shareholder votes. The merged company would instantly become the most powerful movie studio in history with a 40% annual market share of American ticket sales. The stock-swapping structure of the contract would also dilute the holdings of current Disney shareholders by 34%, so the company will need to make up for this pain by unlocking lots of business value from the combination.
The final verdict
Assuming the Fox merger is completed as planned, Disney will look very different a year from now. It will easily crush its all-time revenue records, though bottom-line earnings may dip in the first year due to deal-related costs.
As for Disney's share prices, I would be surprised to see them skyrocketing next year. Dilution and uncertainty around the streaming video and Fox merger moves could put a cap on share price gains in 2018. That being said, my own Disney shares are staying in my portfolio because I see the company building long-term value here.
Let's call 2018 a year of transition for Walt Disney. I'm OK with that, and might even buy more shares if prices take a dive as the story plays out.