Shares of Disney (NYSE:DIS) have languished over the last few years, trailing the market and doing a whole lot of not much — and that’s going to change.
In this week’s episode of Industry Focus: Consumer Goods, host Dylan Lewis and Motley Fool contributor Dan Kline explain what’s behind Disney’s troubles and why the company is setting itself up extremely well for the medium and long terms. Learn about what role Disney+ could play for the IP giant, how Disney has improved its strategy on the theme park side of the business, why a “flop” like Solo isn’t as much of a flop as you might think, where ESPN and ESPN+ fit into the picture, and much more.
A full transcript follows the video.
This video was recorded on Jan. 22, 2019.
Dylan Lewis: Welcome to Industry Focus, the podcast that adds to a different sector of the stock market every day. It is Tuesday, January 22nd. We’re talking about the House of Mouse. I’m your host, Dylan Lewis, and I’m joined in the studio by fool.com‘s Dan Kline.
Dan Kline: I had a mouse in the house. [laughs] Went to the family house in New Hampshire, hadn’t been there in a few weeks. Went to go to the bathroom. Bunch of mice had decided to commit suicide in the toilet.
Lewis: Oh, that’s morbid and gross, Dan!
Kline: Not the mouse in the house we’re talking about. [laughs]
Lewis: No. Big difference between the House of Mouse and mouse in the house.
Kline: Much healthier mouse we’re talking about here!
Lewis: Order and prepositions really matter there. We’re talking about Disney today.
Kline: I’m a Disney theme park pass holder.
Lewis: And I’m a shareholder. And I’ll tell you, Dan, when I joined The Fool, we make a certain amount of money available to new employees, it’s part of your onboarding. You get some money, and the goal is for you to start investing, to buy some shares so that you start understanding how the stock market works, you start following companies. Even if you’re not in an investing role, or in the editorial department, you start following businesses the way that a lot of our investing teams do. And when I made my first purchase with some of this money that I’d been given, I bought a lot of the no-brainer stocks. I was like, “I’m new to this, I want to learn.” It was Whole Foods, it was Apple, and it was the House of Mouse, it was Disney. I think if there’s anyone like me that has the same holding period, they’re like throwing their hands up like, “What’s going on with this company?”
Kline: Disney’s been challenged by, they’ve been spending a lot of money to get to where they are now. If you look at the Pixar purchase, the Lucasfilm purchase, it’s all about amassing a film schedule that they can build everything else off of. When you release movies, are you more likely to go see the new Star Wars or Space Adventure: Part 1? Yeah, it’s a great preview, but you don’t know the Space Adventure characters so well.
Lewis: You take the known entity.
Kline: That’s what Disney has been doing, they’ve been building up intellectual property. But when you look at that, you can’t make a new Star Wars film in three months. You can’t build a Star Wars Land at Disney World and Disneyland in three months or a year or three years. There’s been a long-term investment in getting Disney to the point where their movie business, which, while it’s only a relative fraction of their revenue at about $7 billion this year, is the driver for everything else. You take something like Marvel, how many movies, TV shows, theme park rides — there’s a limit on the theme parks in the U.S. because of the Universal deal, where they don’t have the rights to some of their own characters — pajamas, comic books, video games, ice cream bars? There’s nothing that Disney can’t license once it has the right intellectual property in place.
Lewis: We talk about the Disney magic so often. I think the truth is the magic is its IP if you’re looking at it from an investing perspective.
Kline: Yeah. So, you asked, why has it been so slow? Why has the stock languished in this range? Some of it is, when you’re as successful as Disney, small failures resonate. One of the ones we talked about earlier today was Solo. Solo was a $400 million — $392 million, to be fair — box office bomb. That’s not, by the standard of bombs, very bomb-y.
Lewis: There are a lot of studios that would kill for that to be a bomb.
Kline: It will probably actually break even. You know the movie accounting, they always try to make it not break even to not have to pay actors more. But that film didn’t lose a lot of money. That’s what a Disney bomb looks like now.
