Disney (DIS -0.04%) is a complex business, ranging from broadcast and cable entertainment to streaming, sports, and theme parks and experiences.
Part of that complexity is figuring out the right way to structure the business in order for it to perform as best as possible and so that each division can be held accountable by management and investors. Disney announced a strategic restructuring back in February, its second in just a few years, designed to "restore accountability to the creative businesses."
The entertainment giant just took a significant step down that path, restating the results of the business according to its three new segments: entertainment, sports, and experiences.
The big financial reveal came from breaking out ESPN as a stand-alone business segment for the first time. While that move deserves some discussion, there's another set of numbers in the release that could be even more meaningful for Disney. Let's take a look at ESPN first.
Image source: Disney.
It's showtime for ESPN
Disney's sports media empire has long been seen as one of its biggest cash cows, and the new report confirmed that ESPN is a financial powerhouse, but it also showed that the business is in decline.
That didn't come as a surprise as the Pay-TV ecosystem has been shrinking for more than a decade now, and ESPN is still highly dependent on cable subscribers, though it plans to launch a streaming version of its flagship service by 2025.
For the first three quarters of Disney's current fiscal year, ESPN brought in $13.2 billion in revenue and $1.5 billion in segment operating income, which equals an operating margin of 11.2%.
By comparison, for the full fiscal 2022, ESPN generated $2.7 billion in operating income on $17.3 billion in revenue for an operating margin of 15.7%. In fiscal 2021, it also brought in $2.7 billion on $16 billion in revenue, giving it an operating margin of 16.9%.
Disney did not discuss the results at ESPN this year in the release, but it's clear that profitability has taken a significant hit, with profits down 20% through the first three quarters even as revenue has mostly held steady. That could be because of higher fees for sports rights, declining subscriptions, or weakness in the ad market.
It also explains why the company issued a wave of layoffs early this year, including well-known on-air talent, and why CEO Bob Iger has said that ESPN is looking for a strategic partner to help run the sports media brand.
The good news for Disney stock investors
By breaking out the sports segment as a stand-alone, the restated results also shed more light on Disney's core entertainment division.
That business, which includes everything from ABC to Disney+, Hulu, and Disney's theatrical releases, reported revenue of $31.1 billion through the first three quarters of fiscal 2023, but operating income of just $1.2 billion, or a margin of 3.8%. The narrow margin was largely because of weakness in streaming, where it's lost more than $2 billion so far this year.
The 3.8% operating margin is by far the slimmest margin in any of Disney's three new operating segments, and it shows how much the company has struggled with the decline in linear networks and the transition to streaming.
The good news for investors is that Disney seems to be at an inflection point, and there's a ton of upside for the entertainment business. Not too long ago, Disney's entertainment business was a profit machine. In fiscal 2019, the last year before it launched Disney+, its media networks division generated $7.5 billion in operating income on $24.8 billion in revenue, or a 30% operating margin. Disney's entertainment assets have only grown since then, as the combined revenue from entertainment and sports above shows. Additionally, Netflix has proven that a streaming-only entertainment business can be highly profitable as it's on track for an operating margin of 20% and targeting a 22% to 23% margin next year.
Disney's entertainment assets include the worlds of Marvel, Star Wars, Pixar, and Disney classics dating back to Mickey Mouse, giving it what's likely Hollywood's most valuable trove of intellectual property. Given that, the business clearly has the potential to do much better than a 4% operating margin.
The company already seems to be making progress in that direction as it expects the streaming business to turn profitable by the end of fiscal 2024, and that could happen even sooner due to its recent price hike, the trajectory of the business, and the cost-saving impact of the Hollywood strikes.
It's a mistake to think that Disney's entertainment business can't be significantly more profitable than it is today. Though it could take years for the company to unlock that value, with the stock trading near nine-year lows, the stock is likely to move higher in response to visible progress.
We'll learn more when Disney releases its fourth-quarter earnings report on Nov. 8, but investors who buy the stock now can capture a great value on a beaten-down entertainment stock that's well positioned for a comeback.
