Disney had a truly awful quarter.  But the stock is up 10% today!  Investors have chosen to look past the pandemic’s devastating impact on theme parks, ESPN (no live sports last quarter), and inability to release blockbuster films.  Instead, the focus is on the continuing massive success (as measured by subscribers) of Disney+ and newly announced plans to launch another direct-to-consumer (DTC) service and lean in with further investment as the company goes all in on its pivot from linear to digital delivery of its content.

June quarter results were actually better than expected even as the company reported a loss.  Advertising was not quite as bad as feared, and cost savings due to management actions and delays in paying for sport rights and producing TV and films also helped.  These factors will likely reverse in the current quarter and looking further ahead as hopefully the world returns to normal or a new normal.  The devastation caused by COVID is revealed in the -42% and -72% decline in revenues and segment operating income, respectively, in the quarter.  Theme Parks were closed almost the entire quarter and saw revenues drop by -85% or $5.6 billion.  Revenues at the film and TV studio fell by -55%.  Theme Parks lost $3.7 billion in the quarter.

It is somewhat amazing that Disney investors are ignoring these results even if they were widely expected and understood.  The timing, pace, and size of the recovery in theme parks, film, TV, and ESPN remains highly uncertain.  Furthermore, it is plausible that the pandemic brings about permanent damage to travel, tourism, and entertainment that has driven Disney’s growth historically.

The uncertain future for the traditional business segments is why the company’s pivot to DTC is so important to investors.  To some degree, every traditional media company is pivoting to DTC as cord cutting is eroding the value of linear cable and satellite TV.  Disney’s unrivaled content brands position it best for the transition.  However, what really appeals to investors is that the company is all in and seems willing to risk its traditional profit lines. 

In conjunction with its earnings, Disney made several announcements that emphasized it was all in. First, the company announced it would more or less complete its rollout of Disney+ to all major economies except China by the end of 2020.  Second, the company announced a new general entertainment DTC product under the Star brand that is very successful and well known in India and APAC. Hulu will remain primarily a U.S. service. Third, Mulan will launch as a $30 digital purchase option in lieu of theatrical distribution anywhere that Disney+ exists.  This means no theatrical release in the U.S., U.K.. and ,most of Western Europe.  Fourth, the company announced it was using the extra revenue from the faster than expected start to Disney+ (subscribers already have reached the low end of the company’s 2024 target) to invest further in content to drive the DTC services.  This means profits from DTC will not come sooner than expected but as Netflix has proven, investors are willing to put value on revenue and subscriber growth and wait for profits as the addressable market seems to grow ever larger.

Disney has historically traded based on a P-E multiple.  With COVID massively reducing profits in at least 2020 and 2021, P-E valuation is no longer valid.  Our recent blog posts on Disney had already transitioned to a sum of the parts valuation methodology.  Disney closed yesterday with an enterprise value of about $270 billion against $240 billion for Netflix.  Netflix has 192 million subs around the world paying more than twice the price Disney charges its 100 million subs.  Netflix is profitable today, producing hundreds of millions of dollars in EBITDA while Disney will lose a few billion dollars on its DTC businesses in 2020.  Despite these comparisons it is plausible that Disney’s DTC business can be valued at least half of Netflix given the power of the company’s brand and the pace and ease with which it has gained subscribers.  If this were the case, the rest of Disney’s businesses would be reasonably valued at 10X 2019 EBITDA, a sharp discount to the 15X it traded at pre-COVID. 

With the all in strategy and continued much faster than expected subscriber growth, Northlake now sees a path back to all-time highs in the $150s for Disney.  The next catalyst will be an analyst meeting in a few months that updates investors on the DTC strategy and financial profile.  Disney remains a core holding for Northlake and we would be buyers on a modest give back of today’s large gains.

DIS is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.  DIS is a net long position in the Entermedia Funds.  Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.