ESPN. “Oh, my god! ESPN’s in free-fall! They lost a million subscribers in however many years!” Relatively, ESPN is still the cable channel you pay the most for, it’s still in 90-something million homes, or 88 million or whatever the exact number is.
Every little misstep with Disney is a big deal because it wasn’t Space Rogue: The Movie. It was Solo, and we know who Han Solo is. My mother, my grandmother — who is deceased — my great-grandmother — who is very deceased — all knew who Han Solo was.
Lewis: [laughs] We’ve had a very morbid take so far, between the mice and your family tree, Dan.
Kline: [laughs] It’s not a tragedy that great-grandmother died at 99.
Lewis: You’re absolutely right.
Kline: But, she knew who Han Solo was. So, when that movie doesn’t do well, it really resonates. When the latest Pirates of the Caribbean wasn’t reviewed that well– and while globally, it did OK, it was a middling U.S. thing — that feels like a much bigger failure than when Comcast releases something under Universal that was a $200 million guess. Like their Tom Cruise remake of The Mummy. That’s a much bigger failure than Solo, it just doesn’t have the name recognition.
Lewis: Between some of these quote-unquote “misses” and what’s been going on with cord-cutting, we’ve seen the stock hang out in no man’s land for a while. You look over the last couple of years, they’ve hung out between $90 and $120 a share. Depending on your cost basis, you’re up maybe 20%, trailing the market, or even down, perhaps, on Disney shares.
Kline: It’s the difference between the leeway investors are going to give a tech start-up — it doesn’t matter if Netflix spends three times more on content than what it’s taking in. The ratio isn’t that bad, but let’s pretend it was. When Disney does the same, because it’s a mature company, nobody says, “Hey, Disney is positioning itself so no matter where cord-cutting and streaming bottoms out, they’ll have every answer.” But if you look at Disney+, if you look at their stake in Hulu, if you look at their owned networks and content, when we know what the cable landscape is — and we both cover this, and we don’t know if cord-cutting bottoms out at 50 million homes or 75 million, we really don’t know — Disney will be able to have the right property to sell you what you want in a way that, especially if you have kids, you have no choice but to buy it. You can’t not have the channel that has Frozen or Cars if you have eight-year-olds or six-year-olds.
Lewis: Yeah, the IP library is simply too valuable for Disney, and it’s too much of a must-have for them. Also, looking back at why this company has struggled a bit over the last couple of years, because they have this robust ecosystem where they put out the movie, they sell the merchandise, they create the ride, any misstep at any point, especially when you’re talking about the studio side of the business, is going to create trickle-down problems for the company.
Kline: Right. It’s why they’ve taken a more measured approach. One of the drags on their business has been that later this year, they’re going to launch the largest expansion ever at Disney World and Disneyland, Star Wars: Galaxy’s Edge. If you were planning a once-every-five-year mega-family vacation to Disney World, would you go this year, where they introduced a new-roller coaster themed to the Slinky Dog from Toy Story? Or would you wait until the largest-ever, based on something adults also like? They’ve done a ton of incentivizing to those of us Florida residents who have passes: “Hey, come! We don’t get any extra revenue from you crossing the door, but you’re probably going to buy a churro and a drink and who knows what else.” They have begged because people are pushing off vacations.
Think of it all as investment. Disney has had to invest in Disney+, invest in ESPN+ — which I have a lot more questions about, that’s much riskier — and the theme park investment is absolutely massive. When they launch the Star Wars Hotel, which is going to follow in 2020, 2021, it’s going to be $2,000 a night per person, is the rumor. Think about that. It’s a tiny piece of revenue. It’s only going to be a small hotel. But where else could you possibly charge that, except for an interactive Star Wars immersive experience hotel?
Lewis: It speaks to the value of the franchises. I think a lot of the people that really love the company have been pretty thrilled with the actual product that’s been put out there. A lot of the recent updates to some of the storied franchises have been good, and people have liked them, at least for viewers’ perspective. It’s indulged the fans well. The financial results haven’t been there, though.
