Disney: Dawn is breaking? There is still a disturbance.

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On November 9th, after the US stock market closed, Disney released its earnings report for the fourth quarter of the 2023 fiscal year (CY23Q2). As the last quarter of this fiscal year, Disney continued to implement its "profit first" strategy, and after some adjustments, its internal profitability improved significantly compared to the same period last year. Among them, the biggest change was in the streaming media business, with operating profit improving from a huge loss of -29% in the same period last year to a loss of only 7% after a year. This reduction in losses has given the company confidence in achieving profitability in the streaming media business by the end of the 2024 fiscal year.

The key to improving profitability lies in the internal cost reduction. This year, the actual optimization of expenses amounted to $7.5 billion, which is higher than the originally planned $5.5 billion. Of course, the revenue side also withstood the pressure from various negative factors (disputes with cable operators, Hollywood strikes, delayed release of popular movies, etc.), especially in the streaming media business. Despite the continuous loss of users from Hotstar, Disney+ still gained more incremental subscribers in other international markets, even after another round of price increases.

In addition, Disney's financial report disclosed a significant restructuring of its business segments: the overall group's business structure was adjusted from the original "Cable Media, DTC, Film and Content Sales, Parks and Consumer Products" to the three major business segments of "Entertainment, Sports, and Experiences". The "Sports" business line, mainly represented by ESPN channels and ESPN+, is an area that Disney has mentioned and favored multiple times in the past two years. Its separate presentation also reflects the management's emphasis and future development direction.

However, because the adjusted financial figures in this report include some integration costs or exclude some discontinued business segments, it is difficult to accurately compare them with the previously disclosed data, which increases the difficulty of comparing historical performance for some businesses.

In terms of short-term trends, besides the hope for continued improvement in overall profitability, there are signs of improvement in overall streaming media revenue (the impact of Hotstar's drag has decreased). However, cable media without sports content still faces a long-term irreversible decline, and the popularity of local parks is also cooling down.

But to be honest, after a year of frenzy, it is understandable that the local parks are cooling down, and the heat in the Asia-Pacific region is taking over. However, Disney has always set a high barrier for theme parks, and new park expansions have already begun, so Dolphin Research is not too worried. The only concern is the impact of the declining trend of traditional channels such as cable media on the group's performance. In this earnings report, we can see some signs of improvement in streaming media growth, but it may also require streaming media to return to a stronger growth trajectory.Currently, Disney's valuation is still relatively low, but considering the months-long strike this year and the delayed release of some popular films, Dolphin Research believes that the first half of the 2024 fiscal year may gradually be affected by a shortage of content supply, delaying the company's performance recovery trend. Therefore, we recommend a cautious approach of observing for another quarter in the short term, or if there is a market adjustment, looking for medium to long-term turning point opportunities around the conservative expectation of $130-150 billion.

Below are the detailed contents of the earnings report.

1. Understanding Disney

As a nearly century-old entertainment kingdom, Disney's business structure has undergone multiple adjustments. Dolphin Research has provided a detailed introduction in the article "Disney: The "Anti-aging Technique" of a Centenarian Princess".

This major adjustment at the group level not only changed the leadership team but also altered the business structure and shifted the strategic focus. Under the new business structure, it is mainly divided into three major segments: Entertainment, Sports, and Experiences:

(1) Differences between the old and new structures?

The new structure highlights the strategic position of ESPN, separating ESPN channels and ESPN+ to establish a Sports Business Division, which shows the company's emphasis.

(1) The Entertainment segment includes: traditional linear channels, DTC (excluding ESPN+), and content sales. At the same time, some redundant business lines and low-revenue traditional channels have been disposed of during the integration process.

(2) The Sports segment includes: ESPN channels and ESPN+.

(3) The Experiences segment includes: theme parks, resorts, cruises, merchandise consumption, etc. It is similar to the previous business, but there may be some discrepancies in specific financial data due to adjustments in the business.

