“I happen to believe, in businesses that are changing so fast, in a world that is rife with disruption, and the unknowns sometimes can outweigh the knowns, if you try to maintain the status quo, you’re likely to experience more failure than success. The worst thing a company can do in a dynamic marketplace, is adopt status quo as a strategy. Status quo is a losing strategy. And so if you’re going to stray from the status quo or abandon doing some things the way they have been or doing things the way the company has been doing them, there’s an element of risk right away. Anything that is new and different is risky; but necessary.”Bob Iger
The above is from Bob Iger’s Masterclass, where he shares his wisdom on business strategy and leadership, and is complemented well by his book in which he shares the lessons he’s learned from running Disney and ten principles for true leadership. Similar to investors, management teams also need to think about the future and allocate capital to projects they believe will achieve the highest return for the cost. What differs is that outside investors don’t have all the information management has, but can look across multiple businesses to seek the best expected return for the inherent risk and uncertainty. Investors must critically evaluate what management says and does, since it’s easy to be fooled and even harder to admit it. Most of the time, management is genuine and their vision creates value for stakeholders over the long-term. Sometimes not; incentives matter. For companies with the former, investors benefit from that value-creation when the market is doubtful, indicating a potential divergence between price and intrinsic value. However, easier said than done when it’s nearly impossible to pinpoint the market’s expectations. Moreover, even if you could, why are you more right than the wisdom of crowds?
For long-term investors, which includes myself, time-arbitrage can be a differentiator. Therefore it’s vital to evaluate the durability of a company’s competitive advantage, management’s capital allocation record, and the likely returns on available as well as potential reinvestments. The best investments are made in companies that sustain high returns on investment over a very long time, signifying an ever increasing intrinsic value. Once again, that’s easier said than done since the future is foggy and the past nor the present are predictive of what will happen. But the fogginess creates opportunities for those willing to think differently about the future and assess the risk/reward bet accordingly.
Below are my thoughts on Disney from 2017 when the focus began shifting from their melting legacy media business to a new direct-to-consumer (DTC) model, and refined in late 2018, when Bob Iger named the service Disney+. Although not exactly polished, I don’t want to edit and re-write history. It’s not an analysis of earnings or revenue (for those please see TSOH’s fantastic rundowns and listen to his podcast where he expertly talks Disney with Francisco Olivera) or a valuation exercise, but rather how I viewed the Disney+ opportunity, where I believed the market was wrong, and what I thought the service could become.
“Disney (long): The unraveling of the cable bundle is rapidly diminishing the economics of Disney’s Media Networks segment and has been a huge overhang on the stock. When the stock sold off precipitously in 2015, I thought it was an overreaction. Given the subsequent news and continued trends, I was probably wrong on that one. Nevertheless, I still believe Disney is well positioned to weather the cord-cutting headwinds with its other, increasingly lucrative business segments and their announcement to launch a Disney-branded DTC service in 2019 after the recent acquisition of a majority stake in BAMtech. I find a Netflix-like subscription service an extremely exciting prospect for the company over the long-term, and I believe the market is under appreciating its potential with the stock still around 2015 levels. Disney’s flywheel is still intact and may even accelerate.
In my opinion, the way people consume media is a much larger factor in the rise of streaming (SVOD) than the price of the cable bundle. The Internet upended the traditional media industry and will likely accelerate. Consumers now have the ability to choose what to watch, whenever they want, rather than needing to tune in to broadcast TV at a certain time. This is clearly favorable for evergreen content. On the other hand, sports (ESPN) should be well insulated as they are preferred to watch live. I believe the cable companies also see the writing on the wall, but the innovator’s dilemma is difficult for a reason. Disney self-disruption will be painstaking, but creates new opportunities.
