Weakness in streaming subscriptions and advertising may continue into Q4 (Disney 2Q23 earnings call minutes)

The following is a summary of the 2Q23FY performance conference call for Disney.US, and the financial report review can refer to "Disney: Sacrificing Growth to Maintain Profit, How to Handle the Dilemma?".

I. FY2Q23 Financial Report Overview

1. Revenue: Revenue was $21.815 billion, YoY+13.3%, basically in line with market expectations (-0.01% inline).

2. Profit: Operating profit was $3.285 billion, YoY-11.2%, exceeding market expectations (+3.45% beat).

3. Performance Guidance:

(1) FY2023 Capital Expenditure: Approximately $5.6 billion, lower than the previously guided $6 billion.

(2) FY2023 Revenue and Operating Profit: Maintaining high double-digit growth.

(3) FY2023 Cost Reduction: The strategic restructuring and cost reduction plan continues to be implemented, and it is expected to achieve or exceed the cost savings target of $5.5 billion proposed in the previous quarter.

(4) By Business Segment

1) Cable Networks: The sports advertising market is currently stable, but the overall entertainment advertising market is full of challenges, and it is expected to remain weak until the second half of 2023.

2) DTC: It is expected that the weakness in net additions of domestic Disney+ users will continue until the third quarter, but it is expected to rebound in the fourth quarter. Due to the impact of deferred recognition of marketing expenses, it is expected that the operating loss of DTC in FY3Q23 will expand by approximately $100 million, and it will subsequently return to the pace of improvement.

3) Content Distribution and Licensing: It is expected that the operating profit of this business in FY3Q23 will decrease by $150-200 million YoY, mainly due to the release schedule of key films-Elemental, Indiana Jones, and the Dial of Destiny.

4) Parks, Experiences, and Products: It is expected that the operating profit margin of North American parks in FY3Q23 will slightly decrease YoY, but the performance of the international market is expected to drive a slight increase in the operating profit margin of the segment.

II. Management Remarks

(1) Overall Performance

Before the performance conference officially began, congratulations were given to Super Mario Bros for its huge success, which shows the optimistic prospects of the film business.

This quarter's impressive performance is the result of business strategy changes, and the company is proud of the value it provides to consumers through movies, cable television, sports, news, and theme parks.Recent highlights include Guardians of the Galaxy Vol. 3 (Marvel Studios) topping the box office with $289 million in its opening week; the first round of the NBA playoffs setting a record high viewership for the Disney television network, with an average of 5 million viewers for the first 22 games, a 15% increase year-over-year; ABC ranking first in entertainment broadcast television networks for the fourth consecutive quarter; and US-based theme parks continuing to improve the visitor experience through price changes and new projects, including the redesign of Mickey's Toontown and Tron Lightcycle/Run.

I (Robert A. Iger) returned to the company almost 6 months ago and initiated a major strategic transformation to achieve sustained growth for Disney. Now, all work is progressing in an orderly manner, and the new organizational structure returns power and responsibility to creative officers, while making corporate operations more efficient, coordinated, and streamlined. Cost-cutting progress is going smoothly and is expected to exceed the target of $5.5 billion.

1. DTC

The operating losses of streaming media business have narrowed this quarter; the long-term development prospects of DTC business are good, and the brand, franchise rights, and powerful content library are important differentiation advantages of Disney in this field. The rapid growth of users achieved since the launch of DTC business three years ago is the best proof.

To promote the reasonable development of DTC business, a streaming media application (App) integrating Hulu and Disney+ content will be launched in the United States and Canada by the end of this year. Although Disney+, Hulu, and ESPN+ will continue to be provided as independent services, this new application is for users who have purchased the bundled services of Disney+ and Hulu, and puts the content of these two services in the same application, which is conducive to providing users with a better streaming media experience and bringing more advertising revenue to the company.

Although the entire market is facing macro-level headwinds in the near term, the potential advertising revenue of this integrated platform is huge. Because more than 40% of the domestic advertising portfolio, including streaming media, is reachable, and this proportion is expected to continue to grow. At the same time, the company is also focusing on the growth opportunities of programmatic advertising. With the improvement of the market and the growth of the audience, the company has prepared for expansion. Last year, more than 1,000 advertisers were added, and there are now a total of 5,000 advertisers on all streaming media platforms, one-third of which have purchased programmatic advertising.

