There’s More to Disney Than Movies and Mickey Mouse. Why Streaming Could Power Future Profits.
Disneyland in California reopens at the end of this month with some now-familiar pandemic compromises: 25% capacity, masks for guests, no parades or fireworks, and no high-fives from Goofy. It’s a welcome milestone for America’s recovery. The much larger Disney World in Florida has operated safely since this past summer with similar rules. The capacity cap there has been raised to 35% from 25%, and furloughed workers are trickling back.
Bob Chapek, who ran the parks business for Walt Disney (ticker: DIS) before being named chief executive two weeks before the World Health Organization declared Covid-19 a pandemic, tells Barron’s he’s “terribly confident that the parks will bounce back as good, if not better, than they were before.”
During a video chat this past week, he pointed to operational details that anticipate a return to boom times. Mobile ordering is up to 84% of food purchases, versus 13% before the pandemic. For now, that’s keeping guests apart. But it will also reduce lines and waiting times and improve profit margins and satisfaction scores long after the pandemic has passed.
Photograph by Austin Hargrave
Under Chapek, Disney has faced the severest of financial stress tests and come out ahead. When parks and theaters emptied out a year ago, costs kept rolling in, and the fastest-growing part of the business, streaming, was consuming cash—as it still is. Yet, Disney generated $3.6 billion in free cash during its fiscal year ended last September. It’s seen producing $3.3 billion this year, before the numbers begin a sharp rebound.
Investors have applauded the story. The company suspended its modest dividend last year. Yet the stock is up 45% since Chapek took over, versus 33% for the S&P 500 index. Netflix had passed Disney by stock market value. Now Disney, recently valued at $340 billion, is ahead by $100 billion, and bullish investors say there’s more to come.
Many Wall Street strategists have recently recommended a barbell approach to stock selection, with companies on one side that have shown they can thrive during the pandemic, in case it lingers, and ones on the other that have much to gain if commerce quickly bounces back. Disney is a rarity; it sits on both sides of the barbell.
Chapek’s optimism about movie theaters is more guarded than his bullishness on Disney’s theme parks. “We believe the great majority of them will go back to theaters,” he says of streaming subscribers. “But will it be 100%?” If it isn’t, it won’t be the end of blockbuster production budgets. “I really don’t think it’s going to change how much we necessarily spend on them because we have an absolute quality standard,” he says. “But it may say, OK, we’re only going to put bigger films in theaters.”
To stay nimble and maintain objectivity about where movies should debut, Chapek has merged the distribution arms of the company’s various studios into a single unit.
On streaming, results have shattered forecasts. Back in November 2019, when Disney+ launched, the company had a goal of reaching 60 million to 90 million subscribers by fiscal 2024. In March, it hit 100 million. Netflix took a decade to reach that milestone. It took Disney less than a year and a half. “We were very confident in our proposition, but I think it caught everybody by surprise,” says Chapek.
Now, Disney is targeting 300 million to 350 million subscribers by 2024 across all of its streaming platforms, including Hulu, ESPN+, Hotstar in India, and Star+ in Latin America, which launches in June. Netflix, with more than 200 million subscribers today, is expected to have 306 million by 2024. Chapek isn’t making a prediction about pulling ahead. “We tend to view our success really as more absolute, rather than relative,” he says.
Traditional television isn’t expected to grow, long term. But if it’s dying, it’s taking its time. Last quarter, revenue for linear networks—Disney’s new reporting category for cable and broadcasting results—rose 2% from the figure a year earlier. Over the next few years, TV is seen holding more or less steady, as some viewers cancel their cable bundles but sign up for virtual packages that include ABC, ESPN, and other Disney networks. Operating income for the division is expected to fall by single-digit yearly percentages, which could happen if content costs rise faster than revenue.
Chapek says direct-to-consumer—Disney’s term for streaming—is the priority, but that he’s not abandoning linear TV. “It probably won’t be as fast as people think,” he says of the likely decline there. “This is part of what we have to figure out, both creatively and from a distribution standpoint—how we put one foot on the boat and one foot on the dock during this transition period.”
Two awkward bits of speculation surfaced last year about Disney’s sudden management change. One held that Chapek was put in place as the pandemic spread, so that former chief Bob Iger could go out on top. Follow Disney for long enough and you realize that it’s ground zero for all kinds of odd theories about what management is really thinking. Over the years, Barron’s has been impressed with Iger’s foresight in deal making, but we rather doubt that he had unique insight on the pandemic’s likely severity or longevity.
“Nobody had any idea of how big this thing was,” says Chapek. “We were flying to our annual meeting, going to Raleigh, N.C., and we heard that the governor, quote unquote, whatever this meant at the time, closed the state.”
The meeting was held on March 11, 2020, the day the World Health Organization declared Covid-19 a pandemic. Disneyland in California closed two days later, and Disney World in Florida and Disneyland Paris, two days after that. Parks in Asia had been shut down earlier in the year.
