Disney (DIS) reported its first quarter under its new reporting structure which is designed to isolate the company’s three main businesses and especially highlights the Direct-To-Consumer (DTC) streaming businesses that are the future of the company’s media businesses.  Results in the company’s 1Q21 were better than guidance and analyst expectations but are not a short-term catalyst given (1) confusion related to the new accounting treatment, and (2) the huge run in the shares over the past several months.

Northlake continues to like DIS long-term based on success in streaming and a return of the company’s theme park and movie businesses to pre-pandemic levels.  DIS has elements of both COVID winners (streaming) and COVID losers (theme park and movies) that give investors a bullish story over the next twelve months.  That said, we could see the stock stall for a stretch before the next leg up later in 2021. 

Our revised price target is $225, up 20% from current levels.  It is important to note that we are using an unusual approach to valuation for DIS.  First, we’re looking out to 2023 to value the core businesses now placed in the company’s Content Sales and Licensing, Linear Networks, and Parks, Experiences and Products business segments.  These areas have been the most hard hit due to the pandemic and even with full vaccinations achieved in CY21, we do not expect the business to fully return to pre-pandemic levels until 2023.  We value these lines at 12X 2023 estimated EBITDA with Parks and the film studio worth a premium and the traditional TV media assets worth a discount.  Second, we value the DTC streaming businesses led by Disney+ at 80% of Netflix’s current market capitalization.  This is admittedly an arbitrary valuation measure but we believe that DIS has already proven its subscriber base will match Netflix within several years.  We use 80% of Netflix’s valuation since DIS is not yet close to profitability, unlike Netflix, and DIS average revenue per streaming subscriber (ARPU) is only about 1/3^rd of Netflix.

Given movie theaters and theme parks are either closed or operating at limited capacity, there is not much to learn from 1Q21 results or management commentary on the conference call.  The DTC businesses remain the key driver of investor sentiment and stock valuation.  Overall, 1Q21 DTC results were better than expected led by another upside surprise in subscriber growth at Disney+.  Notably, ARPU fell to $4.03 from $5.56 a year ago as subscriber growth is presently being dominated by India.  However, excluding India, ARPU is holding firm.  ARPU is poised to inflect over the coming year as DIS has announced a price increase and many of the wholesale distribution agreements, such as with Verizon, are expiring.  This brings up the questions of churn.  Management is encouraged by early trends and is optimistic churn will be low.  In Northlake’s opinion, Disney + and the bundle including ESPN+ and Hulu (and Star soon to roll out abroad) offer excellent value which will limit churn.  Management was smart to initially price Disney+ and the bundle very aggressively to drive a quick ramp to scale in subscribers.  DIS has already joined Netflix as a winner in the Streaming Wars while success for everyone else remains uncertain.  As noted at the start of this blog post, operating losses in DTC were much smaller than expected.  Management refused to pull forward its timing of 2024 for DTC profitability and still maintains its outlook that losses will peak in 2021. We think profitability should be reached prior to 2024, and after making assumptions off the 1Q21 DTC segments we think that it is possible FY20 will be the peak for segment operating losses.  If we are correct, this would be the next major positive catalyst for DIS shares and lead to achievement of our $225 target.

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.