2. Has the investment logic changed with the new structure?

The basic logical framework remains the same, but there are some new points to pay attention to.

(1) Firstly, this structural change reflects an important strategic adjustment - content and distribution channels are no longer separated into two businesses but integrated together. The new business structure is more based on different content divisions.

This may solve a problem at the source - the same content may be suitable for initial distribution on different channels. The question of whether Disney's popular blockbusters should be released on Disney+ or in theaters first in the past two years has affected the performance of many highly anticipated films. As a result, actor compensation has been affected, and it has also damaged Disney's cooperation with some celebrity actors.

(2) The Experiences segment has developed for many years and is relatively mature. With the support of a strong IP portfolio, Disney's theme park business maintains a leading position and is more influenced by overall consumer spending. Under normal circumstances, it can be seen as a stable cash flow.(3) [Entertainment] Essentially, it is about the production and distribution of Disney films, including several well-known studio traditional channels and streaming channels. Therefore, changes in revenue are mainly related to Disney's film scheduling and overall film market consumption.

The streaming business is still the focus of Disney's future medium- to long-term business. In the past two years, it was originally a growing business that could secure incremental revenue and profit as a stable traditional business of Disney. However, the competition in the front-end streaming has intensified during the pandemic. And Disney, without the accumulated advantage of producing its own TV series content, has made huge investments but suffered losses.

As the two ends of the seesaw, while streaming development is booming, traditional media's old business naturally cannot thrive on its own. As traditional media declines, streaming for Disney is not purely incremental, but a large part is compensating for the decline of traditional channels.

(4) Disney's new favorite [Sports] business may be a new growth path. Although ESPN has been operating within Disney for many years, sports content and related industries are also entering the vision of more and more streaming companies. For example, Netflix has mentioned several times their emphasis on and increased investment in sports content.

2. Significant reduction in streaming losses, group's first profit

Reducing streaming losses and improving the overall profitability of the group is Iger's first major task upon his return.

In the fourth quarter, the reduction in streaming losses improved the overall profitability of the group, achieving an operating profit of nearly 3 billion, with a dramatic year-on-year increase of 86% due to a low base last year. However, due to the decline in profit margins of cable media and domestic theme park revenues, there was a decrease in profitability on a MoM basis, and the profit margin was also 1 percentage point lower than the previous quarter.

Looking ahead, the company's plan is to continue controlling expenses, and it is expected that free cash flow will show significant growth in the fiscal year 2024 compared to 2023.

Looking at the new architecture, the Sports business line has shown the most significant improvement in profit margins, both YoY and MoM. Although the theme park business has improved YoY, it has worsened MoM, mainly due to the decline in popularity of domestic parks with higher profit margins.

Apart from ESPN+, the other streaming services, merged under the Entertainment business line, have been more affected by the decline in traditional cable media and the deterioration of profit margins in film and television content sales.

Therefore, the progress in reducing streaming losses (2 percentage points improvement on a MoM basis) has not directly manifested in the overall business, but it will be more apparent when further broken down.

However, currently, the profit pillars of the group are still the theme parks, consumer products, and cable media. Therefore, the accelerated decline of cable media undoubtedly adds more pressure to the theme park business, especially when the film and streaming media businesses are facing a short-term content supply gap due to strikes.

3. Under the pressure of price increases, the number of users rebounds, but beware of the delayed impact of strikes

In the fourth quarter, apart from Hotstar, which continued to lose some users due to not obtaining the IPL copyright, the major growth came from non-North American regions (Asia-Pacific region). This growth trend of "quantity and price rising together" was achieved on the basis of a price increase in September.

At the same time, the negative impact on Hotstar has also decreased marginally. In this quarter, it lost 2.8 million users compared to the previous quarter, which is a significant improvement. It is expected that it will quickly return to growth through the addition of other content.

