Although The Walt Disney Company (NYSE:DIS) is better known for its host of parks and resorts and its blockbuster movie releases, the company is at its heart a media-driven company. Led by the most expensive cable channel, ESPN, the company derives most of its income from cable operations.
More recently, however, there have been signs all is not perfect in this division. On one hand, ESPN's subscribers have dropped amid increased cord-cutters and cord-slimmers looking to save money on their monthly bills, and increased content costs from sporting leagues that haven't seen to have gotten the message. As a result, ESPN announced that it would ax 200-300 jobs in hopes of cutting operational costs.
In response, many analysts are expecting Disney's Studio Entertainment business to lead growth going forward. Disney's been very good about bolstering its original business by acquisitions of Marvel, Pixar, and Star Wars to grow its top line. But I find it hard to see how this division will be able to reliably offset losses from Disney's Media Networks business.
A question of scale and margin
While the next Star Wars trilogy receives massive coverage, and rightfully so, Disney's Studio Entertainment business only provided 13% of its total operating income during the first three quarters of this fiscal year, finishing behind Media Networks and Parks and Resorts that contribute 54% and 21%, respectively. For a comparison between Disney's Media Networks division and Studio Entertainment, see the chart below (use the yellow bar at the bottom to see the newest reported quarters):
Perhaps the most striking difference is the aforementioned scale. Using last quarter as an example, Disney's Media Networks recorded nearly $5.8 billion in revenue versus $2 billion from its Studio Entertainment division -- and that was a great result for Disney, as its $2 billion haul is the highest result in the 2-year timeframe and is a 13% increase above last year's corresponding quarter's result.
However, the margin is perhaps the most important difference. Over the past two years, the operating-income margin for Disney's Media Networks division has averaged nearly 34%, whereas the Studio Entertainment averages 21.6. At those op-profit profiles, and for a simple comparison, Disney would have to pull in nearly $1.6 billion more in Studio revenues to offset the same amount of operating profit as $1 billion lost through its Media Networks business.
An entirely different business model
In addition, there's an entirely different business model between movies and television. As for the latter, there's a certain predictability in the monetization model as subscribers and ad-based revenue typically are more predictable. Of course, predicable doesn't make one business model different from another, but to compare the two as if they are interchangeable is a folly.
Movies are more risky in terms of modeling predictability, but the upside is particularly higher as one movie can turbo-charge returns (See: Frozen, FQ1 2014). Unlike cable TV, which is set up like a subscription model with dependable revenue, movies are a one-off affair in which one movie can make or break the quarter. The end result is more variability in terms of operating income. If you scan the difference between the two divisions, you will see at no time does Media Networks fall below an operating-income margin of 25% where Studio Entertainment fell into single digits during FQ4 2013 (Thanks, Lone Ranger).
To be fair, among pure-play companies movie studios typically are given more leeway in terms of valuations -- right now Lions Gate trades at a P/E ratio of 33, whereas CBS trades at 7 -- but Disney is treated as a conglomerate trading at 20 times earnings. If Disney's Media Networks starts to contract, as many are calling for the death of cable, I doubt margin expansion amid strong returns from its movie business will fully offset those losses on a valuation basis.