It would be hard to look at the media properties owned by The Walt Disney Company (DIS -0.04%) and not be impressed. From Star Wars to Mickey Mouse, the company owns iconic brands. So why is the stock down 50% since a recent peak in early 2021? Although it's too soon to make a final call, this is one story that may not have a happy ending soon.
Shut down
Disney's stock plunged in early 2020 when the coronavirus started to spread around the world -- and for good reason. Running amusement parks is a huge business for the media company. Making movies is vital to results too, which was another problem given that social distancing requirements resulted in movie theaters getting shuttered. The company ended up eliminating its dividend, which was an appropriate, though dramatic, move that highlighted just how bad things had gotten during the pandemic.
Image source: Getty Images.
The one bright spot was the company's new streaming service, Disney +. As often happens on Wall Street, investors got so focused on the streaming story that nothing else seemed to matter. And the stock rocketed higher in an almost shocking fashion, driven by robust subscriber growth at Disney +, even though the rest of the business wasn't doing all that well.
Building a business costs a lot of money, however, and investors have started to pay more attention to the cost of the Disney + effort. The red ink is pretty material with the company's direct-to-consumer division reporting just over $4 billion in losses in fiscal 2022, which ended on Oct. 1. That was more than twice the size of the loss over the same span in fiscal 2021.
Interestingly, the company's other businesses are starting to pick up again. But investors are still focused on the streaming operation and the stock has plunged. Investors may be right to worry.
An intense game
Streaming is an increasingly competitive space, with virtually all sizable content owners looking to start their own services. That's on top of aggregators like Netflix and Amazon, which also create their own content. The problem is really the content creation piece. Building a platform is a big up-front cost, but creating desirable content that keeps customers happy (and paying their monthly subscription fee) is a huge ongoing expense. Netflix and Amazon have both been spending huge sums here, too.
Netflix's cost of goods sold, a key earnings statement item that includes the cost of creating content, rose more than $1.6 billion year over year through the first nine months of 2022. Amazon's only profitable business line in the third quarter of 2022 was its cloud division with content costs likely contributing materially to the red ink elsewhere.
So Disney is hardly alone when it comes to the content issue. In fact, Netflix has come to the conclusion that it needs to introduce an advertising-supported product if it wants to remain competitive. That's after it worked for years to effectively destroy that very business model, which is a move that speaks volumes about the intensity of the competition in the streaming space. The long-term problem is that the content arms race seems unlikely to ever end.
Disney's iconic media properties certainly give it a strong foundation, but it isn't clear if that's enough to win the streaming wars. That's the risk that has investors worried, and the one that should probably keep conservative types on the sidelines. Until Disney can figure out how to make a profit in streaming, which it believes it can do, the risk here is material. Disney won't be the same company if content effectively becomes a loss leader for its other divisions.
Wait and watch
Disney is pointing to fiscal 2024 as the year in which it will make money in the streaming space. That's still a year away, and positive earnings aren't really enough -- the company needs to make substantial profits. Right now, given the intense competition and still fast-changing makeup of the streaming industry, it seems like investors are appropriately concerned.
The stock price drop might look like an attractive opportunity to buy Disney on the cheap, but that's only true if its new streaming business ends up being a solid success. That's a far-from-certain outcome. Conservative investors should probably stay on the sidelines for now.
