Analysis of Disney Income Statement: Inside the Magic

Regarding its rising number of subscribers, Disney said that its streaming business does very well, even topping all the most optimistic estimations. In this analysis of the Disney Income Statement, we try to neutralize that euphoria.

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Analysis of Disney Income Statement. In this Issue:

1. Eroding Magic: Segment loss, no, it isn’t only the theme park.
2. Calculation: Getting Real number instead of the rumor
3. Solving The Problem Maybe it doesn’t have to be profit
4. Ideal Model: 365 and Creative Cloud
5. Key Takeaway

Burning Magic

With travel and group activity is restricted due to pandemics, we have a premise that people will sit down in their homes, streaming their favorite movies or TV series. So, investing in a streaming business like Netflix, Amazon (Prime), Disney (+), or Apple (TV) is a good idea, right? As usual, here we propose an unpopular opinion that one new trend doesn’t always lead to a good investment.

Our investigation of the Disney Financial Statement proves that “invest in streaming FOMO” needs to be revisited. According to its annual report 2020, Disney+ still has not recorded a profit. To be detailed, the streaming flagship from Disney accounted for 2 B in losses. The Mickey Mouse creator said that the losses are due to pandemics which we don’t agree with.

Wait, why do this matters? As long as a “whole” Disney account for profit, little loss of other segment is acceptable. Right?

Let’s see.

1. We are in the second year of the worst pandemic in the history of mankind, and we still do not see how or when this will end. When Disney’s best spot — the theme park — is hit terribly by human activity restriction, the firm needs to rely on another segment. What if – this another segment – is keeps burning cash instead of offsetting the loss? Even in a normal situation, the loss of any segment of the business is hard to tolerate.
2. These circumstances are the test for management. Warren Buffett ever said that one prerequisite he needs before investing is management: “the honest and capable one.” Disney+ itself is a rejuvenation of Disney’s business model, it is launched in November 2019 to challenge existing players like Netflix, Amazon Prime, HBO Max. We investors ask, why bother to change the business model if it is difficult to make money?

Analysis of Disney Income Statement: Math and Match

Officially in its Annual Report and any other financial filing, Disney streaming services Disney+ recorded as “Direct to Consumer and International” segment. According to that sources, to generate 16.9 B in streaming revenue, Disney has to spend slightly more than 15 B in expenses as you can see in the snapshot of its annual report we present below.

And as a revenue per subscriber, we have a worse number.

We know that this assessment is very premature since Disney just launched it in November 2019, so it is a little bit in a hurry if we talk about “trend”, however, you get the point.

Disney streaming business isn’t profitable as we think.

It is interesting to note that this isn’t a scale problem. We may think that Disney has to reach a certain number of subscriber to cover its cost, the reality is, its expense or cost increase as the number of subscribers grow. Means that Disney is subsidizing its subscriber, making a lot of promotion and sacrificing the profit.

Right now we could access Disney+ with only 8 bucks.

Solve The problem

To solve this problem, Disney has two choices or combinations of that. Let dig it. First, reducing its cost. Unlike Netflix, Disney content is “homemade”, it is produced by Disney (or subsidiary) itself. With years of experience and reputation in the media industry, we believe that Disney has reached the most efficient cost of its content production. Therefore, this choice isn’t feasible which leaves us with another possible solution.

Raising the subscriber fee is the only way to bring profit for this segment. According to our analysis –Net loss divided by the number of subscribers — Disney burns $12 for each user, Take it another way, the subscriber fee should be at $20 to break even. This figure is far inferior to Netflix.

We still don’t know how the aftermath. We try to see whether customers still stick with Disney+ even when the price goes up. We have seen this magic in Disney Theme Park, we aren’t surprised if Disney could make it once again for another segment. But, we are still very careful.

Another way to see it is…it doesn’t necessarily have to be profit. Take a look at Apple, Apple TV is designed to lock customers in the iPhone ecosystem, or Amazon’s “video” strategy to lock in its Prime subscription. Disney+ may be a just value-added for customers to invite them to Disneyland or to buy more Disney merchandise.

365 and Creative Cloud

The ideal example of a subscription business model is Adobe (creative cloud) and Microsoft (365) which is the production cost is very low. The key is to enhance its service with more features and updates – something that Disney can’t do. Microsoft could add new features for its spreadsheet services or change the UI, making it a product with better value so people don’t need to buy every new office version. Disney can’t – adding some flashback clips of the Mandalorian story doesn’t offer enough value for customers.

The problem with the streaming business is: it is an unbundled version of the TV cable. It needs time to make a profit, and we don’t know when that time pays off.

What we fear.

As we have mentioned, the subscription model best serves when an update is regular and improvement is done on a periodical basis. In Disney’s case, the success of the subscription model depends on its capability to deliver a new story and idea – which we didn’t see.

Another Key Point of Analysis

Yeah, you’re right. Disney isn’t only about streaming, so we present several key points of its annual report:

1. The theme for Disney in 2020 is its theme park segment. One of the glorious industries sealed by the pandemic. We don’t know when it will open with full capacity, vaccine deployment will take care of this. Honestly, this situation is best for value investors as Buffett ever said, a great company in temporary trouble is a good opportunity. Before coronavirus, we never imagine that outdoor activity will be restrained.
2. Besides the shutdown of its theme park, a drop in Disney earnings is contributed by structural change. In 2020, the Mickey Mouse creator announced 28,000 employees lay off. We believe this one-off expense will help boost company profit in the upcoming period.
3. As earning plunge, management reduces the dividend paid and lay off its employee. Painful decision but it is a common and logical decision. What makes we doubt on management stewardship is that bonus and compensation for a top executive are back in pre-COVID level. The management cut the employee, cut the dividend, but still keep paying themselves. It will be a note for us.

Analysis of Disney Income Statement: Key Takeaway

1. The new business model isn’t necessarily profitable. It needs time to prove. It is worth noting that the streaming services need time before covering their loss and begin recording a profit like Netflix and Spotify.
2. Since it burns money and another great segment is shut down, the investor needs to watch closely on Disney’s balance sheet.