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Disney Is Serious About Disrupting Netflix

By Nicholas Rossolillo - Aug 12, 2019 at 4:45PM

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It's a bit of a mess right now, but a new entertainment package is going to be a serious force to be reckoned with.

Disney's (DIS -0.70%) hotly anticipated summertime quarterly report was out last week and was chock-full of details -- a few good ones as well as a number of not-so-good "surprises."

While theme park revenue rose due to ticket price increases, traffic was down. Expenses related to the 21st Century Fox acquisition killed earnings growth, though not surprisingly as this was the first full quarter after the merger. And profits for the high-flying movie business were less than expected, mostly because of the also not surprising underperformance of the X-Men film Dark Phoenix.

Still, investors seemed to be wearing rose-colored glasses headed into the report and seem taken aback by the mixed numbers generated during this time of heavy investment spending at Disney. However, the company is putting the final touches on some transformative moves, with its Disney+ streaming service at the heart of it all.

Disney had a few more details about its streaming ambitions, and it looks like the company is aiming to one-up Netflix (NFLX 1.56%) in that department.

A man, woman, and two children sitting on a couch watching TV.

Image source: Getty Images.

Competitive pricing

During the last earnings call, Disney CEO Robert Iger said Disney+ (to be released on Nov. 12), ESPN+, and the ad-supported version of Hulu (which Disney now controls and has a majority stake in) will be available in a bundled package starting at $12.99 a month.

Disney+ will house family-oriented content, including Disney's back catalog as well as content from Pixar, Marvel, Star Wars, and National Geographic (picked up from Fox). Hulu will become the home of more adult-oriented titles as well as the majority of Fox's content. And ESPN+ will continue to feature select live sports events and original shows. With Disney funneling cash into all three to develop new entertainment, the new bundled package is sure to have something for all ages and tastes.

Of course it's the price tag that is most interesting. Netflix most popular pricing for high-definition streaming is also $12.99 a month, and Amazon (AMZN 0.25%) Prime membership that includes the Prime Video streaming service is that price when you purchase it on a month-by-month basis (it's $119 if you pay for it yearly). A slew of other rival options are gearing up to go online in the next year, so Disney is obviously going aggressive to get households to sign up. Individually, Disney+ will cost $6.99 a month, ESPN+ is $4.99 a month, and ad-supported Hulu runs $5.99 a month.

Ad revenue enhanced

The $12.99 bundled package includes versions of ESPN+ and Hulu that support advertising. While not running at the frequency of ads on traditional cable and network TV, these ad-light versions of ESPN+ and Hulu will generate monthly subscription revenue.

Ad revenue could be a real deal sweetener for Disney's "direct-to-consumer and international" segment. Revenues in the quarter increased to $3.86 billion from $827 million a year ago, mostly due to the inclusion of Hulu, as well as the Fox and National Geographic international TV channels. However, operating losses were $553 million as compared to $168 million a year ago, attributable again to the loss-generating Hulu, investment in content for ESPN+, and other expenses related to getting Disney+ ready. Advertising could be key to getting the segment out of the red if enough consumers sign up in November.

No word yet on whether a bundled ad-free package will also be available, but I wouldn't be surprised if there was one for a premium price to go toe-to-toe with Netflix and Amazon (neither of which run ads with their content).

Enviable vertical integration

Disney's movie business is the biggest upside for the streaming bundle. While Disney's "studio entertainment" results were dragged down somewhat this quarter by the film flop Dark Phoenix, Disney's prowess with theatrical releases creates an extra layer of revenue generation that Netflix and Amazon can't really match -- at least not yet.

Content creation costs money, sometimes hundreds of millions of dollars just to generate a single two-hour feature or TV show season. For Netflix and other similar services, most of those costs are paid for over time via subscribers. Holding on to those subscribers is key, but continuously releasing new high-quality content (which costs more money) is the single most important factor in getting new subscribers to sign up and existing ones to stay. It's a vicious cycle of cash burn that has kept Netflix's profitability in check the last few years as it tries to build out its own library of original titles

Disney, which already dominated the global box office before adding Fox to the mix, can at the very least offset some of the costs associated with producing a film at the theater -- or at best make a tidy profit, as it has been doing this year with Avengers: Endgame, Toy Story 4, The Lion King, etc. And though Dark Phoenix did a great deal to offset those profits with its dismal showing, that should be an exception rather than a rule going forward. Disney has an impressive slate of box office releases planned for the next few years, all of which will leave the theater and head to one of the company's exclusive streaming platforms, where it will continue to generate money via monthly subscriptions.  

In all, Disney's last earnings report was a bit messy, but the strategy the company has been building for the last few years is only just beginning to take shape and should make it a serious contender in the new digital age of entertainment consumption. Expect earnings to keep contracting for at least the next couple of quarters due to integration and content creation costs, but also expect the streaming bundle to pay off in a big way in the not-too-distant future.

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