Kline: Pixar has generally been a home run. They’ve had very few missteps, and even the missteps there are still very successful and well regarded. Obviously, Solo, by the standards of Star Wars, they made a movie nobody cared about. All of these people say, “No one’s going to see that,” well, Episode IX, they’re going to see. They want to know what happens to, call it the Skywalker Saga. They want to know how they handle Princess Leia dying. If they make a Darth Vader prequel, people will go to that. Han Solo was interesting because he was roguish. You didn’t really know his backstory. When you fill that in, that was a misstep. You don’t want to be the mysterious guy out there at a date, and the woman’s got your whole bio. That’s not great.
Lewis: [laughs] So, being plagued with some of these problems, also being plagued with some issues related to cord-cutting, you look at the company’s financials over the last year or so, and going back into 2017, they were flat in fiscal 2017. They returned to growth in 2018. 8% revenue growth. 40% bottom-line growth, which is pretty incredible. I think they benefited a bit from some of the timing of releases. They were really crushed in 2017 by their release calendar.
Kline: Yeah, fiscal 2017 did not have an Avengers movie. The Star Wars movie was the end of the year, so that put it into fiscal 2018. It had Coco, which was a surprise hit, Thor: Ragnarok, which did better than the other Thor movies, but is still just middling — which is ridiculous to say. Any other company would be thrilled to have a $500 million global box office success. But by Disney standards, they didn’t have their billion-dollar standards. And when you have a surprise — like Moana, the level of hit that Moana was a surprise. That means that when you go to stores — and we saw this with Frozen when it came out. Nobody knew Frozen was going to be a phenomenon. You couldn’t go to Target and buy a Frozen backpack. They sold out in 8 seconds. I had friends who were combing the earth or making their own. A year later, that wasn’t an issue. They knew that demand.
So, when you have an off year with box office, maybe the things you’ve lined up, the big deals, don’t do as well in the other channels. And it’s a ripple effect. Nobody wanted to go to Disney World to do a meet and greet with young Chewbacca from Solo, or whatever. I didn’t see Solo. I’ve read every Star Wars book and seen every movie, except the books about Solo and the movie just didn’t have any appeal, and I am the core audience.
Lewis: I know that my girlfriend, who’s a big Star Wars fan, loved Solo, because her ultimate fan crush is Harrison Ford as Solo. So, it met that audience very well. She was very happy with the movie. But, I think you’re right, the timing of some of those releases made it tricky, and also the level of hit factor that they were made it a little tricky with their financials.
We look now, they just closed out fiscal 2018 back in the fall. I mentioned 8% revenue growth. The EPS numbers are looking pretty good, too. And yet, we’re seeing Disney now trading at the lowest valuation that it’s seen in the past couple of years. I think right now, shares are around 13.5X trailing earnings.
Kline: There’s uncertainty in a number of areas. The Fox purchase, $20 billion or something, could be a drag. They brought back a lot of intellectual property that will eventually work, but it’s going to take them a while. How does Disney put out a Deadpool movie? [laughs] That’s not a classic Disney release. Can Disney do something like the Logan movie, which was one of the later X-Men sequels that was very, very dark and doesn’t feel like Disney at all? I think they’ll figure out how to make those movies and then make them theme park rides when they have the rights, but there’s a lot of questions about that.
The other big question is ESPN+. This is the one area, if I’m going to question what Disney’s doing — when they launch Disney+, they’re going to launch it with Star Wars shows, Marvel shows, Disney Kids properties, Mickey Mouse. It’s a no-brainer. I will pay for that right now in advance. ESPN+ is spending huge money, $200 million a year, to UFC for things that 600,000 people watched when they were on FS1 for free. I question building a service around stuff not good enough to air on ESPN.
Lewis: Do you think that some of that, though, is people looking out and saying, “All right, professional sports contracts are getting outrageous. It’s becoming so expensive to be the source for all of the main leagues. We need to appeal to the niches that we know exist.” WWE is the perfect example of a company that, it doesn’t make any sense to me as a niche, but it’s built an empire on a very specific audience.