As of the end of this quarter, Disney+ has 150 million subscribers, ESPN+ has 26 million, and Hulu has 50 million, totaling 226 million subscribers. Although the company's current focus is on streaming media, it still emphasizes the operation of reducing losses in the streaming media business. However, with the streaming media operating profit margin only in single-digit losses, reinvesting in user expansion can quickly yield results. Iger once again emphasized that the streaming media business will achieve profitability in the fourth quarter of 2024, which means that we may see Disney increase its investment in streaming media content in the second half of next year.

Therefore, if we see Disney's profits decline due to content shortages, declining user subscriptions, and subsequently declining profit margins in the first half of the 2024 fiscal year, there is no need to panic. Instead, it could be a turning point for returning to growth if we follow the market adjustment to a relatively low price.

Currently, the downward trend in Netflix's content investment is slowing down (the abnormal value in the third quarter was due to the impact of strikes and the stagnation of some project investments). Although the company stated that it will not blindly invest in the future, it also mentioned that it will gradually increase its investment in content production.And from the fourth quarter earnings report (calendar year third quarter) of Disney, the main direction of capital expenditure is in theme parks (YoY +37%). Considering that the strike will have an impact on the supply of content for the next half year to a year, the company needs to strike a balance between "profit goals" and "increased investment" at the right time. Dolphin Research believes that since the supply of high-quality content has a greater impact on streaming media, the window for reinvestment will not be too long.

Streaming media needs series to support subscription stickiness, but Disney is better at movies, so in the past, it tended to bring classic old series to Disney+. Looking at the subsequent pipeline, although there are some Marvel IP series, it was reported last quarter that Disney is reducing its investment in Marvel series, which may affect the release plans of these reserve series.

4. Fewer and poorer movies, major releases delayed

In the fourth quarter, content sales generated revenue of 1.86 billion, a YoY decline of 2.5%, mainly due to the underperformance of the movie "Haunted Mansion" compared to last year's "Thor: Love and Thunder". At the same time, the distribution effect of home entertainment was also mediocre.

With several popular films being delayed in the middle of the year (the red marks in the figure below indicate films delayed for release), and the previously controversial "Snow White Live-Action" performing poorly after "The Little Mermaid", news of further delays has also emerged. I don't know if it's to avoid repeating the mistakes of "The Little Mermaid" and choose to quickly change course and reshoot. In short, the second half of the 2024 fiscal year will bring another small climax in Disney's film content.

5. Theme parks: Domestic returns are flat, overseas continues to be enthusiastic

In the fourth quarter, revenue from theme parks and consumer products reached 8.16 billion, with a YoY growth of 12.5%, relatively stable. However, in terms of internal structure, the growth rate of the park business was 15.9%, remaining stable MoM, but consumer product sales continued to decline YoY by 5%.

Domestic parks have already cooled down significantly, following the 100th anniversary event at Disney World in Florida. The enthusiasm did not continue to decline this quarter, but with the support of the event, it only maintained slow growth. It can only be said that after a year of playing, even North American users can't keep up.

6. Cable Networks are "Revolutionized"

In the fourth quarter, cable TV revenue declined by 9% YoY, and the decline was even greater without ESPN's sports channel. Both advertising and subscription fees have declined, and Dolphin Research predicts that the loss of advertising revenue will have a greater impact. Subscription fees and distribution revenue still have inertia due to payment habits, so the impact of streaming media on cable TV still lags behind, but the trend is basically unstoppable.

Looking at the entire industry, this quarter, most streaming media companies are thriving. Led by Netflix, YouTube, Roku, and HBO are all doing well. Even Disney+, which is now in the stage of compressing investment to increase profits, has gained nearly 5 million new users this quarter, despite the unfavorable factors of price increases.

The trend of traditional media being revolutionized by streaming media is basically unstoppable. Cable TV only has rigid demand in certain areas, such as political advertising during elections and sports event advertisements controlled by cable operators.