I agree with the consensus that Netflix will continue to be the juggernaut in the space. I was wrong to be bearish on Netflix due to their increasingly negative cash flows and elevated valuation. The massive spending on content has actually been successful in driving continued subscriber growth and has solidified their prominence in the mind of the consumer. Despite the ease of unsubscribing, I believe FOMO (not having a subscription to watch the new content) likely prevents elevated churn. Clearly, Netflix is the “Kleenex” of streaming, which is fully reflected in its market capitalization. Disney is a much better proposition.
Regarding the “Streaming Wars,” I disagree with the entire premise. I don’t view the landscape as head to head match ups with a winner or a loser; rather I see SVOD services each presenting their unique value proposition to consumers, with different content at different prices. I understand the notion that some consumers may be forced to choose between services if they are budget constrained, but SVOD services are cheap compared to the cable bundle. Shouldn’t competition diminish pricing power? Traditionally yes, but I believe unlikely in the streaming space since content is a unique differentiator and global scale provides a competitive advantage. Even if I’m wrong and competition does limit price increases, that should play to Disney’s favor, rather than Netflix’s.
Why? Because Disney can leverage subscriber eyeballs to a much greater extent than Netflix can. Netflix is a pure-play subscription service, while Disney has multiple ways to monetize subscribers. Therefore, in my opinion, Disney’s playbook shouldn’t be to emulate Netflix; it should be to emulate Amazon. There are few, if any, CEOs better than Jeff Bezos; his vision and capital allocation are top-notch. But Iger is right up there. Similar to how Bezos recognized the transformative nature of the Internet, and later the potential of AWS, Iger recognized the necessity of owning valuable content, and later the future of media consumption. And Disney’s future depends on it.
It’s well known that Disney is horizontally integrated, monetizing its stories and intellectual property (IP) across multiple business segments; Disney Studios/Animation creates characters featured in films, TV shows, comics, and books that come to life in their parks where people have wonderful experiences and go home with memorabilia, and so on. That has powered the company since 1956 and has flourished under Iger’s tenure, specifically the acquisitions of Pixar, Marvel, and Lucas Films. The return on those acquisitions has been extremely high; a Dow company where goodwill is actually understated! Clearly, Iger’s capital allocation has been supurb, and I am relieved he extended his tenure. I think he wants, and feels obligated, to remain CEO until Disney+ is brought to market – his final, and hardest challenge.
I believe Disney+ is not just another Netflix peer; Disney+ is Disney Prime – a subscription membership to the company, and future hub of the Disney ecosystem. With Disney+, Disney is becoming more vertically integrated. Disney+ will allow Disney to have a vastly more intimate relationship with its customers and fervent fan base through direct connection and data collection. Disney can circumvent 3rd party intermediation, which has the potential to dilute the brand experience, customer relationship, and profit share, and instead reach its consumers directly, in their family rooms.
Bezos famously quipped, “When we win a Golden Globe, it helps us sell more shoes.” When Disney adds a new Disney+ subscriber, it will help them better monetize their content across their entire ecosystem. Prime subscribers buy more from Amazon, Disney+ subscribers will buy more from Disney. It’s undeniable that Disney has some of the best IP, stories, and content creators in the industry. Disney’s blockbuster hits already drive massive revenue and profits; Disney+ will be a fantastic conduit for bringing the excellent content to consumers and improve engagement.
Disney can consistently “sell” its brand by promoting its own products and experiences. More time spent in the ecosystem means more eyeballs for the company and more opportunities for monetization. Disney+ will strengthen the brand-consumer connection, and potentially make it more personalized. Special events, press releases, features, theme-park tickets, and lotteries or giveaways should be prominently highlighted for Disney+ subscribers to view and potentially participate in. Digital advertising is already targeted, but what if the only “ads” on the platform were for the same company. The era of anonymous viewership is gone. But until now, Disney hasn’t been able to know exactly who watches what. Those insights may also drive content creation, as it reportedly has at Netflix.
