Activist investor Dan Loeb has a bold plan for Walt Disney (NYSE:DIS).
The founder of the hedge fund Third Point sent a letter to Disney CEO Bob Chapek calling on him to ditch the company's dividend and reallocate the roughly $3 billion it spends on it into boosting its Disney+ streaming service.
Loeb argued that this plan would allow the entertainment giant to double its spending on content for Disney+, unlock value for shareholders. Loeb said he believed that Disney+ could overtake Netflix (NASDAQ:NFLX) in a few years if the company invested enough in the platform.
"Meaningfully accelerating DTC content spend will further broaden the divide between Disney and its traditional media peers -- AT&T's WarnerMedia, Discovery, ViacomCBS, Comcast's NBCUniversal and Fox -- none of which have the financial capabilities to execute such a bold plan," said Loeb.
Like other Disney investors, Loeb likely looks enviously at Netflix's valuation. In fact, Netflix now has a higher market cap than Disney, even though the pure-play streamer lacks counterparts to Disney's theme parks and resorts, its box office studio business, its intellectual property including the Marvel and Star Wars franchises, and its cable and media networks such ESPN and ABC.
The Disney+ juggernaut
Within the realm of streaming services, Disney+ seems to pose the greatest threat to Netflix. When it was launched last November, Disney management said they expected it would reach 60 million to 90 million subscribers globally by 2024; it has already passed the 60 million subscriber mark.
Stacked with family-friendly content from Marvel, Star Wars, Pixar, National Geographic, and a library of Disney classics, Disney+ has attracted viewers from around the world, and those subscriber numbers have been boosted by its partnerships with telecom operators like Verizon. However, Disney's spending on original content has been relatively meager: The company said last year that it planned to spend $1 billion on original content this year, and boost that annual outlay to $2.5 billion by 2024.
Netflix, on the other hand, spent $14 billion on original content last year, and was set to spend more than that in 2020 before the pandemic disrupted its production schedule.
Unlike Netflix, a pure-play streamer, Disney has to balance the needs of multiple businesses -- and Disney+ is only one of its three streaming services along with Hulu and ESPN+. The company waited so long to launch Disney+ in part because it enjoyed bumper profits from ABC, ESPN, and the Disney Channel, as well as its box-office releases. The streaming service directly undermines those businesses by encouraging cord-cutting and providing easy access to Disney entertainment that doesn't require consumers to go see its newest releases in the movie theater.
In Disney's most recent fiscal year, its media networks segment accounted for half of its operating profits, or $7.5 billion. Its streaming business, on the other hand, is still burning billions in cash. Through the first three quarters of fiscal 2020, the company has lost $2.2 billion in its direct-to-consumer and international segment.
The coronavirus pandemic has changed the balance of power in Disney's business segments, favoring Disney+ and its other streaming services, while hurting businesses like its theme parks and big-budget movies. Given the challenges now facing Disney, it makes sense for the company to step up its investments in Disney+, considering its growth potential and ability to perform during the pandemic. However, becoming another Netflix won't be easy.
Can it top Netflix?
The global streaming market still offers plenty of room for growth as internet connectivity and mobile technology improve across the developing world and as more consumers cut the cord. Netflix already has nearly 200 million subscribers globally, so it's still well ahead of Disney+, but it's hard to ignore a business that has attracted 60 million subscribers in less than a year.
Will Disney take Loeb's advice? Even Disney can't build another Netflix overnight. Netflix has forged partnerships with key creators like Ryan Murphy and Shonda Rhimes, established popular shows that have built audiences over several seasons, and has local-language programming targeted at markets from Turkey to South Korea. Netflix has been developing original programming for nearly a decade now and released 371 original series and movies last year, more than the entire U.S. television industry produced in 2005.
It's able to do that in part because of the flywheel it has created from its massive subscriber base, which allows it to spend more on content than any of its competitors. That constant supply of fresh content keeps its previous subscribers satisfied (and less likely to cancel) and also allows it to attract new ones.
With its strong brand equity and formidable intellectual property, if Disney decided to spend $10 billion a year on original content for Disney+, it might be able to catch up to Netflix eventually, but doing so would require running up billions in losses in its streaming business, and that doesn't make sense for the overall company, especially as boosting Disney+ would cannibalize profits from its media networks. However, given that it's only charging $6.99 a month for the streaming service, raising the price could be an option.
Accelerating content spending on Disney+ moderately seems like the right move in the current environment, but Disney is never going to warrant the kind of valuation that Netflix gets. For Disney stock to break out to new heights, the company needs to get its legacy businesses like its theme parks back on their feet, and that can't happen until the pandemic is over. However, if Disney+ continues to grow, and if the company's other businesses can also return to their historical levels of profitability, the stock in its current price range will look like a bargain. Loeb is right that there's hidden value here.