For years, Walt Disney Co (DIS 3.69%) was a great stock to own. From its nadir during the recession to its peak in 2015, the stock gained more than 500%, but over the last two-and-a-half years shares have essentially traded sideways. Bedeviled by the unraveling of the traditional pay-TV bundle, Disney has seen its growth plateau as operating income in its media networks division, its largest segment, fell by 11% in its most recent fiscal year.
CEO Robert Iger acknowledged the challenges back in 2015, noting that ESPN, the company's biggest cash cow, was seeing modest subscriber losses as cable viewers traded down to skinnier bundles or cut the cord altogether. While the company now seems to have a strategy to adapt to the changing media market, by launching a pair of streaming services and acquiring the entertainment assets of Twenty-First Century Fox (FOXA), there are reasons to believe that won't be enough to overcome the secular headwinds it faces.
1. Streaming is not a savior
Faced with declining subscribers to its cable networks, Disney is following in the footsteps of several other traditional media networks. The company said last August that it would launch two of its own streaming services, going directly to the consumer, rather than relying on carriage fees from cable providers like Comcast. The first of its services, ESPN Plus, will come out this year and will focus on sports and ESPN programming. The second package, which is due out in 2019, will center around movies and TV shows from its popular Disney and Pixar studios.
There's little doubt that Disney, with its brand name and content library, will be able to draw an audience to its new platforms as even Netflix (NFLX 5.03%) CEO Reed Hastings thinks the service will be a success, but the profits won't match what the company generated in the heyday of the cable era. Today, the ESPN suite of networks alone generates more than $9/month in carriage fees -- what cable companies pay programmers -- from more than 80 million subscribers.
Netflix charges just $11/month, and even the most premium streaming service, HBO Now, only charges $15/month. Comparing streaming prices to the average cable bill of more than $100/month, it's clear the profits legacy media networks had before just aren't coming back. Technology has a way of leveling the playing field, and that's exactly what's happening here. In other words, even if Disney's streaming services are successful, the profits won't make up for the continued loss in its cable division.
2. Content costs are only going up
The cost to air live sports has already ballooned in recent years as broadcasters have recognized the unique value that sports has for advertisers. Unlike scripted television, sports can draw an audience to the TV at a specific time, and it's DVR-proof. ESPN is committed to paying more than $8 billion a year for rights to air a range of pro and college sports through the early 2020s, a deal that is proving costly as its subscribers decline.
However, when broadcast or streaming rights go up for bidding next time, Disney is likely to face competition from not just traditional rivals like CBS, NBC, and Fox, but also new media companies like Amazon, Facebook, and even Apple.
It's the same story on the scripted television side. Netflix recently pilfered one of Disney's top creative talents, Shonda Rhimes, the creator of shows like Grey's Anatomy, and her production company Shondaland. Meanwhile, Apple is promising to spend $1 billion on original content this year, Amazon is upping its streaming budget as it searches for the next Game of Thrones, and Facebook just launched its own "Watch" tab for streaming. Now that tech companies are able to reach audiences just as broadcasters can, the media landscape is getting a lot more competitive.
3. The Fox deal is risky
Much of Disney's hopes seem to be riding on its proposed merger with Fox's entertainment assets as Disney will take over Fox's movie studios, cable networks like FX and National Geographic, its 30% stake in streaming service Hulu, and content library for $52.4 billion in stock. Yet the deal carries significant risks. First, it could be blocked by regulators -- the media industry has already gone through a wave of consolidation with Comcast taking over NBCUniversal, Charter Communications' acquisition of Time Warner Cable, and AT&T's purchase of DirecTV. However, regulators have indicated they would challenge the AT&T-Time Warner deal, and the same could happen with a Disney-Fox merger, as it would only add to Disney's dominance in sports programming and the combined company would control 40% of box office sales. If the deal gets blocked, Disney would owe Fox a $2.5 billion breakup fee.
Even if the deal is approved, it constitutes a bet on old media assets above all else. Disney would be acquiring movie studios at a time when ticket sales are falling, and taking on cable networks even though subscribers are declining. If the company can repackage those assets and an expanded content library into a profitable streaming service and leverage them across its business segments, including theme parks and consumer products like toys, the deal could pay off, but like much of Disney's legacy assets, Fox's seem likely to lose value over the coming years.
Disney still has plenty of enviable assets and competitive advantages, but it faces a classic innovator's dilemma. Even if it's successful in pivoting to streaming, that achievement will come at the expense of billions in profits from the cable bundle. With competition increasing and those profits from its media networks likely to keep dwindling, the stock seems like it will continue to be stuck in neutral. Disney might be a great company, but it's not a great stock.