The second rumor is almost the opposite of the first—that Iger quietly retook control of the company to save it during the pandemic. Our conversations suggest otherwise. Technically, Chapek reports to Iger, now executive chairman, until Iger retires at the end of this year. Realistically, if you’re running Disney and you have its most successful chief since Walt on hand, you compare notes when you can.
But it was Chapek who ramped up spending on new streaming titles; moved some planned theater releases to Disney+, where subscribers pay extra for them when they’re first released; and reorganized distribution. And it was largely Chapek—aided by some fortunate timing in Disney’s fiscal calendar—who kept the loss at the parks, experiences, and products segment, which includes cruises and merchandise, tiny last year, with a modest profit expected this year under his successor as the unit’s boss, Josh D’Amaro.
There is a history of drama around successions at Disney, which we suspect explains the short notice on Chapek’s appointment. There is also a history of underestimating new bosses. Iger, some said early on, is no Michael Eisner.
Barron’s took a favorable view of Chapek’s appointment (“Why Disney’s Sequel to Bob Iger Looks Like a Hit,” Feb. 26, 2020). Chapek’s experience as head of distribution for Walt Disney Studios appeared to have given him the know-how to make the streaming operation a success. Even more important was his parks experience—though investors have been wowed by the subscriber gains at Disney+, parks are likely to outearn streaming for many years to come. So far, so good.
Investors eyeing Disney shares must typically wrestle with two issues. The first is whether the company can improve on what it has just done. That was trickier back when it was blowing up box office records and packing its parks to their limit. Now, there is no end of room for improvement. The second issue is whether the stock, which trades at pricey levels, has more upside. But there is a case for additional gains from here.
Disney’s free cash flow peaked at $9.8 billion in fiscal 2018, just before the company's spending on content surged to prepare for the Disney+ launch. Free cash flow is expected to climb to a record $10.3 billion by fiscal 2023. Not many analysts have guessed beyond that, but those who have think free cash flow can top $15 billion by fiscal 2025.
That’s plausible, considering that Wall Street expects streaming to swing from sizable losses to fast-growing profits by 2023, a year ahead of management’s guidance, while traditional TV gives up ground only gradually. In addition, the parks segment could go from near zero to $10 billion in operating profit within five years. Based on what parks were earning before the pandemic, that doesn’t seem especially theoretical.
Even assuming all that, Disney trades at an ambitious 22 times the free cash it could be generating in five years. Ultimately, the stock’s performance over the next year could rest on whether investors decide Disney deserves more of a tech-stock valuation.
Disney bull Alexia Quadrani, who covers the stock for J.P. Morgan, reckons the shares can hit $220 by the end of this year, 18% above their recent quote. That price comes from a sum-of-the-parts analysis that assumes the streaming business is worth 10 times revenue. Netflix trades at eight times revenue.
Quadrani views Disney’s streaming business as similar to Netflix’s international operations, which are growing much faster than its domestic ones, and therefore deserve to be valued at a higher multiple of revenue.
Changes are afoot in the parks, as always. Disney World’s Epcot park is getting an overhaul, complete with a new restaurant-theme Ratatouille ride. The company’s Hollywood Studios is getting the Galactic Starcruiser. Don’t call it a Star Wars hotel, says Chapek—it’s really where people will “stay and get completely immersed in a Star Wars experience for two days.” A new Avengers Campus is coming to Disneyland, and work is under way on a Zootopia Land at Disneyland Shanghai.
Adding attractions sometimes means retiring old ones, which has the potential to cast any chief in a villainous role. “Sometimes, there’s a difference between how often fans go into an attraction and what they feel about it as voiced in social media,” says Chapek. Barron’s couldn’t secure a commitment either way for the animatronic Country Bears Jamboree, which like the rest of Disney World, turns 50 in October.
At Disneyland, one thing that won’t reopen at the end of this month is the annual pass plan. It’s being replaced with a membership program that will offer more predictability about attendance.
This year’s film slate is flexible, but 2022 will bring a female Thor, a new Indiana Jones with Harrison Ford, a Black Panther sequel that must honor late fan favorite Chadwick Boseman without reprising his role, and a long-awaited follow-up to Avatar. The movie set the all-time box office record twice—once shortly after its 2009 release, and again last month, after a rerelease in China vaulted it back ahead of Disney’s 2019 Marvel smash Avengers: Endgame, which had surpassed Avatar.
Chapek says that his favorite part of his job is extending Disney stories to new business lines, geographies, and generations. He mentioned seeing a compilation video years ago, featuring the “Let It Go” song from Frozen in 25 languages, and realizing the impact that the initial content had. And he says that optimism is one of the company’s core cultural values.
“It’s been a rough year for us,” says Chapek. “It’s been a rough year for our cast. It’s been a rough year for consumers. But if, in the recovery, you can bet on anybody, bet on Disney, because we’ve got the stories that people love.”