Kline: We’re taping this in advance. The day we tape this, I did a Market Foolery with Chris Hill, and we talked about exactly this topic. WWE brings an audience. WWE to Fox, where they’re paying $1 billion over five years for SmackDown Live, will do 1.8 to 2.2 million people. Maybe it’ll tick up, maybe it’ll tick down. If they get a character that’s hot, maybe it can get to three million. It’s not going to bottom out. That is a sure thing. When you’re taking Top Rank boxing and giving them hundreds of millions of dollars with only a few stars, people have actually so far proven more willing to spend $60 on a pay-per-view than $6 a month. It’s been a problem for the WWE Network. They said, “OK, Dylan’s not a wrestling fan, but he loved Hulk Hogan.” I know you did.
Lewis: [laughs] I’ll play along.
Kline: “And he buys WrestleMania every year and one other pay-per-view. He’s spending $150 for this every year. Why wouldn’t he spend $9.99 a month?” Because it’s an impulse buy. That’s where I think, maybe they’ll figure out enough niche sports that I say, “Ooh, because I want to watch that boxing fight, I will happily watch the other shows they’re producing. It’s worth it to me.” For me, I have every other streaming service, almost literally every other streaming service. Nothing ESPN+ has showed me — like, I’d love to watch Katie Nolan’s show. I think she’s a great performer. I’m not paying $6.99 or $5.99 or whatever the number is, it depends how long you subscribe for. That’s the one I question.
But, remember, this isn’t ESPN. This is the add-on. If they start giving me ESPN and make it $9.99 a month, that’s part of why I have Sling TV, is access to ESPN. They’re protecting their cable business by not doing that. Someday, they won’t do that.
Lewis: It seems like so much of the uncertainty that’s currently priced into Disney and the expectations for the company are, what value does ESPN have in the future for them? That’s been, not quite the moneymaker, but it’s been one of the strongest franchises they’ve had outside of the traditional movie library.
Kline: And it’s been a subscription business. If you look at it, it’s almost $9 for the ESPN family of channels. It varies by cable company. You couldn’t opt out. It was part of basic cable, and everyone had to have cable. That’s a pretty good business to be in. Now that cable is probably going to lose two million subscribers this year, and then another four million or five million will have switched to cheaper streaming, that gets to like eight or nine million potential customers lost by ESPN that they used to do nothing for. So, yes, ESPN is going to take a hit.
But Disney has all these other ways they can make that back. Could they bundle ESPN in with the Disney Channel, all of its Kids stuff, Disney+, Hulu, whatever else, and make you a very attractive offer that starts to reverse that growth? Or could Disney just say, “It’s a new world. We’re going to buy all sorts of niche stuff. We’re not going to buy the NFL next time.” Right there, budget problem solved!
Lewis: All right, Dan. We’ve painted a little bit of an uncertain picture for Disney in this first half of the show.
Kline: It’s an uncertain if your timetable is short.
Kline: They own everything they need. They just don’t know how to deploy those assets. Even if you look at, the movie theater business is becoming blockbuster driven. The art house film is much more likely to have a limited release and go to Netflix now. The only films you’re going to see are the Disney ones. We passed around this list, was it 7 out of the 10 most anticipated — it was a Fandango list?
Lewis: Oh, yeah, it was something ridiculous.
Kline: Seven out of 10 are Disney movies. They have the next Star Wars movie and Avengers: Infinity War and Frozen 2 — which didn’t make the list! — coming out next year. That’s $4.5 billion in the box office if they don’t do well.
Lewis: Yeah, to your point earlier about the Disney standards being a little different, there’s a lot to be excited about with this company. You named a couple, but the slate for 2019 releases is darn impressive. I have to think, looking back at how we were talking about it before, the studio business fuels the merchandise business fuels the theme park business. You get those types of hits, it could be off to the races again, especially because so many of these are proven franchises.
Kline: They’ve also gotten smarter about their business. Part of the reason for the Fox acquisition is so, when Disney makes its box office slate every year, it can line up and say, “We have 10 guaranteed hits. We’re taking two shots of, maybe a remake, and maybe one new property,” which they’re more likely to do animated because the failure on an animated can be made up in the secondary market, there’s still a DVD market, there’s still a kids’ market. If you put out a Cars 3 and it doesn’t do as well in the box office, it’s still going to do fine. Kids like to watch movies. Parents can’t pay attention all the time.