In addition, a subscription service with advertising for Disney+ will be launched in Europe by the end of this year to promote long-term growth of inventory and revenue. In fact, advertising on Disney+ has just begun, and Disney's long-term advertising positioning is highly regarded.

Meanwhile, the price adjustments that the company has implemented have proven to be successful, and plans to increase the subscription fee for ad-free streaming media services later this year. Looking ahead, the pricing model will continue to be optimized to reward user loyalty, reduce churn, increase revenue from paid ad-free service subscribers, and promote growth in subscribers who choose low-cost advertising support options.In addition to the above, we will also improve our streaming media business in the following key areas: reasonable arrangement of the quantity and cost of creative content; traditional platforms are conducive to expanding the audience and spreading content costs across multiple windows; balancing local and global marketing; and calibrating investments in specific markets to evaluate profit potential based on the total addressable market and ARPU prospects.

2. Theme Parks

Theme parks are a key growth factor for performance, and international theme parks have performed well this quarter. Currently, several international expansion projects are underway to increase capacity and drive long-term growth: in Paris, the Avengers Campus was successful in its first year and investment continues, including the construction of a Frozen-inspired project; in Shanghai, the Zootopia-inspired expansion project will open later this year; in Hong Kong, the Arendelle and The World of Frozen expansion projects will open to visitors in the second half of this year; and in Tokyo, new Frozen Kingdom, Rapunzel's Forest, and Peter Pan's Neverland will open in the next year.

Domestically, more changes will be made in 2024 to improve the park experience, such as further expanding the access rights of annual pass holders on certain days without reservations, and canceling additional reservations for visitors with dated tickets.

Since 100 years ago, Disney's stories and characters have been the key to success, occupying a special place in the hearts of several generations of fans and families. Every part of the company's business relies on this, just like the summer movie release plan, including The Little Mermaid (Disney), Elemental (Pixar), Indiana Jones and the Dial of Destiny (Lucasfilms).

3. Others

Appointed Asad Ayaz as the company's first Chief Brand Officer in history to unleash the company's full potential by enhancing the unity and coordination of marketing across all business units.

(II) Performance Guidance

1. Media and Entertainment Distribution

(1) Cable Networks

Currently, the sports advertising market is stable, and ESPN's domestic linear cash advertising sales have grown this quarter. However, the entire entertainment advertising market has been challenging. Although the weak momentum has eased, it is expected to continue to soften in the second half of this year.

However, the company is optimistic about its ability to continue to be a leader in the advertising industry throughout the entire business cycle, especially with its competitive advantages in reachability and programmatic.

(2) DTC

Although the weakness of domestic Disney+ ad-free subscriptions in FY2Q may continue into FY3Q, core subscription business growth is expected to rebound in FY4Q.

In FY2Q, DTC operating performance exceeded expectations by about $200 million, partly due to recent adjustments in marketing expenses for Disney+ and Hulu - some of which will be transferred to FY3Q, resulting in a $100 million increase in DTC operating losses compared to the previous quarter.（3）Content Sales/Licensing

FY3Q, it is expected that operating profit will decrease by $150-200 million YoY. This is mainly due to the choice of cinema release time - key films Elemental, Indiana Jones, and the Dial of Destiny are scheduled to premiere at the end of the quarter.

2. Park Experience and Merchandise Sales

This year's Walt Disney World 50th Anniversary Celebration is less impressive than last year's.

When similar events occur, the company usually notices signs of easing demand, and FY3Q's performance so far is consistent with these historical trends. At the same time, inflation cost pressures and new union agreements are expected to lead to a YoY decline in operating profit margins for US and Canadian theme parks in FY3Q.

However, it is expected that the continued strong performance of international parks in FY3Q will drive the overall operating profit margin slightly higher than last year.

DPEP will continue to drive the company's growth business.

3. Overall

In 2023, excluding any potential impact of writer strikes, cash expenditures are expected to be roughly the same as last year; total capital expenditures are approximately $5.6 billion, lower than the previous guidance of $6 billion, mainly due to the timing of DPEP projects and lower technology spending by DMED.

Revenue and operating profit are still expected to grow in the high single-digit percentage range in 2023, but there are many factors, such as macroeconomic conditions, the global advertising market, and changes in content timing, that could affect the company's plans and expectations for the second half of this year.

