Walt Disney (NYSE:DIS) has finally had the last laugh after enduring months of intense flak following the spectacular flop of The Lone Ranger, a big-budget movie that had earlier been slated to become a blockbuster. Walt Disney returned stellar fourth-quarter results, much to the consternation of its numerous critics. The global entertainment giant was criticized for its insistence on creating big-budget films that quite often turn out to be box office flops. The Lone Ranger's dismal failure looked particularly bad when compared to Comcast's (NASDAQ:CMCSA) high-flying Despicable Me 2, since the two hit theaters around the same time.
The Lone Ranger had been modeled as a glorified sequel to the wildly successful Pirates of the Caribbean. Walt Disney sunk a good $220 million to create it, more than three times the $72 million used by Comcast on Despicable Me. Despicable Me grossed $142.1 million in its first five days of screening, easily becoming Comcast's best five-day gross ever.In sharp contrast, The Lone Ranger could only manage a measly $48.94 million in its first five days. As late as mid-August, The Lone Ranger had only managed to pull in just $86 million, and it doesn't take a financial genius to figure out that its chances of ever breaking even with its $220 million production budget are slim-to-none.
After the dismal performance of The Lone Ranger, Walt Disney still went ahead to post record fourth-quarter results, with the firm recording sizable gains for both its top line and bottom line. Diluted EPS jumped 13% from $0.68 in last year's comparable quarter to $0.77. Yearly revenues improved 7% to hit a record $45 billion.
Blockbuster strategy suited for Walt Disney
In her book Blockbuster, Anita Elberse, Harvard Business School's entertainment industry expert, succinctly explains why big bets in the entertainment industry have continued to trounce their smaller budget counterparts. Elberse recently issued a keynote address at the FutureM conference where she compared two leading entertainment companies that have adopted diametrically opposed strategies: NBC, with its spending cuts across the board vs. Warner Bros' risk-embracing strategy, characterized by relying on a few huge bets each year.
The results have been startling: NBC has fallen from number one to the fourth position, and its profits have nosedived. Warner Bros, on the other hand, has continued to increase its revenues impressively. The notion that smaller bets are safer is really nothing but a myth that seems to fly in the face of reality.
Uneven track record
The Lone Ranger was not Walt Disney's only large box office flop. Disney Land has a history of struggling with unproven commodities. The firm has enjoyed ringing success with its past films that feature Marvel characters, mainly because these fictional characters are well known and hugely popular with both young and middle-aged audiences. This holds true for the firm's Star War franchise as well. Walt Disney is exceptionally good at making big bucks and creating great sequel potential from its movies that use well-known characters. But the company struggles badly with completely new off-the-block characters such as John Cater, and, of course, The Lone Ranger.
Despite this trend, Walt Disney will probably continue to stick to its big-bet strategy since it helps the company to add new storylines to Disney Land theme parks and move the company's merchandising needle. A behemoth like Walt Disney needs big-bets to drive its revenues. Think of the firm's past movies such as Frankenweenie. The movie cost Walt Disney just $40 million to make, but in turn brought in a mere $67 million. The margins are alright, but the absolute numbers are too low to move the needle for Walt Disney.
Perhaps investors should worry more about how Comcast, Walt Disney's major rival, is able to eke out a lot more mileage from the dollars it invests in its movies. Comcast spent a puny $3 million to make The Purge but got $74 million from it, close to 25 times as much. The firm used $35 million on Identity Theft but received $174 million in revenues from the picture. Walt Disney's 26.2% gross margins are worse than its peer median of 45.2%, but its 21.5% pre-tax margins are better than its peer median of 17.8%. This suggests that Walt Disney has relatively tighter controls on operating costs.
In this age of video streaming, firms such as Netflix (NASDAQ:NFLX) and Hulu offer a delivery channel for Walt Disney's movies. Walt Disney made a deal with Netflix in December 2012 that will enable the firm to bypass traditional premium channels like HBO that control the delivery of movies to subscribers. The deal enabled Netflix to stream Walt Disney's first-run movies to its subscribers. Netflix will start streaming Disney's movies in 2016.
Although Netflix reported that its global subscriber base had hit 40 million subscribers during its blowout third-quarter earnings call, the firm's growing cost of creating original content remains a point of concern. Bank of America Merrill Lynch analysts Justin Post, Nate Schindler, and Jason Mitchell recently warned that Netflix's shares were way overvalued, and the firm would have to grow its global subscriber base to at least 140 million to justify a $400 share price.
Outerwall (NASDAQ:OUTR) operates in the stodgy business of DVD rentals. The firm has proved it is not the falling knife it has been widely labeled as by its detractors. Outerwall has also been defying growing concerns about the dying DVD business by continuing to increase its revenues impressively. The firm increased its revenues by 30% in the two years that Netflix has been streaming video. Its net income shot up by 53% in a similar timespan.
There is now growing evidence that DVD and Blu-Ray technologies will be with us longer than most initially thought. There is a sizable class of consumers who still prefer renting Redbox DVDs. Redbox recently said that about 20% to 30% of its regular customers have subscribed to a streaming service such as Netflix or Hulu.
Walt Disney was unfairly criticized after the failure of The Lone Ranger. But the truth of the matter is that the firm needs big budget pictures to move its merchandising needle. Admittedly, some of these will turn out to be duds. But overall, the revenue generated by its big hits will more than wipe out the losses by box office flops.
Fool contributor Joseph Gacinga has no position in any stocks mentioned. The Motley Fool recommends Netflix and Walt Disney. The Motley Fool owns shares of Netflix and Walt Disney. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.