Disney (NYSE:DIS) CEO Bob Iger has been forthright in noting the company's focus on direct-to-consumer streaming will weigh on the company's bottom line in the short term. In particular, Disney is giving up high-margin licensing revenue from its deal with Netflix in order to retain those rights for its own Disney+ service.
During the company's first-quarter earnings call, CFO Christine McCarthy said investors should expect a $150 million drop in operating income as a result of decreased licensing revenue. That's actually a relatively small number. For reference, Disney generated $3.7 billion in operating income in the first quarter alone and $15.7 billion for the full year last year.
In the context of Disney+, for which Disney hasn't announced pricing, it could mean just a couple of million subscribers paying $7 or $8 per month. Disney grew ESPN+ to 2 million subscribers in just nine months, so it's feasible Disney could cover its licensing revenue loss in about a year.
But lost licensing revenue is just part of the equation. Let's break down the true cost of Disney's direct-to-consumer service and how many subscribers it'll need just to get back to where it started.
Opportunity cost is just a small expense
Disney isn't just forgoing licensing revenue to build Disney+ and its other streaming services. It's also investing in new content for the services and must market them in order to attract subscribers.
Disney is investing in exclusive series and films based on its Star Wars, Marvel, and classic Disney intellectual property. The company hasn't disclosed how much it's budgeting for exclusives, but considering the talent it's signed, it should be substantial.
Spending on marketing could also add up. Macquarie analysts estimate marketing and technology expenses for ESPN+ alone will total $100 million through its first three years of operation. Considering the broader target audience for Disney+, the marketing budget could be much higher.
How much will this whole thing cost?
Development of the Disney+ platform alone is costing hundreds of millions of dollars. Disney disclosed that investments in ESPN+ and Disney+ resulted in a $200 million negative impact on operating income in the first quarter. About one-third of that -- $66 million -- is tied to Disney+.
As a reminder, that doesn't include any of its content costs (which start amortizing after the service launches), and there's no marketing expense for the product yet since there's no product to sell.
The $133 million or so loss associated with ESPN+ may be an indication of ongoing costs associated with Disney's streaming services after launch. Those expenses are offset by the 2 million or so customers paying $4.15 to $5 per month for the service, plus ad revenue. That's likely over $30 million in revenue offsetting the operating loss.
Disney's investments in content and marketing will likely be bigger for Disney+, but the technology back end may be less expensive due to less live streaming and a lack of advertising on the platform. Based on the roughly $16 million in content and operating costs for ESPN+ last quarter, Disney+ will likely cost more than $200 million per quarter once it launches. That number could climb much higher if Disney doubles down on content or marketing expenses.
Adding it all together
When you add in the $150 million in lost annual operating income from its licensing deals, Disney's annual costs (including opportunity costs) for Disney+ after launch could be around $1 billion. Iger said consumers should expect Disney to charge less than Netflix for its service -- and he said that when Netflix charged $10.99 per month for its most popular plan. A price around $8 per month, about $100 per year, sounds more reasonable.
At that rate, Disney will need at least 10 million Disney+ subscribers to reach true breakeven, including its foregone licensing revenue.
That's likely going to take a few years, but Disney has been forthcoming with milestone updates for ESPN+, so investors should get a good idea of how the company is progressing with regard to Disney+, as well. Disney will provide additional details on Disney+ at its investors meeting in April, so look for a clearer outlook on the service then.