Lewis: Parents love for their kids to be watching movies. [laughs]
Kline: [laughs] Yes. But the other thing they’ve gotten really smart about doing is, there are all sorts of additions coming to the theme parks. There’s a Tron roller coaster. There’s the Guardians of the Galaxy roller coaster at Epcot. There’s a pretty major makeover at Epcot. There’s some tweaks and some new shows at Hollywood Studios. They aren’t telling you when any of those things are coming because if I really, really want to go to Hollywood Studios because of the new Mickey Mouse ride, which is the first-ever Mickey Mouse-featuring ride, and some people are very big Mickey Mouse fans — I know, living in Florida — they’re not letting you know exactly when that’s going to open because they don’t want me to say, “Eh, I won’t renew my pass. I’ll wait six months until I know when that ride is opening.”
Lewis: That dynamic reminds me a little bit of the Apple iPhone product release problem. They say, “OK, we’ve got the new device coming out. Here’s where it is.” And then sales halt. Everyone is like, “Well, I’m not going to buy a new one. I’m going to wait until the next one comes out. I want to see what the specs look like.”
Kline: Right! And the other thing that Disney has fallen victim to is, when you put something out that’s kind of underwhelming — their big release this year was Toy Story Land. Toy Story Land was: an existing ride, Midway Mania!, which is a great ride, it’s really fun, it’s a shooting gallery, it’s interactive, it’s a lot of fun; a carnival spinner ride that’s nothing special, there’s 30 other versions of it in the parks; a family roller coaster; and a couple of new quick-serve restaurants. A very nice addition to a park that needed it, but nobody’s taking your vacation for that one.
The same thing happened at Universal Studios. Their big ride this year was Fast and the Furious, which is a fine ride. It’s not that fast, it isn’t it all furious. It’s not a thrill ride. And that was the big release for the year. Now, they’re only going to do major releases when it really is something major. When it’s just an incremental, “Here’s something cool that’s new,” they’re going to downplay it a little bit and try to even out their business. The biggest challenge Disney’s going to have in the next two years is, how do you manage capacity? When you have the Star Wars ride that has, you’re piloting the Millennium Falcon, and there’s six simulators, and six people can sit in six, and it’s a six or seven-minute ride, you can see how the line’s going to get pretty long for that one. So, how do they entice you — and they’re doing it with pricing — to go to Animal Kingdom that day? Or to go to whichever park isn’t going to do well? Take a water-park day?
The pricing on the tickets for one day is different by park. It’s different by crowd. There’s all sorts of premium upcharges. If you want to ride that ride five times in a row and you’re willing to pay $200, there will be an option for you to do that.
Lewis: Something I want to do while we’re talking about Disney is dissect the Disney+ offering a little bit. I know as a shareholder, this is something I’ve looked to and said, “This is the no-brainer service. If you’re a parent and you have young kids, you pretty much have to have it because that’s what they want. They want that IP library.”
Kline: You assume they’re going to bundle a lot of the kids’ programming.
Lewis: I would think so.
Kline: Obviously, some of that is licensed elsewhere, but eventually — just like they pulled back everything Marvel from Netflix — eventually they’re going to pull back whatever they can pull back. You’re going to get your Mickey Mouse and Goofy and Pluto and eventually the library of movies, and all the stuff that every kid watches a thousand times. That’s going to be an enticement.
Where they have an advantage over Netflix — and we’ve talked about this a few times personally and on the air — is that they know, in creating two Star Wars shows, unless those shows are terrible, which they won’t be, given the creative people involved, I’m going to watch that. Michael Douglass is going to watch that.
Lewis: Not the actor, The Fool’s Michael Douglass.
