Showdown 2019: Disney vs. Netflix

In this episode of MarketFoolery, Mac Greer talks with Motley Fool Stock Advisor Canada's David Kretzmann and Million Dollar Portfolio's Matt Argersinger about today's biggest market news.

Chinese search giant Baidu (BIDU 1.24%) is planning to deepen its partnership with Netflix (NFLX -0.51%), which could lead to some big results for both companies in the long run. Comcast (CMCSA 1.62%) is reporting stronger than expected earnings this quarter, and doesn't seem particularly bothered by cord-cutting. Netflix CEO Reed Hastings noted on this quarter's conference call that he'll be subscribing to and taking notes on Disney's (DIS -0.45%) video streaming platform, and the company seems far from worried about the competition the new service could present. Click play to find out more.

A full transcript follows the video.

This video was recorded on Jan. 24, 2018.

Mac Greer: Welcome to MarketFoolery for January 24th. I'm Mac Greer. I'm joined by Matt Argersinger from Motley Fool Million Dollar Portfolio, and David Kretzmann from Motley Fool Stock Advisor Canada.

David Kretzmann: All up north, that's right.

Greer: Gentlemen, welcome!

Kretzmann: Great to be here!

Matt Argersinger: Yeah, thanks for coming down south of the border of here.

Kretzmann: It's a little bit warmer. I was getting cold up there. I want to give a quick plug, today we're launching Hidden Gems Canada, our brand-new service up in Canada. Last night, we had a live chat with Motley Fool co-founder and CEO, Tom Gardner. I'll just say, at the end, totally arbitrarily, he gave a tease that he will give new members of Hidden Gems Canada his top two favorite U.S. small caps. If you're interested in checking out the live chat and everything else we have going on with the campaign, fool.ca/hiddengems, we have some cool stuff. Leave it to Tom. 

Argersinger: Tom G.

Greer: OK. On today's show, we're going to talk some Baidu and some Disney, but let's begin with Comcast. Comcast reporting stronger-than-expected fourth quarter earnings. David, some really nice numbers here, including a $12.7 billion gain from changes to the tax code. Comcast also buying back some stock and increasing its dividend.

Kretzmann: Yeah, this is a company you hate to like, but it's a decent business at the end of the day. A lot of times, you'll see headlines that they're losing video customers, and that's true. They lost 33,000 video customers this quarter. They lost 13,000 voice customers. But what's really continuing to drive the business is their high-speed internet business, their broadband business, which added 350,000 new subscribers this quarter. To give some high-level context, in 2009, they had 16 million total broadband internet subscribers. They're almost at 26 million today. So, over the past seven or eight years, they've added close to 10 million new subscribers. Now they have more internet subscribers than video. So, a nicely diversified business. It's a sticky relationship, as we all unfortunately know. A lot of times, there isn't any other option if you want internet or video. So, they lock in that relationship, and then they can find other ways to add on, with home security services or other things through that Xfinity brand. A company that continues to churn out a lot of cash. Over the past year, they've generated close to $12 billion in free cash flow. As you mentioned, Mac, that gives them a lot of leeway to bump up share repurchases. They have a 1.5% dividend yield. It's a solid business trading at about 20X trailing earnings, but you hate to like it at all.

Greer: Taking everything you just said and marrying it to this whole cutting the cord narrative that we hear over and over, as an investor, what do I do with that? What do I do with Comcast and cutting the cord?

Kretzmann: Obviously, they are losing video customers who are cutting the cord. But if you're cutting the cord, you're not completely leaving content behind. You're usually going to be subscribing to an internet-based service, in which case you're going to sign up for their high-speed internet service. They're not actually losing customers at the end of the day, they're actually seeing a net gain of subscribers over time as more people drift to these internet services. The underlying business continues to be in healthy shape.

Greer: OK, guys, let's move on to the Chinese internet search giant, Baidu. Baidu looking to deepen its partnership with Netflix. Last year, Netflix signed a deal with Baidu to provide programs like Stranger Things to Baidu's streaming service. In an interview with CNBC this week, Baidu's president hinted that there may be more deals to come, more deals bringing more Netflix content to China. Matt, what does it mean?

Argersinger: It's a big deal. I think it's a big deal if you're Baidu and you're the iQiyi service, which happens to be the neck-and-neck leading streaming service in China with Alibaba and Tencent. With iQiyi, you have 200 million unique monthly users, over 20 million paying subscribers, so it's trying to adopt that Netflix model. And Netflix, as many U.S. companies have, has been trying for years to get into China. And they saw iQiyi as a licensing partner, a way to get a foot into China, and they did that last year. I think the hint of more content from Netflix coming in to China via iQiyi is very exciting. If you think about it, Netflix is now worth over $100 billion after this week's earnings. So impressive. Do you think, Mac, that the leading streaming video service in China could also maybe be worth $100 billion? I mean, there's more people in China and everything. iQiyi right now is roughly the leader. And that valuation is more than Baidu's worth right now in its entirety. So, it's very exciting, I think, if you're a Baidu shareholder, because iQiyi is going to get this great content which I think Chinese customers are really hungering for. 

