When it comes to multimedia entertainment, no one can hold a candle to The Walt Disney Company (DIS 1.54%). Its reach is unparalleled, from feature films to television stations, theme parks, consumer products, sports, and cable -- the House of Mouse has it all.
Yet, it was the company's foray into streaming video that generated the greatest degree of investor excitement. At the height of the fervor, Disney shares climbed to a new all-time high, fueled by big subscriber gains and even bigger profit prognostications. More recently, however, enthusiasm has waned as mounting losses sent fair-weather investors to the sidelines, pushing Disney stock down 13% on the day following its most recent quarterly results.
You have to break a few eggs to make an omelet, as the saying goes, and investors appear to be ignoring an important lesson about the growth trajectory of streaming video services. As a result, they could be underestimating Disney's biggest growth engine and the equally big profits that could come as a result.
Image source: Disney.
Viewers are streaming in
When Disney reported its fiscal 2022 fourth-quarter results, the state of the company's streaming business should have had investors dancing in the streets. Subscribers for Disney+ reached 164.2 million, up 39% year over year. Add in another 24.3 million for ESPN+ and 47.2 million for Hulu, and its total paying subscriber base climbed to nearly 236 million. For context, Netflix (NFLX 4.17%) closed out the quarter with 223 million -- giving Disney the streaming crown.
However, investors seemed to focus on operating losses for the segment, which ballooned to $1.68 billion for the quarter and $4 billion for the year. The results shouldn't have come as a surprise, as Disney has been investing heavily in programming for its streaming network, including recent programming like Willow, Andor, Disenchanted, and The Guardians of the Galaxy Holiday Special. Furthermore, the company reiterated its forecast for Disney+ to be profitable by 2024.
By focusing solely on the segment's losses, however, investors are repeating the same costly error made by Netflix investors years earlier.
If you build it, they will come
For years, Netflix investors bemoaned the company's lavish spending to build out its library of content and attract the number of subscribers necessary to achieve scale. This involved spending nearly every penny the company could generate, while simultaneously accumulating a mountain of debt. Yet management argued that the company would continually improve its cash burn each year, slowly moving toward being free-cash-flow-positive.
At its peak spending in 2019, Netflix was burning through more than $3 billion per year in free cash flow, while amassing nearly $15 billion in debt.
Fast-forward several years, and the picture is very different. Netflix reached the scale necessary to finance its content spending from current profits, and made good on its promise to generate positive free cash flow while also paying down its debt. So far in 2022, Netflix has generated roughly $1.3 billion in free cash flow and its debt has dipped below $14 billion, marking solid progress on both counts.
Netflix proved that if you build out a sufficient content library, the subscribers will come -- and profits will inevitably follow.
An important ad-dition
There's yet another reason investors may be underestimating Disney+. The company is scheduled to launch its ad-supported tier in the U.S. on Dec. 8. Disney plans to adjust its prices to coincide with the debut. Disney+ basic (with ads) will cost $7.99 per month, while Disney+ Premium (no ads) will climb from $7.99 per month to $10.99 per month. The company is borrowing the template that has been used successfully at Hulu for years.
Estimates suggest that that 23% of Disney+ subscribers will trade down to the lower priced, ad-supported tier when it launches, according to data analytics company Kantar Research (via Deadline Hollywood). That means 77% will willingly pay the new higher monthly fee. With roughly 46 million U.S. subscribers, Disney will book roughly $1.28 billion in additional subscriber revenue -- not including its take from advertising.
Furthermore, MoffettNathanson analyst Michael Nathanson has put pen to paper and estimates that Disney+ could generate $1.8 billion in ad revenue by 2025. While these are only estimates, it does suggest that Disney's strategy could net the company billions of dollars in additional revenue, hastening the day Disney+ reaches profitability.
The Iger factor
This all comes on the heels of news that made Disney investors jubilant. Former CEO Robert Iger has returned to the helm, with Bob Chapek stepping down. Iger was the driving force behind the acquisitions of Pixar, Marvel, and Lucasfilm, as well as the architect of much of Disney's success during his tenure. His return bodes well for the company's future.
Disney has an unrivaled collection of intellectual property, with plenty of new stories to tell. The company has only just begun to tap the massive potential of Disney+ and if the aforementioned figures are any indication, investors are clearly underestimating the potential of its streaming business.