Kline: I was going to say, those of you who have been an Industry Focus follower for a long time, you know Michael’s name. He’s a very big Star Wars fan, along with me. When they launch a show based on Loki starring Tom Hiddleston, the actor who played him in the movies, that’s going to be a major draw. And I look at Netflix — if there’s one show I’m watching that gives me something to do tonight, that’s worth it to me. Disney won’t have to make as many shows to hit all the age demographics. Plus, they do have whatever they own through ABC, I don’t know, Roseanne reruns? [laughs] I’m not really sure what ABC owns and doesn’t own. All the old Wide World of Disneys, all the archival programming. But in terms of their new content spend, they’re going to be able to figure out, “Gee, Dylan is not a Star Wars fan, but this is what we own. He loves Pirates of the Caribbean. We’re going to do a show based on the young Captain Jack.” I don’t even remember if that’s the guy’s name. I think it is.
Lewis: It is! It’s Captain Jack Sparrow. Yeah, they don’t have to build out the library and spend $8 billion, $14 billion, whatever it is that Netflix wants to drop to create shows that they can then spread fixed cost over. So, the financials look a little bit different. But thinking about Disney+ a little bit, you tell someone, they’re getting into streaming. This is where the industry is going. That sounds like a game changer. Then you start looking at the numbers a little bit, and it’s not quite the case.
Kline: No. Everybody’s launching a streaming service. Most of the wireless carriers — AT&T, Verizon. Comcast has NBC and Disney owns ABC. CBS has their service with Star Trek and… that’s it? [laughs] The Good Wife spinoff, The Good Fight. But Disney can do this in a way that really nobody else can. You could argue maybe if Comcast and Sony teamed up, maybe they’d have even half of what Disney can launch with. But think about it, they could do a spin-off of Frozen and an adult-themed X-Men show. [laughs] Not that adult, it’s Disney.
Lewis: Yeah, but, they have the content library to draw on. I think what’s interesting, though, is you hear that, and you think, this should be a boon for them financially. And the reality is —
Kline: It’s a cost for a long time.
Lewis: It’s a cost for a long time. And even if it hits the scale that a Netflix is at, it isn’t going to be a huge, huge driver short-term for them financially. They’ve already talked about in the past how they know they can’t price at what Netflix is at because — and CEO Bob Iger has said this — they have less volume. They’re not going to have the depth in terms of product library. They’re going to have everything you want to watch.
Kline: See, I don’t think they could launch at $11.99 a month. I think they’re going to launch at $6.99, $7.99, or do what some of the other services have done, give you a year for $60 or whatever you pay up front. But I think the reality is, it’s not going to take them that long of dollar-a-year price increase to get where they need to be. This will hurt third-rate streaming services. Are you going to maybe drop DC Universe, WWE Network, MLB, whatever it is, if you’re only kind of using it? Yes, because your whole family is going to get value out of this.
But I really do think this becomes the one. Yeah, you’re going to have Netflix, you’re going to have Disney, you’ll have Amazon Prime not because you’re paying for it but because you like free delivery. And maybe you’ll have Hulu or Sling, your streaming service. That’s going to be your $60, $70, $80 cable bill. I don’t see anybody else being able to get in as cheaply as Disney’s going to be able to get in.
Lewis: I 100% agree with you, Dan, in terms of the pricing being, “We need to start low and see exactly where the price sensitivity is.” But, knowing that they’re probably going to be coming in at $7 or $8, think about it, if they get 100 million subscribers — years out from not, not immediately. This will launch in late 2019. That’s not going to be a huge boost to the top line for them. They’re a big business. They make $60 billion in trailing 12-month revenue.
Kline: No, it’s not going to be a huge boost. But it’s also going to be all of the other things you can do with that. This will support more theme park rides. They will, in theory, make stars out of characters that were in their universe but weren’t stars. That becomes meet and greets, that becomes more pajamas, it becomes video games. It’s all the ability to get every nickel out of what they have.
Much like Netflix, Netflix is spending $6 billion to $8 billion, whatever the number is, that’s not a forever number. At some point, they’re going to say, “We have this huge library, and all we need is for the existing customer, the one or two things they’re going to watch every quarter.” So, if you’re Disney, once you have 10 seasons of Star Wars: The Mandalorian and whatever the other Star Wars Show is going to be, maybe you only have a Star Wars series that produces 13 episodes every two years. You’re not going to need the level of content spend as you build the library. And your library is going to be way more hit-driven. If I said The Ranch and The Laptop, do you know which one is a Netflix show?