According to Nielsen data, the share of TV users' time spent on cable TV channels has continued to decline since the beginning of the year. In September, there was a certain rebound in the share of traditional media due to the concentration of sports events. In the medium to long term, cable TV's advertising revenue will continue to be under pressure.

7. Stable Improvement in Cash Flow

In the fourth quarter, free cash flow had a net inflow of 3.428 billion yuan, continuing to improve the cash flow situation through profit release and restrained investment. As of the end of the fourth quarter, the company had 14.2 billion yuan in cash and 3.1 billion yuan in short-term investments. Although the company has a total of 46.4 billion yuan in long- and short-term borrowings, more than 90% of them are long-term US dollar notes, so the actual cash flow situation is not bad.

With the further increase in management's profit requirements, there is no need to worry too much about cash flow. The management has also stated that the cash flow situation next year will be better than this year.

However, we hope to see the problem of content shortage resolved. Traditional content businesses such as movies should reduce their drag, and at the same time, we hope to see a clear expansion trend in streaming media users after the content library becomes richer. There have been some positive signs in the fourth quarter, and when the lagging impact of the strike on content supply eases, Disney may truly regain its past glory.

Dolphin Research "Disney" Related Articles

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August 10, 2023 Conference Call: "Disney: More Open, More Cost-Saving (3Q23FY Earnings Conference Call Summary)"

August 10, 2023 Earnings Review: "Disney: Where is the Bottom in the "Crisis" Moment?"

May 11, 2023 Conference Call: "Weakness in Streaming Subscriptions and Advertising May Continue into Q4 (Disney 2Q23 Conference Call Summary)"

May 11, 2023 Earnings Review: "Disney: Sacrificing Growth for Profit, How to Handle the Dilemma?"

February 9, 2023 Conference Call: "The Future Belongs to Streaming, But It Requires Reasonable Operations (Disney 1Q23FY Conference Call Summary)"

February 9, 2023 Earnings Review: "The Legend Returns, Disney Begins to Change"

November 9, 2022 Conference Call: "Disney: Focusing on Profit, Seeking Both Internal and External Savings (4Q22 Conference Call Summary)"

November 9, 2022 Earnings Review: "Titans Taking Turns to Strike, Can Century-Old Disney Hold On?"August 11, 2022 Phone Conference: "Disney: Strong Offline Demand, Lowering Medium to Long-term Streaming User Guidance (3Q22 Phone Conference Summary)"

August 15, 2022: "Disney: Theme Parks Remain Popular, Streaming Continues to Expand (Earnings Report)"

May 12, 2022 Phone Conference: "Disney: Strong Content and Park Performance in the Second Half of the Year, Content Licensing Reduction and Asian Park Closures are Negative Factors (2Q22 Phone Conference Summary)"

May 12, 2022 Earnings Report Review: "Disney: Accelerating Profits in Traditional Business, Striving to Support Streaming"

February 10, 2022 Phone Conference: "Entering the Content Cycle Gradually, Management Confident in Growth Targets (Disney Phone Conference Summary)"

February 10, 2022 Earnings Report Review: "Disney: Streaming Growth Regains Glory, Theme Parks Shine Even Brighter"

November 11, 2021 Phone Conference: "Disrupted by the Pandemic, Disney's Content Cycle to be Seen in the Second Half of the 2022 Fiscal Year (Phone Conference Summary)"

November 11, 2021 Earnings Report Review: "Sluggish Streaming Growth, Disney's Long and Challenging Transformation Journey"

In-depth:

June 1, 2022: "Disney: Bursting the Streaming Bubble, Returning to the Essence of Theme Parks"

October 10, 2021: "Disney: The 'Age-Defying' Magic of a Centenarian Princess"

October 15, 2021: "Disney, Constantly 'Creating Dreams,' Can It Achieve a 'Dreamy Valuation'?"

Risk Disclosure and Statement for this Article: Dolphin Investment Research Disclaimer and General Disclosure