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Analysts May Have Underestimated How Quickly Disney's Streaming Business Will Grow

By Adam Levy - Nov 12, 2019 at 7:45AM

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Days ahead of the Disney+ launch, management had a lot of good news to share about its streaming business.

Disney's ( DIS -0.67% ) direct-to-consumer (DTC) streaming plans were the focus of the company's fourth-quarter earnings call. CEO Bob Iger spread the love across all three of Disney's streaming properties: Hulu, ESPN+, and Disney+.

The DTC segment produced an operating loss of $740 million in the quarter. That's significantly better than the $900 million loss management forecast in its Q3 earnings report. The outperformance was fueled by strong growth at ESPN+ and Hulu.

ESPN+ now has 3.5 million subscribers, up from 2 million in February, and more than a third of the way to the midrange of Disney's five-year forecast for the service. Hulu ended the fourth quarter with 28.5 million paid subscribers, up from 26.8 million in May.

Meanwhile, Disney+ appears poised to have a huge first year. Disney signed a distribution deal with Verizon and finally came to an agreement to distribute Disney+ on Amazon's Fire TV. Both deals should add millions of subscribers at launch. Additionally, the flagship service will launch in Western Europe on March 31, which is earlier than expected.

All of this is combining to produce subscriber results that should outperform what analysts had previously modeled for Disney's DTC business.

Disney+ logo.

Image source: Disney.

Disney+ could reach 20 million subscribers in year one

Demand for Disney+ is extremely strong. A three-year promotional offer earlier this year saw significant consumer demand, and it even caused a server crash. On the earnings call, Iger said, "We are enthusiastic about what we saw the consumer reaction to be," regarding the promotion. 

Combined with the Verizon deal and Western Europe launch in March, Bernstein analyst Todd Juenger believes "year one subs of 20 [million] look much more likely." Likewise, Michael Nathanson from MoffettNathanson admitted, "We might be underestimating the size of the first year of launch."

20 million subscribers in the first year, largely concentrated in the United States and other early launch markets, would put Disney well ahead of schedule. Management expects to reach 60 million to 90 million subscribers five years from now, with roughly one-third coming from the U.S.

Don't forget about Hulu and ESPN+

Hulu and ESPN+ are very important pieces of Disney's DTC business.

Management said it will use its recently acquired FX property as a key value proposition for subscribing to Hulu. Hulu will become the exclusive home of FX series in March, and subscribers will be able to watch new episodes the day after they air. Additionally, FX will produce original series for Hulu starting next year to go along with the Hulu-branded originals like Handmaid's Tale.

Fox Searchlight will also produce some films for Hulu. Searchlight films with theatrical runs currently go to HBO (owned by AT&T), but Iger suggested that output deal could eventually move to Hulu.

Meanwhile, ESPN+ has seen a lot of success recently with its UFC pay-per-view deal. Iger said UFC 244 produced one of ESPN's largest live audiences to date. "We believe we have numerous interesting opportunities to expand ESPN+'s live and original program offerings and to steadily grow subscribers," Iger added.

The bundle should be popular

One of the key parts of Disney's direct-to-consumer strategy is the introduction of a bundle that combines Disney+ with Hulu and ESPN+. The offer will go live the day Disney+ launches, and it will cost $12.99 per month -- a $5 monthly discount compared to subscribing to all three separately. 

With the success of Hulu and ESPN+ so far and the pent-up demand for Disney+, the company should see strong results from offering the bundle. There are a couple of big advantages to selling a bundle of services over offering each as a stand-alone product.

First, bundling will increase the take rate for ESPN+ and Hulu. With full operational control of Hulu, Disney will be able to target subscribers taking two of its three services and offer the third at minimal to no additional cost.

Disney should be willing to do that because it can generate additional revenue from selling advertisements on ESPN+ and Hulu. Even if engagement on those services is lower on the bundle, there's still incremental revenue to generate through ads with minimal marginal expenses. On top of that, using a single account to login to all three services will enable better ad targeting and measurement.

Furthermore, bundling all the services together should reduce subscriber churn compared to stand-alone subscriptions. Bundling improves perceived value and creates additional friction for canceling just one service.

A strong Disney+ launch and continuously improving the content on Hulu and ESPN+ should make the bundle extremely attractive. As a result, Disney should see better-than-expected subscriber gains not just at Disney+ next year, but across all of its streaming properties. Management said it's not making any updates to the financial outlook it provided for its streaming services in April, but it wouldn't be a surprise if the company outperforms.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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