However, DIS shares still rose more than 2% on November 13.
Fiscal 4Q revenue fell a staggering $4.4 billion or 23% year-over-year as COVID-19 continued to pressure the company’s businesses, particularly the Parks and Studio Entertainment divisions, though the September-quarter decline was still better than the $8.5 billion falloff in the June quarter. The Direct-to-Consumer & International division, the division housing Disney+, and the Media Networks division both reported good revenue growth, just not nearly enough to offset the large declines in the other two divisions.
With the Parks and Studio Entertainment divisions posting large losses. As might be expected with the Disney Park restrictions/closures, the Parks division showed a devastating $2.5 billion year-over-year negative swing in operating profit and reported a loss of $1.1 billion. However, the company’s leading Media Networks segment reported a 5% increase in profit, benefiting from savings from content production shutdowns and an extra week compared to 4Q19. We note that the production costs savings are temporary, as sports programming and content production have resumed. Sports rights and production costs, in particular, should continue to ramp up in coming quarters, perhaps crimping segment profitability. The consolidated segment operating margin narrowed by 14 percentage points to 4%.
The adjusted loss from continuing operations was $0.20. The 4Q20 results excluded $0.30 in amortization and fair value step-up charges related to the 21CF assets and the Hulu acquisition, $0.17 in restructuring costs, and a $0.28 gain on investments.
For FY20, revenue declined 6% to $65.4 billion. Adjusted EPS declined 65% to $2.02 from $5.76 in FY19.
The new Disney+ digital video streaming service again provided one of the few bright spots in a bleak 4Q20, with paid subscribers rising 16.2 million to a total of 74 million, quite impressive given that the service was launched less than a year ago, though likely aided by COVID-19 lockdowns and the new stay-at-home paradigm. The extraordinarily successful launch validates Disney’s decision to pivot into direct-to-consumer distribution and highlights its sterling execution in the rollout. The service also had the good fortune of launching in November 2019, as it was able to gain momentum before the pandemic spiked demand for video streaming entertainment. The massive success of Disney+ has even moved competitors ViacomCBS and Fox Corp. to accelerate their own plans around DTC.
Disney World Orlando, Disneyland Anaheim, Disneyland Paris, and Disney Cruise Line all closed in mid-March due to the pandemic. Disney World Orlando reopened on July 11 and Disneyland Paris on July 15, though Disneyland Paris closed again on October 29 due to the COVID-19 spike in France. Disneyland Anaheim is closed and management expects it to remain closed through December. Shanghai Disneyland closed on January 25 and reopened on May 11. Hong Kong Disneyland closed on January 26, reopened on June 18, closed again due to a COVID-19 resurgence on July 15, and then reopened again on September 12. All of the park reopenings are subject to limited attendance with strict social distancing and health requirements, along with intensified cleaning. Disney Cruise Line remains closed and will likely not return until 2H21.
Advertising agency Magna Global has published its revised forecast for advertising spending in 2020 and 2021. For Disney, the key forecast is the 12% decline in linear television advertising that Magna expects in 2020. Disney’s cable channel crown jewel ESPN depends on advertising as a critical revenue stream. The Magna forecast includes the expected increase in political advertising spending in 2020.
EARNINGS & GROWTH ANALYSIS
While several parks are now open, at least with limited capacity, and advertising may be beginning to recover, we also expect narrower margins in the coming quarters as sports rights amortization is compressed and investments in new streaming platforms continue to ramp up. The company is also prioritizing debt repayment over share repurchases for the foreseeable future. The share count rose 19% with the 21CF acquisition.
Management noted on the quarterly call that Disney World (Orlando), Shanghai Disney Resort, and Hong Kong Disneyland all generated revenue in excess of variable costs, i.e., a ‘net positive contribution,’ even with limited attendance. However, the impact of theater closures on the Filmed Entertainment division could be long lasting, with only limited permitted attendance if and when movie theaters do actually reopen. All of these COVID-19 effects heighten the importance of the Disney+ rollout and the company’s overall direct-to-consumer strategy.
