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Stock in focus: Disney

Disney- where dreams come true.

I believe Disney is a familiar name to almost everyone of us, probably more so to those who are already parents and reliving their second childhood. Most of us grew up with various Disney characters like Mickey Mouse and Donald Duck, and some even continued to adore these characters in their adult life. In an earlier article on economic moat which I wrote about, Disney or Pixar is a regular occurrence in the Prophet Relevance Index. As discussed in the article, companies with an economic moat tend to be able to consistently do well in the long run as they are able to steadily defend their huge profit margins. In this article, we will do a deep dive into Disney's business.

Disney is a hugely diversified mass media and entertainment conglomerate. For the uninitiated, Pixar, Marvel Studios, Lucasfilm, 20th Century Studios, and even ESPN belong to Disney. You could be watching Frozen with your kid in the morning, chasing an episode of Agents of S.H.I.E.L.D in the afternoon and catching the NBA finals in the night without consciously knowing that you are consuming Disney products for the entire day. Disney's business could be broken down into four major segments. They are namely Media Networks, Direct-to-Consumer and International, Studio Entertainment and Parks, Experiences and Products. Out of these four, Media Networks is the largest revenue driver and also the segment which brings in the most operating income.

Here is a brief introduction of the various business segments.

Media Networks consist of the various cable networks such as National Geographic, Disney and ESPN, various broadcasting television networks/stations and also National Geographic magazines. Direct-to-Consumer and International comprises various streaming services such as Disney+, Hulu and ESPN+. Studio Entertainment represents the motion picture production and distribution, and comprises various studios such as Lucasfilm, Marvel, Pixar and Twentieth Century Fox. Lastly, Parks, Experiences and Products refer to the various Disney theme parks which are opened in different locations such as Florida, Paris and Hong Kong etc.

*Please take note that Disney has just announced restructuring of their business to focus more on its streaming business. Hence, the segments highlighted above will see some major changes. More details about these changes will be announced on their Investor Day on 10 December*

The beautiful part about Disney's business is that there is strong synergy among these various segments. And there is also exactly why they could build a very strong economic moat around its business. A huge popular production released by the Studio Entertainment is able to be distributed to a wide audience via its Media Networks and various streaming services in the Direct-to-Consumer and International segment. Finally, the audience is able to relieve this experience again via interactions with these characters or park rides in various different Disney theme parks with a purchase of the merchandise or products of the characters of the production at the end of day. Many of us probably went through this process numerous times without realising that we are providing huge lifetime value to Disney's business. Such strong synergy in various different Disney's business segments mean that they are capable of creating multiple potential revenue streams from a single production and also ensuring high profit margins in some parts of the business (eg. merchandise sales). This is certainly a huge economic moat in the entertainment business which I believe none could replicate now or even in the future.

However, even a company with such a strong economic moat faces strong challenges in this current pandemic. The various lockdowns happening in various countries and states dealt a huge blow to the Studio Entertainment and Parks, Experiences and Products segments of Disney's business. Revenue from these two segments fell 42% as they now merely account for ~20% of the overall revenue as compared to almost half of the overall revenue a year ago. With the possibility of people having less disposable income as the unemployment rate climbs in the near future, the recovery of the Parks, Experiences and Products segment will be a long and slow one.

While Media Networks remains to be the primary breadwinner amid this current pandemic and accounts for a large portion of its operating income, revenue attributed to it actually drops by 2% as compared to the same quarter last year. The silver lining for Disney in this pandemic is that it now has more than 100 million subscribers across all of its streaming offerings (~60 million subscribers belong to Disney+). This is huge as Disney was only expecting to have more than 60 million subscribers on Disney+ by the end of 2024 in its forecast last year. The pandemic has brought forth an unprecedented adoption wave on streaming services and Disney has much to gain from it. However, this particular segment is still seeing losses with a reported figure of $2.2 billion in the first three quarters of fiscal 2020. This is not unusual for the streaming business though as Netflix is also burning around $3 billion in 2019 (though the cash burn rate seems to have already peaked in 2019 and turns better in 2020). Such operating losses in the streaming business are expected as companies aggressively invest in infrastructure to acquire as many subscribers as possible in the early stages. Once there is a huge base of subscribers, the streaming business will see a jump in profitability as the average cost per subscriber/user will be much lower and there is much more flexibility for the business to increase prices which results in an even larger profit margin.

If you look at Disney's current market capitalisation, it is now around $225 billion. In comparison, Netflix's current market capitalisation is now around $215 billion. Yes, Netflix is almost the same as Disney in market capitalisation. Does this signifies that Disney is currently undervalued? Let us dive a bit deeper into the numbers.

I have no doubts about the continual survival of Disney in the long term. The board has been making very good decisions in the recent years with strategic acquisitions to further grow the business and the quick shift towards streaming business seems to be a wise and timely one. With the recent restructuring to go full steam ahead on their streaming business, I strongly believed that the company is heading in the right direction. It's now just a question if they could execute their restructuring plan well. The current pandemic could represent a good opportunity for potential investors who're looking to own a piece of the Disney universe.

I would be keeping Disney on my watchlist.

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