Like Prime, Disney+ members could also receive discounts for hotels, movies, theme parks, merchandise, etc. – the real moneymakers. And Disney will have credit cards on file, making purchases easy. One click and character merchandise from the movie or show you just finished watching could arrive at your door, 30% off for being one of the first 1 thousand viewers. Framing influences behavior. Catch consumers in a good mood after an episode, show, or season and they’re much more likely to purchase.
Disney already has unrivaled content, but what if blockbuster films were released in theaters and on the platform. Or what if subscribers could gain early or exclusive access. Disney+ could even have pricing tiers to provide different levels of service or content. Instituting a variable pricing strategy could enable Disney super-fans to pay for things that normal fans don’t see value in. I wouldn’t go as far as predicting there will be two separate theme park lines for Disney+ subscribers, but it’s not inconceivable.
Prime was a huge risk for Amazon, and wasn’t predestined to succeed as spectacularly as it has. Disney+ is as well. Nobody can know how many people will sign up, but in my opinion, it will likely rival Netflix in a few years. Netflix had to spend a lot of money creating the market and acquiring customers; Disney just has to say, “We now have a streaming service” and show an amazing montage of content. Amazon needed to incentivize customers with monetary and time savings; Disney is already a beloved brand with beloved content. Netflix needed to spend a tremendous amount on content. Disney already has a massive archive to draw from and already has more content in the works. Content and scale are crucial, and somewhat intertwined, in a DTC world. Disney has the former and can achieve the latter.
This wholesale shift in company direction is “risky, but necessary.” The transition will be bumpy and expensive.
- How costly will the cannibalization be (ie. buying back content rights, forgone revenue, etc.)?
- How costly will exclusive Disney+ content be and will it generate buzz and adequate returns?
- Will the content be attractive for a wide-enough audience, across countries and generations?
- How will consumers respond to the pricing and incentives?
- How high will churn be or will customers choose yearly subscriptions?
Transformations are possible. If history is any guide, Disney is well positioned to make this one. But it will take time, patience, and a lot of mental and financial capital. It requires fundamentally uprooting their existing media business model, and pivoting to making Disney+ a successful DTC offering and the center of the Disney Universe. Disney+ will further solidify brand loyalty and brand affinity, enabling Disney to more effectively monetize its creative storytelling and unlock value across the entire ecosystem. To bet against Disney+ is to bet against Disney’s brand and content, and consumers’ desire to access content through streaming. I don’t think that is a good bet.”
And back to the present: Quite a lot has happened since writing those thoughts. Iger has stepped down as CEO, but remains Chairman of the Board. Disney had a blockbuster (pun intended) year in 2019, yet 2020 has been an unlucky disaster, as it has for the much of the economy and business world. The only bright spot has been Disney+’s success, gaining almost 75 million subscribers already. The growth will likely slow as yearly subscriptions are up for renewal, but Disney+ is launching in more countries globally. Looking back, I was right to be bullish, although the success is undoubtedly impacted by the pandemic, low price point, and sign-up incentives. Additionally, Disney+ has become the company’s main focus, exemplified in their strategic reorganization, has quality exclusive content, and has featured movies directly on the platform (although the Mulan experiment was not met with much enthusiasm).
But I was wrong about a lot of other things: Disney+ has not personalized the experience, promoted events, merchandise, or ticket sales (likely impossible though due to the forced closures), offered discounts or exclusive access, or explored different pricing tiers. I still believe these could unlock massive value. Further, the price point is lower than I expected and is extremely generous. It’s clear Disney is going for the land and expand model. Once on board, it’s hard to get off, especially for families with young children. The price will likely rise over time since high quality companies like Disney command pricing power; just look at Disneyland ticket prices as any indication. However, the price will be just one factor in ARPU if management focuses on the holistic picture.
All that being said, Disney+ went from a cheap call option to the life vest keeping Disney afloat. The risk/reward has shifted. Recent optimism around an impending vaccine provides some light at the end of the tunnel for theaters, parks, and resorts, and general economic activity. Now that Disney has access to more data and an even stronger connection with millions of consumers globally, the long-term future is still bright.