In March 2021, Walt Disney (DIS 0.16%) stock reached an all-time high as investors cheered the prospects of Disney+, the reopening of its parks, and expectations for the return of blockbuster hits. Since then, Disney+ has continued to grow faster than Disney could have ever hoped for. Its parks are booming. And it has a highly anticipated slate of feature films that could get Disney's movie business fully back on track in 2022.
Yet despite all of this good news, Disney's stock price is down 45% from its all-time high. For investors new to the stock market, it can seem bizarre that a company in better shape now than it was a year ago is worth so much less. But the stock market is unpredictable in the short term. And the sentiment toward streaming stocks has shifted dramatically in the last few months.
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Disney looks like a great long-term investment. But it has an $887 million red flag that is hurting its investment thesis. Here's a look at the profitability of Disney+, and what to expect from the company in the years to come.
Steep losses at Disney+
Disney's direct-to-consumer (DTC) segment posted an operating loss of $887 million in Q2 fiscal 2022. For some context, DTC notched a $593 million loss in Q1 fiscal 2022.
In Q2 fiscal 2022, gains from Disney's linear networks, parks, and experiences more than made up for this loss, as Disney posted $3.7 billion in operating income for the quarter. However, Disney told investors during its Q2 fiscal 2022 earnings call that DTC programming and production costs in Q3 fiscal 2022 are expected to be $900 million higher than Q3 fiscal 2021 as a direct result of content expenses from Disney+ and higher sports rights and programming fees from Hulu Live. Disney said that it now expects its cash content spending to be $32 billion for all of fiscal 2022, versus an earlier estimate of $33 billion. But still, that level of spending is nearly double the $17 billion that Netflix (NFLX -9.09%) spent in 2021.
Given the trajectory of Disney's content spending for the remainder of fiscal 2022 and fiscal 2023, Disney owes investors an explanation for why they should tolerate DTC losses. The short answer is that the company expects Disney+ subscribers to reach 230 million to 260 million by fiscal 2024, compared to the current 137.7 million. It also reiterated guidance that Disney+ expects to be profitable by fiscal 2024.
Netflix finished its most recent quarter with 221.64 million subscribers. With Netflix's growth slowing, if Disney hit its goals by fiscal 2024 Disney+ could be the largest streaming platform by subscriber count, and could be profitable in less than two years. For that reason, Disney has some time to make good on its promise. But if it misses its fiscal 2024 guidance, investors would be right to question the future of Disney's DTC segment.
Delayed gratification
Disney has been upfront with investors regarding its intention to front-load content spending in fiscal 2022 and fiscal 2023. The objective is to capitalize on folks returning to the movie theater, as well as load Disney+ up with fresh content to attain new subscribers.
Disney+ has its own in-house content, like the recently released show Obi-Wan Kenobi. But another draw to the service is to catch films just a month or two after they leave theaters. For example, Doctor Strange in the Multiverse of Madness hit theaters on May 6. Disney announced that the movie will begin streaming on Disney+ on June 22.
A six- or seven-week delay between theater releases and Disney+ releases creates a content-creating machine for the foreseeable future. For example, just as Doctor Strange is about to leave theaters, Lightyear will hit theaters on June 17. Thor: Love and Thunder debuts on July 8. Then soon after Lightyear leaves theaters sometime around early August, the Disney+ original Pinocchio will be available to stream on Sept. 8. Then there's the usual seasonal gap in the late summer/early fall before Black Panther: Wakanda Forever hits the big screen in November, followed by Avatar 2 in December.
Disney's movie releases are deliberate. On one hand, it doesn't want to cannibalize any single film's importance by releasing similar films in quick succession. And on the other, the media company wants to make up for lost movie revenue in 2020 and 2021. Disney wants each movie to mean something to its fans, and it doesn't want to exhaust its viewers in any one universe, whether that be Marvel, Pixar, Star Wars, etc.
Playing its cards right
Disney's DTC losses are unsustainable. But if I were Disney, I'd be playing my cards the exact same way. It makes sense to accelerate production this year, ease it in fiscal 2023, and then pull back heavily in fiscal 2024 and set a new precedent for annual content spending on films and Disney+-specific content. After all, demand is currently high for Disney's movies and attendance at its parks. So it makes sense that Disney should lean into that.
If all goes according to plan, Disney will have successfully set itself up to spend less on films and shows in subsequent years and focus on quality over quantity and earnings over growth. Lower spending should help Disney+ reach profitability and boost margins in Disney's content sales, licensing, and other segments (which is where the movies are accounted for).
So while it's easy to look at Disney's high DTC losses and sell the stock, the better approach is to think big-picture about Disney's strategy, where it is headed, and how it is positioning itself in the years to come. From that perspective, Disney's DTC losses make sense, and the company is making the right moves to make it an even more vertically integrated and profitable media company.