There's also a rumor out there that Baidu -- and it's a legitimate rumor -- might actually spin off iQiyi later this year. So, as a Baidu investor, you'll get shares in iQiyi, which could be its own independent company. But, yeah, I think it's very exciting. Baidu recognizes that having quality original content is the right way to continue attracting paying subscribers, and Netflix has some of the best content out there.

Kretzmann: And certainly, for better or worse, the competitive dynamics in China are great for iQiyi and Baidu, because there really can't be any external competition, due to the regulatory framework there. So, that gives them an advantage where Netflix can't directly offer its services in China. You've seen a lot of, I think a good amount of, U.S. companies or companies outside of China trying to serve that market, but they either get turned down by the government or for whatever reason they can't get their offerings to stick there. So, that gives a huge advantage for Baidu and iQiyi to bring a lot of this great international content into China, and then continue to develop their own content without a whole lot of competition, the same way that you see outside of China.

Argersinger: And I think it's telling that iQiyi is choosing Netflix as the partner. We know Netflix has great content, but one thing that Netflix has done so well is really broadening the type of content that they have, from comedy to dramas to serials. They're producing content in a lot of different countries that appeal to a lot of different cultures or audiences. And I think that's very attracted to China, which is trying to broaden that reach within its own country.

Greer: Guys, for our final story, I want to talk about the Disney vs. Netflix coming cage match. On yesterday's Market Foolery, Chris talked about Netflix's earnings, and I want to pull that thread out a bit more, because what we learned in Netflix's Monday night earnings call is that Disney's direct-to-consumer subscription service, which they're going to be launching in 2019, we know now they have at least one subscriber. And that subscriber: Netflix CEO Reed Hastings. In the Netflix call on Monday, Hastings said that he expects Disney's service to be very successful, and said that he'll be a subscriber. Hastings also said that Netflix doesn't see Disney's service as a threat any more than Hulu has been. David, what do you think about Hastings' assessment of Disney?

Kretzmann: It's interesting, because over the years, this is really what Hastings has said about the competition. He's never been one to bad-mouth the competition, whether it was HBO or Hulu or Amazon (AMZN -1.14%), and now Disney. On the conference call, he mentioned that they have a lot to learn from Disney, and they'll be curious to see what Disney does, how they interact with users, what that whole interface looks like. I think it also gets to the point that, Netflix has said over the years that it isn't a zero-sum game, that consumers aren't going to just subscribe to one of these video offerings. You'll get access to Amazon's Prime movies just by being a Prime member. You might subscribe to HBO and Netflix. Similar to how you're not just subscribing to cable for just one or two channels, necessarily, you have access to a lot of different channels, I think in this direct-to-consumer age, you'll be subscribed to a variety of these different apps. 

I think the concern that some people have, because actually, when I was out at CES 2018 a couple of weeks ago, I had a chance to interview a couple of authors, and there was a good amount of bearishness toward Netflix, mainly because of this looming competition from Disney. Essentially, the common thread there was, everyone is gunning for Netflix. Netflix is clearly the top dog with online streaming. And you have the big dogs like Amazon and Disney going after Netflix. And potentially the disadvantage that Netflix has is, they have a one-prong business model. They only make money through these monthly subscriptions, whereas Disney has the parks and the movies and everything else. Amazon obviously has the retail side of things. But Netflix, potentially, I think the argument you could see bears making is that Netflix could become similar to be position that Pandora is in today, where you're going up against Apple (AAPL -0.57%) and Amazon and all these huge tech giants that don't need that to be their main revenue generator, and that could potentially squeeze Netflix down the line. So, I would say that's the bearish argument that I see over the long term. But I don't know, Netflix has been up against the Goliaths before it with the DVD business. They took on Blockbuster. I wouldn't underestimate Netflix now. So, I don't think it's going to be a be-all end-all with Disney's amped up competition.

Argersinger: Yeah. And also, I think there's a beautiful part of simplicity that Netflix has in just focusing solely on producing and delivering great content. It doesn't have the distractions, the other business lines, that your Disney or Amazon is going to have. So, from that point of view, I really like Netflix a lot. But I think in five years, if we look down the road a little bit, I think it's very possible that we have four big platforms or brands in video streaming. I think Amazon, Netflix, YouTube, and Hulu-Disney. And the reason I say Hulu-Disney is because I think of those, especially Disney in the process of buying 21st Century Fox and acquiring a majority stake in Hulu, I still think that's going to become their go-to platform. I know they're talking about having that separate Disney app and the separate ESPN app, but I don't know why you would do that. I think the right strategic move would just be to go after Hulu and make Hulu yours, that's where all the Disney content gravitates toward. 

