Walt Disney (DIS 0.81%) is one of the most successful entertainment companies in the world. And with this recognition, its stock is usually a favorite among the investment community.
But the business isn't without its own set of issues, primarily as it relates to the direct-to-consumer (DTC) segment, which includes all of the company's streaming services. It saw operating losses widen to $4 billion in fiscal 2022 (ended Oct. 1), from $1.7 billion in the previous year.
Shareholders need to start paying closer attention to what's really going on under the hood, especially with the stock down 43% over the past two years. With that being said, here's the worst mistake that Disney investors can make.
The path to profitability
Disney's current and former CEO, Bob Iger, was at the helm when the business launched its highly anticipated streaming service, Disney+, in November 2019. The offering found immediate success and now counts an impressive 164.2 million subscribers. This rivals the dominant player in the space, Netflix (NFLX 0.15%), which had 223.1 million members as of Sept. 30.
At the time that Disney+ was introduced, Iger mentioned the service would achieve profitability by fiscal 2024, a target his replacement and predecessor, Bob Chapek, reiterated during the latest earnings call on Nov. 8. Chapek thinks that losses for the segment have peaked and will decrease going forward.
I struggle to believe that DTC positive net income is within reach. In fact, I don't think it'll happen within the stated time frame. So, the worst mistake shareholders can make is to blindly assume Disney+ will achieve profitability by fiscal 2024, which the leadership team seems to be suggesting.
While Disney+'s user growth has been nothing short of spectacular, its average revenue per user (ARPU) has been disappointing. In the U.S. and Canada, for example, ARPU fell 10% year over year in fiscal 2022 to $6.10 on a monthly basis. Disney+ prices in the U.S. did rise from $7.99 a month to $10.99, a move that should boost ARPU. But this could also lead to a meaningful bump in member churn.
NYSE: DIS
Key Data Points
To be fair, Disney owns a lot of incredibly valuable intellectual property, with the Marvel Cinematic Universe, Pixar, and Lucasfilm. But its pricing power is yet to be proven, especially given how fierce the streaming landscape has become.
What's more, management highlighted how Disney+ subscriber growth will likely slow down. "We currently expect total company fiscal 2023 revenue and segment operating income to both grow at a high single digit percentage rate versus fiscal 2022," CFO Christine McCarthy said on the fourth-quarter 2022 earnings call.
This tempered outlook incorporates the business' launch last month of a cheaper, ad-supported Disney+ tier. A slowdown in revenue growth from last fiscal year doesn't really exude confidence in the streaming service's growth potential.
In addition to lowering Disney+ revenue estimates, the other factor that will make it more difficult to reach profitability is the trend with content costs. Disney's leadership team mentioned that programming and production costs will increase.
Taking a closer look at Netflix's past is why I'm skeptical of Disney+'s profit target. Netflix has historically been successful at implementing membership price hikes, resulting in overall revenue rising faster than annual cash outlays on content. This meant improved unit economics and rapidly expanding margins. Netflix's operating margin went from 4.3% in 2016 to 20.9% in 2021.
The caveat, however, is that Netflix was able to do this when competition in the streaming space was far less cutthroat and it was the clear leader in the industry. How does Disney+ expect to raise prices, while hoping to attract new subscribers and boost revenue, all while keeping costs under control, especially in the current streaming environment? It seems like a tall task to achieve in two years' time.
The House of Mouse is certainly facing some challenges right now, particularly in its direct-to-consumer segment. More specifically, its key growth engine, Disney+, might disappoint shareholders when it comes to generating positive net income within the next couple of years, a goal management remains stubborn on. Therefore, it's probably best to lower expectations.
