Disney's Comeback Is Gaining Momentum

A year ago, Disney’s stock was almost toxic to investors. The company was bleeding money in streaming, cable was losing subscribers, and debt was becoming a huge problem as interest rates rose.

Since then, Disney has reported a sharp rise in free cash flow and streaming is now profitable (barely). Cable is still dying, but it’s still generating cash flow. Shares are only up 14.8% since the spotlight, which lags the market, but the business has turned a sharp corner and the growth strategy is playing out nicely.

Then there’s the recent hit Inside Out 2, which has a chance to be the highest-grossing movie of 2024.

Despite the media narrative that Disney’s studios are out of touch and its streaming service is getting crushed by Netflix, Disney is hitting on all cylinders in the second Bob Iger era.

The Foundation — Parks and Experiences

Any update on Disney needs to start with parks and experiences. This is the company’s differentiator from Netflix, YouTube, and every other streaming TV company. No one can match Disney’s experiences operations, which generated $9.6 billion in operating income over the past year — more than the $7.9 billion in operating income that Netflix generated as a company.

We can quibble about how quickly cable is dying or if streaming is growing fast enough or the content Disney is making each year, the parks are a money-making machine and that’s the foundation of the business and any investment in Disney.

Old Media — Dying But Profitable

Yes, linear TV is dying. But it’s still spitting off a lot of cash. Below is a look at linear network revenue and operating income reported in May 2024. Despite losing steam, the segment is making nearly $1 billion per quarter in operating income so far this fiscal year.

Add in sports — aka ESPN — and you get about a $7 billion annual operating profit run rate for legacy media.

This is the financial bridge to the streaming future. And streaming has a brighter future than you might think.

The Smiling Curve — Disney+ and the Disney Bundle

The biggest upside for Disney stock has always been streaming.

I’ve explained Disney’s strategy using the smiling curve. On the internet, winners tend to be companies that reach scale (top right of the smiling curve) or serve small, niche audiences (top left). Most internet markets look like this when they mature and have a single winner take all of the profits, like social media (Facebook/Instagram), search (Google), streaming music (Spotify), and smartphones (Apple).

In streaming, we will likely have more than one winner due to regulatory pressure and the dynamics in legacy media content. Netflix is one winner and I think Disney is the only company with the scale (118M Disney+ Core subs) and pricing power to compete with Netflix. Mapping out subscriber numbers and revenue per subscriber, I think the industry looks like this:

The limit for Disney+ today is the family and propriety nature of its content which doesn’t appeal to everyone. To appeal to more consumers, Disney needs general entertainment and sports to play a bigger role in its content. That’s why bundling is the future.

Over the past year, we’ve seen the company lay out its bundling optionality.

• Disney-Only Bundle: A package of Disney+, Hulu, and ESPN with pricing to make taking the full package a compelling option.

• Cable Bundle: Add streaming to traditional cable subscriptions, adding incremental users and reducing churn at a cost of lower revenue per user.

• Streaming Bundle: Disney announced a bundle with Warner Bros. Discovery’s Max service earlier this year. And Disney was the power player in that partnership, handling distribution, and potentially advertising.

• New Cable Bundle: The old-school triple play was cable TV, cable broadband, and cable phone services bundled together. The modern bundle is the wireless smartphone, wired/wireless broadband, and streaming services. Verizon’s MyHome is an example of this, bundling with Disney’s three-service ad-supported tier for $10 per month. I think we will see this strategy proliferate.

This is where Disney has an infrastructure advantage over Netflix. We have seen Netflix grow essentially on its own with no bundles or distribution partners but that leaves it without legacy media partners to turn to today. Disney can bundle its services with traditional competitors, partners, and distributors to cast a wider subscriber net and reduce churn along the way.

This also leans into Disney’s streaming advertising business that it’s swallowing from Hulu. It was Hulu that was early to streaming ads while Netflix was playing catch-up. Disney is trying to lean into that advantage which only works if there’s a large subscriber base of content being watched.

If the bundles work to grow the user base and keep them engaged, advertising is what will pay the bills.

The Competition — Disney’s Legacy Competitors Stink

The other thing I want to note is the inept nature of most streaming competitors. Netflix is a beast, but behind Disney, you have Peacock, Max, and Paramount+ in some order. Max just lost the NBA. Paramount is in chaos. And Peacock is showing millions of viewers how confusing its app is with the upcoming Olympics.

Then there are smaller rivals like Bally’s, who has the rights to my local sports teams and has the single worst streaming app I’ve ever seen.

Disney’s streaming experience isn’t perfect, but it looks incredible next to the competition.

And if the smiling curve holds in streaming — as I think it will — Disney has a chance to be a go-to global streaming company. Disney’s direct-to-consumer streaming business (which doesn’t include ESPN) is already at a $22.4 billion run rate, within shouting distance of Netflix’s $37.5 billion revenue rate.

As the smiling curve flywheel kicks in, Disney could sharply increase revenue and I think it’s possible Disney will make $100 billion in annual streaming revenue by 2034. If it can also go from barely breaking even to approaching Netflix’s 22.5% operating margin, this will be a cash machine.

That would be truly transformative for Disney and the vision is there. Investors just have to wait for the strategy to play out.

Disclaimer: Asymmetric Investing provides analysis and research but DOES NOT provide individual financial advice. Travis Hoium has a long position in all stocks mentioned. All content is for informational purposes only. Asymmetric Investing is not a registered investment, legal, or tax advisor or a broker/dealer. Trading any asset involves risk and could result in significant capital losses. Please, do your own research before acquiring stocks.