Q&A Session

Q: Reasons for high confidence in Disney+ pricing power; progress of cost-cutting plan

A: [1] Disney+ Pricing

Reality has shown that the impact of raising the price of ad-free Disney+ on subscriptions is limited, and the company has a certain pricing elasticity. The company needs to expand the difference between ad-free and ad-supported subscriptions to attract more users to subscribe to ad-supported services. As digital advertising is very attractive to advertisers, raising the price of ad-free subscription services again, keeping the price of ad-supported subscription services at a relatively moderate level, and promoting ARPU growth.

[2] Cost Optimization

Cost cutting is divided into two parts: content spending and SG&A.

(1) Content spending:

• Most of it will start from FY2024 to FY2025.

• Disney+ has been launched in many markets around the world and corresponding investments have been made in marketing and local content production. Some markets have low ARPU values, and spending in these markets will reduce revenue potential.

(2) SG&A: Actively seeking opportunities to reduce redundancy, such as layoffs. Some of the impact will be evident by the end of this year, but the real impact will be evident in 2024.

Q: Comparison of Shanghai Disney's performance before and after the epidemic; short- and long-term impact of the Florida incidentA: [1] Shanghai

After the relaxation of epidemic prevention, the rebound is significant, and the number of visitors and per capita spending in the park are strong and continue to grow. Zootopia will be launched later this year, which is expected to further increase the number of visitors and consumption.

[2] Florida

There are about 2,000 special zones in Florida, most of which are established to promote investment and development, and Disney is one of them.

The company has more than 75,000 employees and has attracted millions of people to the state. Therefore, it is misleading to say that the Reedy Creek special zone established more than 50 years ago benefited the company without considering how much Disney has benefited Florida. Moreover, Disney is not the only company operating special zones. In the 2000s, there was one at the Daytona Speedway, one famous retirement community village, and countless others. If the goal is a fair competitive environment, laws or government supervision applicable to all special zones are needed.

In addition, there is a misconception that the company has always been trying to protect tax incentives - but in fact, the company is the largest taxpayer in central Florida, paying more than $1.1 billion in state and local taxes last year alone.

Due to this special zone, the company paid more taxes, especially more property taxes. And before the company commented on this bill, no action was taken to dismantle the Reedy Creek special zone. Therefore, this is obviously a retaliatory issue - other special zones in Florida basically continue to operate as usual.

The company's main goal has always been to continue investing in Florida. There was no intention to defend its business interests in federal court, especially under the premise of maintaining a good relationship with the state government for more than 50 years.

And the company still has a huge opportunity to continue investing in Florida. The plan is to invest $17 billion in the next 10 years, which is also what the country hopes the company will do. The company operates responsibly, pays a fair share of taxes, employs thousands of people and pays salaries that are significantly higher than Florida's minimum wage, and provides generous benefits and free education.

Therefore, the final question is raised to end this somewhat lengthy answer: Does the country want the company to increase investment, employ more people, and pay more taxes?

Q: The impact of slowing down DTC content spending on global user growth; the role of launching integrated Hulu and Disney+ applications in the United States and Canada; cash spending guidance

A: [1] DTC

DTC has only been launched for three and a half years and is still a novice in many areas, with the goal of increasing global subscription users.

As the business grows globally, it is realized that many contents may not necessarily drive the growth of subscription users. Therefore, DTC content is being strictly reviewed and content spending is being reduced in a way that does not affect the growth of subscription users. In this process, there is an opportunity to discover the key driving factors of subscription users.

For example, movies released in theaters, especially major films, are the key driving factors for subscription users. However, due to the excessive dispersion of marketing costs, insufficient funds are available to promote these movies (such as Avatar, Little Mermaid, Guardians of the Galaxy, Indiana Jones, which are about to be released).Strictly review the DTC content and allocate funds from content that will not drive subscription growth to the correct content. This is a process of maturation, learning the performance of different content in services, and the true needs of consumers.

【2】Cash Expenditure

(1) A total of 30 billion US dollars, saving 3 billion US dollars per year. Among them, the sports part of this amount has now exceeded 30% due to the increase in sports rights contract rates.

(2) The situation in 2023 is roughly the same as last year, slightly lower than 30 billion US dollars last year. Among them, due to the impact of the writer's strike, which cannot be quantitatively evaluated, this estimate does not include any potential impact of the writer's strike.

(3) Overall, what is really being done is to focus on general entertainment content rather than just the Disney brand, reduce the amount of content, and review creative plans.

Q: Is the decline in pay-TV accelerating, and is digital or AVOD sufficient to offset cable losses, or when is it sufficient to offset linear losses and begin to drive growth? What is your view on ESPN and when will it transition to ESPN+?

