Disney Q3 Earnings: The Painful Transition To Direct-To-Consumer
Yesterday a besieged Bob Iger, chairman and CEO of Walt Disney Co. had to defend his company’s Q3 (calendar Q2) results against the inflated demands of Wall Street. Disney has come out with a bold strategy to compete directly with subscription video on demand (SVOD) services, with the announcement of its intent to launch a direct-to-consumer Disney originals content proposition in 2019, alongside the launch of streaming sports service ESPN+ in April 2018. To support this bold undertaking it acquired a controlling stake in BAMTech in 2017— the tech company that built HBO Now, and it also announced an audacious takeover bid for 21stCentury Fox’s non-sports and news assets in December of last year.
The Q3 performance of the Media Networks and Studio Entertainment underlines the need for change
Of the four segments in the Disney portfolio, the two that provide the strongest indication of where audiences are going and what the impact will be for Disney are the Media Networks segment and the Studio Entertainment segment.
The two divisions of Media Networks (Cable Networks and Broadcasting) had contrasting Q3 results. Cable Networks saw a 2% increase in revenues compared to the same quarter in 2017. However, its year-on-year operating income decreased by 5% driven by an ongoing decline in viewing, cord-cutting, and increasing content costs—in particular, the increased costs of the 2016–2025 NBA broadcast rights for ESPN. For the first time BAMTech was also added to the profit and loss for Cable Networks as a result of Disney’s 75% stake in the company. This also had a negative impact on the operating income for Cable Networks, as BAMTech has shouldered the development costs for ESPN+.
The Broadcasting division on the other side saw an 11% year-on-year gain in revenue and a 43% gain in operating income, which was largely ascribed to the increase in programme sales led by Designated Survivor, How To Get Away With Murderand Luke Cage. All programmes have been sold to Netflix, and this underlines two key challenges for Disney as it prepares for 2019. On the one hand the 43% increase in operating income reflects the current content bubble, where direct-to-consumer video businesses are overbidding for proven content. On the other hand, it underlines the hit to revenues that will occur when Disney brings its content in-house and stops selling to its SVOD rivals.
The Studio Entertainment segment experienced a 20% year-on-year revenue growth, but only 11% growth in its operating income over the same period of time. This was due to a combination of the increasing costs of making big-budget four-quadrant productions such as Avengers: Infinity War,alongside the continued decline in home entertainment revenues. Effectively, it is costing more to generate incremental revenue growth in this segment, while Home Entertainment as a segment is haemorrhaging customers to SVOD.
Disney is betting the farm on generational change in consumer behaviour
Yesterday’s results in the Media Networks and Studio Entertainment underline the challenges that face Disney, as consumption behaviours shift towards on-demand video consumption. The impact of this shift will be as profound as the switch from radio to TV in the 1950s and as long lasting. To Disney’s credit, it has decided to implement profound institutional change and go direct to consumer, in an attempt to gain a seat at the table of next-generation media players. The risks in doing nothing are now clear. The challenge for Disney is how to buy sufficient time to enact the necessary change in the light of the quarterly demands of impatient, and short-term-thinking Wall Street.