Lewis: [laughs] I know The Ranch is a Netflix show. I’ve never watched it.
Kline: Can you promise me The Laptop isn’t? [laughs]
Lewis: I can’t.
Kline: Neither can I.
Lewis: They’re both nouns. [laughs] The other thing you need to keep in mind if you’re looking at Disney shares over the next year or so, and you’re thinking about what the streaming service might do, is, there are going to be people that are cable subscribers that decide, “I don’t need this anymore because all my kids want are the Disney franchises anyways.”
Kline: I have everything and cable. I am right at the edge of saying we don’t need cable. One of my logics on cable was, you pay extra on some of the services. Sling costs you more for multiple streams, so it wasn’t feasible for my wife and I had to be watching one show and my son to be watching another. We’d have to pay extra for that. My son doesn’t watch traditional television. He’s much more likely to watch a Disney streaming service than he is to ever flip around and watch Iron Man on the Disney Channel. It’s a cartoon, I watch it sometimes. Or, to watch Star Wars Rebels, or any of the Disney content that he’d probably like. He’s much more comfortable with an iPad or his phone watching stuff.
We’ve gotten to the tipping point, where the only reason I keep traditional cable is that I don’t want to have to go to the bar to watch sporting events. When I figure out the best way to bundle — because I live out of market for my team, so it’s not that hard. When I figure out the way to get the Rangers, the Red Sox, Boston Celtics, and the New England Patriots and it doesn’t cost me…it would cost a lot to do that now. Then I’m done.
Lewis: And I don’t think you’re alone there, Dan. I mentioned that to say that Disney+ is not necessarily found money for this company.
Kline: It’s protecting their own turf.
Lewis: It’s protecting their own turf, and in some ways, it reminds me a little bit of what we’ve seen so many software companies do over the past 5, 10 years. I think of Microsoft specifically. They said, “We’re not going to sell individual years of Office. We’re going to slide over to the software-as-a-service model.” And they weathered some lumps in doing that but look at where they are now.
Kline: And I think that’s where Disney is going. They’ll own a controlling stake in Hulu, which has a live TV service, whether they buy out their partners or do something on their own. Their ability to take what they already own in the cable space, maybe make deals with some lesser players like a Discovery or who knows who else — maybe Fox because they have a good Fox relationship. If you have Disney and Fox in your bundle, that’s a lot of sports. You’re losing a little with TNT, TBS. Maybe you can make that deal, too. But your ability to be the Disney package that costs $22.99 and makes it not worth having Sling TV or whatever else the options are, that’s going to be there. They just don’t know what the deals are going to be. They’re going to have to sell you ESPN. At some point, they have to go to their cable partners and say, “I’m sorry.” If you look, Sling TV has ESPN, but it’s at a capped total. They don’t publicize what that number is, but there’s some point where Sling will say — and that’s how they appeased cable — “This is only going to take so many subscribers before they have to pay more or whatever.” Eventually, it’s going to be a free-for-all. They’re going to lose rates here. But cable, if it slips from 88 million to 80 million to 75 million, wherever it’s going to go, it’s going to lose bargaining power. And Disney is going to say, “Hey, you’re not selling this for me. I have to go sell it myself.”
Lewis: To bring this conversation full circle here, we started out talking about how over the last couple of years, Disney shares have not really done a particularly great job for their shareholders. They’ve been below market in terms of their returns. Looking out, I think there’s a lot of things to be excited about with this company. I don’t think that Disney+ is something that they’re going to turn on and start printing money.
Kline: No, it’s a drag for three to five years.
Lewis: Yeah. I think the slate of movies that they have coming out in 2019 really cues them up well for subsequent years, and the box office numbers are going to look great, but the other stuff is going to come in the years that follow.