A:【1】ESPN

The position has never changed: to transform ESPN's flagship service into a DTC or streaming platform, the key is pricing and timing. Obviously, this will have a great direct impact on cable.

【2】Cable Networks

The decline in subscription numbers and weak advertising have a negative impact on its economic benefits, forcing the company to review the cost structure of video channels, and ultimately may review all related expenses.

In fact, the decline of limited networks has put greater pressure on streaming business to achieve profitability. Therefore, the company has taken a series of measures, such as optimizing organizational structure, reducing costs, transforming marketing, and tilting towards advertising. In fact, it has invested a lot of money in the technology field to provide digital services that advertisers need more effectively through automated sales and very refined ways.

Therefore, it is very optimistic about the tilt towards digital advertising and the positioning of the company. At the same time, it is also very optimistic about the combination of Disney+ and Hulu. By making Hulu an application, it will increase engagement and increase opportunities to provide digital advertising and grow advertising business.

Therefore, everything is connected: from ESPN, to the long-term health of bundled services, to the need for streaming business growth to respond to the deterioration of cable business, to all measures taken to achieve profitability.

Q: Can the integration of Hulu and Disney+ change Hulu's cost structure; the impact of wage increases in Florida on the theme park business; the logic of the growth of this business now having more boats, attractions, and pricing, but also higher costs

A:【1】Content Integration

According to the contract with Comcast, it will return its holdings of Hulu to the company in early 2024.General entertainment content integrated with Disney+ is beneficial for attracting new subscribers, retaining existing subscribers, and advertising. The final integration result of general entertainment and Disney+ depends on negotiations with Comcast. It is difficult to estimate, but it can be determined that the integration of general entertainment and Disney+ can generate real value. If Hulu is the final solution, it will be highly regarded.

[2] Profit prospects of theme parks

The overall North American park will be very stable, but costs are expected to rise, mainly due to new union contracts and wage inflation. The addition of the fifth cruise ship (Wish Back) by Cruise Line provides operational support.

Therefore, we will continue to look for ways to solve cost management problems. The team did a good job during the epidemic, using various strategies to alleviate potential profit margin pressure and downside risks in various areas - using some levers to solve the problem, that is, looking at production capacity. Some new attractions have increased their footprint or capacity, opening the valve to accommodate more visitors; some new attractions are based on updated IPs, attracting more visitors to the park experience.

The cruise business was hit hardest during the epidemic, but the business has rebounded at an astonishing rate this year, including new and old ships.

Q: More details about Disney+ advertising subscription service; views on artificial intelligence

A: [1] Artificial Intelligence

Artificial intelligence is beneficial for improving efficiency and better serving consumers. The company has begun to adopt artificial intelligence, and there are legal teams dealing with challenges such as intellectual property management.

[2] Disney+ Advertising

Advertising was only launched on Disney+ in December last year, which is a great opportunity for long-term advertising positioning.

The advertising loading rate of Disney+ is lighter than that of Hulu, and despite the extremely challenging macro advertising market, there are still existing and new users subscribing to the advertising version service.

The company has invested a lot of money in advertising layer technology and data platforms to truly provide advertisers with the most advanced programmatic and reachable advertising tools. It will not only have returns today, but also prepare for the future as the overall advertising market becomes stronger.

The Disney+ advertising version will be launched in Europe at the end of this year.

Q: The impact of integrating Disney+ into one platform on the number of subscribers; Is FY3Q the peak of streaming business losses?

A: [1] Disney+

The comprehensive application experience is for consumers who have already subscribed to two services. In other words, it adopts a double-bundled service and puts it in one experience, which is obviously good for consumers.

In addition, it is beneficial for general consumption, reducing churn rate, and more attractive. This is a multi-in-one, larger platform with more content than it previously offered. Outside the United States, this platform was created with Star, which does not have all of Hulu's programs, but it has quite a bit of content and works quite well, which is one of the reasons it was launched as an advertiser-supported platform.【2】Streaming Media

FY4Q22 was the peak of DTC's losses, with a reduction of $400 million in losses in FY1Q23 and another $400 million in FY2Q23. However, due to the launch time and related marketing, the loss only decreased by $100 million in FY3Q23.

Overall, FY4Q22 was the peak of losses, FY1-2Q23 showed significant improvement, FY3Q23 will see a slight decline, and FY4Q23 will return to the right track.

Risk Disclosure and Statement of this Article: Dolphin Analyst Disclaimer and General Disclosure