Disney (DIS -0.04%) shareholders have experienced a nasty downturn over the past couple of years that has led to doubts about the company's long-term prospects. In fact, this February I warned Disney's stock was at risk due to several company-specific and industrywide challenges, noting I had greatly reduced my personal stake to a negligible amount.
However, the stock has fallen another 20% since then. And CEO Bob Iger, who returned to the CEO role last November, has begun implementing some strategic shifts that should improve results.
Moreover, the standoff between Disney and cable company Charter Communications (CHTR -1.73%) was just resolved, removing an overhang to both companies. Does the deal, new turnaround progress, and a lower stock price now make Disney a buy?
Disney and Charter avoid a lose-lose situation
Charter's Spectrum cable subscribers have likely noticed the blackout in Disney's channels, including ESPN, since late August. Both companies had a right to negotiate hard. ESPN's live sports is one of the main reasons people still subscribe to a cable bundle, and since Disney bought Fox's entertainment assets back in 2019, it has more control over overall content.
However, Disney also couldn't afford a blackout for long. Charter has a massive footprint in the legacy-cable bundle, which is declining but still an important source of profits for Disney. Moreover, Disney pays long-term fixed prices for sports rights. So if the House of Mouse can't monetize those rights to their fullest extent, that would result in actual losses for Disney. Overall, it's estimated Charter accounted for about 20% of ESPN's linear subscriber base.
Fortunately, the matter was resolved on Monday with a solution that gives a bit to both sides in the age of streaming. Charter has wanted more optionality in offering slimmed-down packages that include streaming channels. The deal appears to do that, with Charter now being able to offer Disney+ for its slimmer Spectrum TV Select package at no additional cost, while ESPN+ will be available in the higher-priced Spectrum TV Select Plus plans. The direct-to consumer ESPN will also be available to Spectrum's Select Plus when it comes out. In addition, Spectrum's linear-cable package will be able to cut some lesser-watched channels in Disney's portfolio, including Baby TV, FXX, Nat Geo Wild, and Freeform, among others.
In exchange, it appears as though Charter will pay Disney's proposed rate increase per subscription in exchange for more flexibility in offering Disney's content for different video-package tiers.
Image source: Getty Images.
What this means for Disney
While Disney's Parks, Experiences, and Products segment has been a steady source of growth and profits, the company's turnaround will depend on how profitably it can make the handoff from highly profitable linear cable to streaming.
The new deal with Charter is one aspect of how Iger is negotiating this tricky transition. Other areas are multifaceted, which Iger addressed in the recent conference call with analysts. But the gist is clear. Instead of Disney relentlessly pursuing subscribers, as it has in the recent past, it will now be raising prices while focusing its spending on content within its most profitable brands.
For streaming, Iger noted that the company grew subscribers really fast over the past few years, "really before we even understood what our pricing strategy should be or could be." So going forward, Disney will increase prices on the company's Disney+, Hulu, and ESPN streaming products, which will either boost profits or cause people to trade down to the ad-supported tiers.
But that's OK, as the advertising market for streaming TV is now picking up in a big way, with the ability to more precisely target consumers. "The advertising marketplace for streaming is picking up. It's more healthy than the advertising marketplace for linear television," Iger remarked. In the third quarter, Iger also noted 40% of new Disney+ gross additions opted for ad-supported tiers, with 3.3 million out of the company's 105.7 million Disney+ subscribers now in the ad-supported tier.
The biggest risk to streaming success: ESPN
The biggest risk to Disney's turnaround could be ESPN. Obviously, ESPN has highly sought-after sports content, which had traditionally enabled Disney to force the expensive channel into all cable packages. That meant even non-sports households were forced to buy the expensive channel.
The current version of ESPN+ offers some supplementary content but not all the content of the main cable-based channel. But even Iger admits the full ESPN direct-to-consumer channel is a matter of "if, not when." Whenever ESPN becomes disaggregated from the bundle, Disney will have to make up for the inevitable loss of some households that don't watch sports but still subscribe to cable.
The good news is that since cord-cutting is already happening, Disney has felt some of that headwind already. And if ESPN does go direct-to-consumer, an ad-supported streaming service will likely command high advertising rates. Of note, even though Disney's linear cable channels saw an overall advertising-revenue decline last quarter, linear ESPN advertising still grew 4%. That bodes well for any advertising revenue ESPN will command in an ad-supported streaming format and means Disney could also price an ad-free ESPN channel at a very high price. Iger also noted Disney was exploring more partnerships to distribute ESPN outside of cable along with other technology and content partnerships as the channel adapts to the streaming world.
"There's obviously complexity as it relates to decoupling the linear nets from ESPN, but nothing that we feel we can't contend with if we were to ultimately create strategic realignment," Iger noted.
Disney may be interesting at these levels
Disney shares now trade at 16 times fiscal 2024 earnings estimates, which does assume some improvement from here but would still leave earnings a whopping 45% below Disney's peak 2018 earnings of $8.36.
The thing is, streaming is unlikely to yield the profitability the linear bundle used to have five years ago. But Disney should also be able to improve streaming profitability in fits and starts over the next few years based on the strength of its brands and the targeting potential of digital ads.
That means the stock may well find a floor at these levels. But for those believing Disney could get back to its all-time highs, that is likely a long, long ways off.