But, I think you set aside CBS, Viacom, I think you forget Comcast NBC, which we talked about earlier. I even think you put aside HBO. I think your final four are Amazon, Netflix, YouTube and Hulu-Disney. And I think that might be the future that Reed Hastings sees a little bit as well, in that these four platforms, everyone might subscribe to them, and they might complement each other. They don't have to be competing directly with each other.

Greer: Along those lines, maybe there's room for all of those on the consumer level, but we're a show for investors and we're investors. When you look at those final four, do you think those are all market beaters? It's one thing to say that there's room for both Netflix and Disney. It's a completely different thing to say that they're both going to be market beating stocks.

Kretzmann: I think with Netflix, you have a $100 billion company. Now, realistically, the company could have several hundred million subscribers in five years or so, just as they continue to see higher penetration internationally. When you look at countries like Brazil, where they've operated for over four years now, it's something like 77% of Brazilian households with broadband subscribe to Netflix now, so just incredible penetration. And if you can play that out, even not necessarily to that degree, but play out that increased penetration globally in these relatively newer markets that they're in, that will really bump up their subscriber count a huge amount in the coming years. 

So, I think the question mark with Netflix remains, when do they get to a point where that content spending, which is supposed to hit $8 billion this year, when do you get to a point where that plateaus and it doesn't keep increasing by several billion dollars each year? I think Reed Hastings or one of the managers on the conference call alluded to that potentially happening in the next couple of years. So, that's the main question mark I have: when will that content spending finally plateau, and you'll see more of that subscription revenue drop to the bottom line? At this point, they're pumping so much into that content spending, and they're relying on debt for that. That puts the company in a little bit more of a precarious position financially than some of those other big dogs that they're going up against. But I think they'll continue to do really well. They're still just in the very early stages of capturing global market.

Argersinger: Yeah, I'll echo what D.K. just said. I think Netflix is the riskiest of the four. With Amazon, the video streaming service sort of reinforces their Prime business and reinforces their e-commerce business. For YouTube, it reinforces Google and Alphabet's advertising business. And of course, for Hulu-Disney -- I keep using that word, Hulu-Disney.

Kretzmann: Trademark that.

Greer: I like it.

Argersinger: But, it reinforces everything else Disney does, their parks and movies and everything else. Netflix is the pure-play, which makes it exciting, but it definitely makes it the riskiest of the four by far.

Greer: I noticed you did not mention the name Apple.

Argersinger: Yeah. The interesting thing is, Apple is a company that stands out as the hardware, the platform, the place, the screen that we're looking at, in most cases, for all this content. And it did occur to me as we were talking about Netflix that going forward, a partner like Apple might be the way you stand up to these other titans. Apple has plenty of cash, looking for original content of its own. $100 billion is not quite a drop in the bucket as it was as Netflix was a few years ago, but it's still very digestible for something like Apple.

Kretzmann: And one other thing I'll mention, too, I think people underestimate the advantage that Netflix has from a head start perspective. They have years of data that they've accumulated on users, both with the DVD business and now with the online streaming business. By far, they have the most data of any of these companies, Disney included, of what consumers are watching, when they watch it, what they prefer. And I wouldn't underestimate that advantage. Disney is really going in blind. They haven't done direct-to-consumer with these TV shows or movies before. Obviously, their content tends to do very well, so I don't think that's a huge hurdle for them. But I wouldn't underestimate that that's a competitive advantage for Netflix going forward.

Greer: That's such a great point. When you hear "head start," I tend to immediately jump to Disney and think of their library and everything they can populate that library with from day one. But to your point, David, they don't have analytics near as much as Netflix does. And maybe we're taking that for granted.

Kretzmann: Yeah, this is new territory for Disney. I'm curious to see what that user interface and user experience looks like, because they haven't had a direct-to-consumer platform like this before, and they are going in blind with a lot of that data. I think that's something that's sort of a hidden advantage to Netflix that I think is overlooked, because having years of data, that really helps Netflix, especially now that they're relying more and more on their original content. Disney can pull off its content from Netflix now, and Netflix didn't bat an eye. They added even more subscribers this past quarter. You're not seeing a whole lot of concern from management. So, I think that really shows that data is a big advantage.

Greer: We'll keep an eye on it. Guys, thanks for joining me!

Kretzmann: Thanks, Mac!

Argersinger: Thanks, Mac!

Greer: As always, people on the show may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of Market Foolery. The show is mixed by Dan Boyd. I'm Mac Greer. Thanks for listening! We'll see you tomorrow!