Disney launched its Disney+ streaming video service, the ‘cornerstone’ of its DTC strategy in the U.S. Disney+ joined Disney’s other two streaming services, ESPN+, which launched in April 2018, and Hulu. The Disney+ geographic market rollout has continued in 2020, with the addition of countries in Western Europe (the Nordics, Belgium, Luxembourg and Portugal are next on the list), and South America. In September, the company launched a co-branded Disney+ Hotstar service in Indonesia.
Management has emphasized that it will invest heavily in all three DTC services to produce and globally distribute the kind of high-quality video entertainment that could lure subscribers to these services and that has, indeed, been a hallmark of Disney for many years. The accelerated airing of ‘Hamilton’ on Disney+ in July and the addition of ‘Star Wars’ saga movies to the site are just the beginning of management’s moves to provide a stream of fresh, high-quality content. While we expected Disney+ to be successful given Disney’s superior library and original content, brand, and powerhouse marketing, the actual pace of subscriber acquisition has been surprising. Disney targeted 60-90 million Disney+ subscribers by the end of FY24 (September 2024), though, as noted above, it has already broken through 60 million. Management expects Disney+ operating expenses to peak in FY20-FY22, and looks for the service to reach profitability by FY24.
All these services are not only jostling for their own place in the market, but also gunning for the original first-mover in digital video streaming, Netflix.
Disney+ entered the market at very attractive price point of $5.83 per month for an annual subscription, or $6.99 per month for a month-to-month subscription. Disney+ has also gained distribution on Roku and Amazon, which, according to research firm Parks Associates, together control 70% of the U.S. streaming device market, certainly a boon to subscriber acquisition and a distinct competitive advantage. Disney’s price also undercuts the Netflix $8.99 ‘Basic’ monthly subscription and is even more favorable than the $13.99 ‘Standard’ Netflix subscription. An Amazon Prime membership costs $8.25 per month and video streaming is essentially an add-on to that company’s Prime free shipping service (or $8.99 per month as an Amazon Prime Video stand-alone service). Another new market entrant, Apple TV+, has an even lower price of $4.99 per month; however, its current content offerings are no match for Disney +. While competition from a surging Netflix makes DTC a must-have defensive strategy for Disney, DTC could also become a driver of significant future growth. However, the costs of capturing market share in the growing video streaming business will be high and sustained.
FINANCIAL STRENGTH & DIVIDEND
Disney took on an incremental $36 billion in debt with the 21CF acquisition in FY19, ballooning its total debt. In 3Q20, the company added another net $9 billion in new debt in order to boost liquidity. The company closed on a new $5 billion revolving bank facility, increasing the total capacity of its bank facilities to $17.25 billion.
Disney’s board suspended the company’s semiannual dividend for both July 2020 and January 2021. Disney’s regular semiannual dividend was $0.88, or $1.76 annually. We are adjusting our FY21 estimate to $0.88 to reflect the temporary dividend suspension and establishing an FY22 forecast of $1.76.
MANAGEMENT & RISKS
The effects of the pandemic have rapidly become the top risk for Disney, with significant damage from park and theater closures and weak ad revenue. The mitigation of this damage will depend on uncertain epidemiological outcomes and how long a ‘new normal’ of social-distancing restrictions cut into attendance at the company parks and cruise lines, and at movie theaters. Further, COVID-19’s longer-term impact on the economy, with millions of unemployed, and on consumer psychology and spending patterns, remains unclear.
While Disney has completed the Fox acquisition, it still faces significant integration risks for this large and disparate collection of assets, as the financials in recent quarters have indicated. The launch of Disney+ and the large and continuing investments in the company’s DTC strategy are a significant risk if these new services are unable to gain traction with consumers. The uncertainties surrounding the COVID-19 pandemic substantially magnify these risks.
The shutdown of live sports events due to the COVID-19 pandemic directly impacted ESPN. While live sports events have resumed, it remains uncertain whether a COVID-19 resurgence could again lead to shutdowns and cancellations. ESPN+ has also been growing nicely since its launch.
The shares have declined 7.5% year-to-date. However, the stock’s performance has been heavily impacted by the pandemic.