Kline: This year will be a record box office. I wouldn’t be shocked if they hit $10 billion, when you look at the slate of what they have. That said, there will be something that fails. Probably not one of the big three. Avengers 2 isn’t going to fail, Star Wars isn’t going to fail, Frozen 2 isn’t going to fail. But there’s probably a misstep in there. And it doesn’t matter. The reality is, this year is going to set them up. But that’s the blueprint they have. If they can add two films a year from the Fox library that become automatic box office hits, essentially, that shores up their whole business and resonates through all of it, down to the streaming service.
This was a period of investment to figure it out. And even with Star Wars, they’re not never going to make another stand-alone movie again. They’re just going to pick better. Or, if they make a Solo, they’re not going to spend $250 million making it. They’re going to recognize that a Boba Fett movie is maybe a $500 million box office movie, spend $60 million on it and another $60 million marketing it. Don’t spend $250 million and go through three directors.
Lewis: Yeah, more lessons learned for Disney. For me as a shareholder, I would have liked to have seen better returns over the last couple of years. I understand why it didn’t happen. I’m still not expecting anything crazy in 2019 for them.
Kline: I think you might get, call it an artificial bump, because the box office will be so high from that surface report. Box office numbers get a lot of media. It’s one of the few business metrics that everybody hears all day, and it’s never explained right. They never talk about what it costs to make the movie or the fact that the theaters get some of the money. [laughs] Disney is in a very good position to negotiate those splits for some of those movies. I think there might be some artificial bumps, but when you dig into the numbers, the costs are going to be very high.
At the theme park level, they’ll come off the Star Wars. They’re not slowing construction at all. There’s multiple hotels, there’s multiple major rides. They’re still in a very big capital-intensive period. And frankly, that’s not going to slow down. But the content investment will slow down. They don’t need 17 more Star Wars products for the streaming service once they’ve made a couple of shows. The Loki series, The Scarlet Witch series, those are going to be valuable to new subscribers for 30 years, probably, until they look bad because they’re old.
Lewis: Yeah. I’m looking at this stock and I’m saying, I think 2020, 2021 could be far better for this company than 2019 will be, even though there’s a lot of really good stuff to look forward to. On that, though, I will add that if people are looking out at 2019 and they’re a little bit concerned about what’s going on in the market, Disney’s a company that’s not going anywhere.
Kline: It’s a safe haven. The reality is, it could have a middling year based on expenses dragging on profits, but it’s not going to fail.
Lewis: It’s not going to fail, and it trades at such a low valuation right now that there’s only so much room for it to go down. I talked about this with Brian Feroldi on the Tech show a couple of weeks ago, and we talked about that with Microsoft and Verizon. Those are the types of companies that, yes, they’ll get stung a little bit by a recession, but they’re not going anywhere. Not a bad place to park cash. I look at Disney the same way right now. Yes, there are some good things to look forward to. I don’t think 2019 is going to be the banner year, you could do far worse.
Kline: There’s also some things — I’ll close on this — that Disney can do. Netflix has intentionally not sold DVDs of anything it owns. Some things, it doesn’t control the ability to not do that. Disney could very much say, “There’s a percentage of people who are never going to buy Disney+ but who will buy The Mandalorian on whatever format,” streaming, DVD, whatever it is, “at a premium price.” So, their ability to wring every dime out of this stuff — and I get why Netflix is doing that. They want you as a subscriber. It becomes a passive renewal. But if you’ve made a decision that all you like about Disney is Star Wars, Disney will sell you Star Wars at whatever price you’re willing to pay for it.
Lewis: Disney will find a way. Dan, thanks for hopping on today’s show!
Kline: I’ll wear Jedi robes next time.
Lewis: [laughs] Listeners, that does it for this episode of Industry Focus. If you have any questions or if you want to reach out and say hey, you can shoot us an email over at firstname.lastname@example.org, or you can tweet us @MFIndustryFocus. If you want more of our stuff, you can subscribe on iTunes or check out the videos from this podcast on YouTube, where you’ll see that Dan is not wearing a Jedi robe. [laughs] As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don’t buy or sell anything based solely on what you hear. Thanks to Austin Morgan for all his work behind the glass! For Dan Kline, I’m Dylan Lewis. Thanks for listening, and Fool on!