Charlie Munger Just Sent a Big Warning to Disney Shareholders

At first glance, Walt Disney (DIS 1.54%) stock seems to have everything going for it. After all, Disney is home to the best brands in entertainment, from Disney itself, to Pixar, Marvel, Star Wars, ESPN, and others. Not only that, but Disney has also been masterful at exploiting its top storytelling through other mediums, from theme parks and cruises to Broadway shows and toys.

Yet investors should keep in mind that while a company's past is important, its stock price is all about the future. And on that front, shareholders have a few things to worry about.

Don't believe me? Just ask Warren Buffett's longtime partner Charlie Munger... or even CEO Bob Iger himself.

"Tougher than it used to be"

At the recent Daily Journal annual meeting, the subject of Disney was brought up to Buffett's longtime partner, 99-year-old Charlie Munger. Needless to say, Munger wasn't that enthusiastic:

Practically every business that Disney has, has gotten tougher than it used to be. Again, welcome to human life. Think about Disney -- once owned the world. Lion King was running a long run in the Theater District of New York. They went from triumph to triumph, marching, marching, marching. All of a sudden, practically every front, it's more difficult. ... How would you like running the sports, ESPN, now at Disney compared to its heyday? It's going to be way harder for them.

In the chart below, you can easily see how Disney's operating profits were severely impaired by the pandemic, which eviscerated Disney's theme parks profits. Yet even more than a year after the economic reopening, Disney's operating profits still haven't fully recovered.

The reason is that Disney is still dealing with problems that emerged back in 2016, As you can also see, Disney's profits began to stagnate at that time -- a big disappointment compared with the prior decade of growth.

DIS EBIT (TTM) data by YCharts

The reason for the 2016 stagnation? The rise of internet streaming led to widespread cord-cutting, harming some of Disney's largest profit centers in the linear cable bundle. Meanwhile, the high-growth streaming division, including Disney+, Hulu, and ESPN+, is still realizing large losses as Disney competes in the global war for streaming subscribers. In short, Disney has had to spend more on content to attract and retain customers who are more price-sensitive and have more options than ever.

In fact, if not for the terrific recent performance of the theme parks division, Disney's operating income would be much worse. Comparing the relevant combined divisions for the fiscal year ended Sept. 30, 2016, versus fiscal 2022, you can see how the profitability of the media division has flipped places with parks, resorts, and consumer goods:

Data sources: Disney 2016 and 2022 annual reports.

Can Iger come to the rescue?

While many are enthusiastic about the return of CEO Bob Iger, who replaced outgoing CEO Bob Chapek in November, they shouldn't necessarily pop the champagne just yet.

Yes, Iger led Disney through a golden age in the 2000s and 2010s, acquiring Pixar, Marvel, and Lucasfilm, each of which turned out to be a home run, while riding profitable growth of ESPN. However, in the prior period, Iger still had the opportunity to scoop up the aforementioned amazing brands. Today, with Disney's size, there don't seem to be as many high-quality assets available for purchase that would move the needle. 

In fact, Iger may have reached a bit too far with his last acquisition. The massive $71.3 billion acquisition of Fox's entertainment assets in 2019 isn't exactly looking like the home run that Pixar, Marvel, and Lucasfilm were.

The Fox acquisition was made in order to bolster Disney's content engine for a more generalized entertainment streaming service such as Hulu, with some content making its way over to Disney+. However, on the recent conference call with analysts, Iger admitted the volume-based general entertainment strategy wasn't as profitable as he'd imagined:

[T]hings, in a very competitive world, have just simply gotten more expensive. And that's something that is already underway here. In addition, we're going to look at the volume of what we make. And with that in mind, we're going to be fairly aggressive at better curation when it comes to general entertainment. Because when you think about it, general entertainment is generally undifferentiated as opposed to our core franchises and our brands, which, because of their differentiation and their quality, have delivered higher returns for us over the years. So, we think we have an opportunity to, through more aggressive curation, to reduce some of our costs in the general entertainment side and, in general, in volume.

Basically, after spending over $71 billion on Fox for more generalized entertainment content, Iger is saying Disney will now pull back its spending on that very type of content.  

Image source: Getty Images.

The whole media business has gotten worse for investors

Buffett once said, "When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact."

While Iger is perhaps one of the greatest CEOs of the modern era, it's quite possible the media business will just have worse economics going forward than it did in the past. When everybody was forced to buy an expensive TV bundle -- with Disney's ESPN being the most expensive part of that -- that worked great for content producers like Disney.  Furthermore, expensive one-off DVDs were how film content was sold to consumers after their theatrical run. 

Yet with streaming, in which the customer can buy services a la carte for one month at a time -- with more recent movies available, too -- the economics just don't work as well.

How does Iger plan to fight back? In truth, the strategy doesn't seem that compelling:

[W]e will focus even more on our core brands and franchises, which have consistently delivered higher returns. We will aggressively curate our general entertainment content. We will reassess all markets we have launched in and also determine the right balance between global and local content. We'll adjust our pricing strategy, including a full examination of our promotional strategies. We will fine-tune our advertising initiatives on all streaming platforms. We will improve our marketing, better balancing platform and program marketing while also leveraging our legacy distribution platforms for marketing and programming.

In addition to these various steps, Disney also plans on cutting 7,000 jobs.

The takeaway? This strategy seems more about better execution and cutting costs. That's fine, and could improve the bottom line in the near term, but it's not really a growth strategy. Perhaps Disney can also raise prices and hope consumers continue to pay them, even while Disney spends less on content, but that remains to be seen.

Is there any good news to be had?

Even the best companies can be disrupted by big technological shifts, and the advent of streaming has done just that to the media business. Media companies used to generate high, recurring profits with good growth, largely thanks to the cable bundle. However, going forward, it looks like it's going to be much tougher for the large companies to grow -- even with a CEO as skilled as Iger at the helm. 

The good news is that Iger and his capable team realize the challenge ahead. Iger acknowledged:

[T]he impact of technology is basically creating a huge authority shift from the producer and the distributor to the consumer. And as that authority has shifted, it's made the traditional business more complicated, more ... challenging. ... The streaming business, which I believe is the future and has been growing, is not delivering basically the kind of profitability or bottom-line results that the linear business delivered for us over a few decades.

Disney's beloved brands and top-notch management should enable it to do relatively well compared to the rest of the media business. However, investors should also be prepared for profit growth to be harder to come by -- not only at Disney, but for TV media in general. 

In short, Disney seems like one of the best houses in a neighborhood that's fallen on tougher times.