Volume 165: A Disney Masterclass.
Offensive, Defensive, Opportunistic: Disney’s Strategy Masterclass.
tl;dr: Disney makes big plays for the future.
Disney is a fascinating company right now. A 100-year-old entertainment behemoth, it finds itself with some major post-pandemic structural issues. Specifically, it faces three negative realities:
Cord-cutting continued through the pandemic, significantly weakening Disney’s broadcast revenue, primarily at television properties ABC and ESPN. This is a bit of a double whammy since fewer cable subscribers means revenue from subscription fees (paid by the cable operators) and advertising both decline.
Its forays into streaming are yet to be profitable, as the costs for original content and subscriber growth eat heavily into potential profits, while subscription fees and digital advertising are yet to take up the slack.
Movie-going appears to be in structural decline as audiences are yet to return to cinemas at pre-pandemic levels and may never do so, significantly crimping the earnings potential of the Disney studio business.
The net result of these issues, plus strategic missteps in responding to them during the brief tenure of former CEO Bob Chapek, has been a significant slide in the stock price at the same time the broader market has rallied, leading hedge fund billionaires to enter the fray in an attempt to control of the future of the company.
As a result, Disney now faces a three-way proxy battle for board control, where shareholders will be asked to vote for the board slate put up by Disney itself, or an alternative proposed by Trian Partners, and another alternative proposed by Blackwells Capital.
So, last week, and true to form for a corporation seeking to stave off activist investors, Disney delivered a healthy increase in profits and announced a dividend increase of 50% (the fruit of cost-cutting measures). In addition, it unveiled some major strategic shifts in an attempt to persuade investors that they’re on the right track and have no need for activism on the board.
Specifically, it made the following announcements:
It will partner its ESPN business with FOX and Warner Bros. Discovery to pool broadcast rights into a new streaming sports service that will cover pretty much every major US sport and league - NFL, MLB, NBA, NCAA, golf, soccer, hockey, car racing; you name it.
It’s making a $1.5bn investment in Epic Games, and Epic will build a persistent “games and entertainment universe” for Disney that’s interoperable with Fortnite, which boasts 236m active monthly players.
It signed an agreement to exclusively stream the Taylor Swift ‘Era’s Tour’ concert film on Disney+.
What I love about this is that each represents a big strategic move and is quite different in context. Let’s walk through them in turn.
First, partnering with FOX and WBD on sports represents an absolutely seismic shift. Even a few short years ago, the idea of competing entertainment networks pooling their sporting properties would have been a complete anathema. However, this move demonstrates the sheer scale of the existential threat of big tech. Live sports has been one of the few bright lights for broadcast television and cable, but it has only slowed the pace of cord-cutting, and in the meantime, tech has been getting much more aggressive in landing sporting rights. Netflix recently signed a multi-year deal with the WWE, Apple signed a multi-year deal with the MLS, and Amazon, which already had the rights to Thursday Night Football, is now adding exclusive rights to a playoff game next year.
The writing is clearly on the wall. Major tech-owned streaming services are reaching maturity on the subscriber front and are increasingly looking to advertising as a revenue source, so sports represents one of the last untapped pools of future profits (new subscriber fees plus more advertising). For different reasons, I can see both Amazon and Apple becoming more expansive in seeking sporting rights. Amazon because sports sits perfectly within its ad-supported Prime streaming, retail media, and retail store flywheel. And Apple because it likely wants to tie up immersive sports as a way to boost sales of cheaper, next-generation versions of the Vision Pro. (Although I suspect this new sporting venture will have a Vision Pro app of its own).
As a result, this new distribution partnership is fundamentally defensive in nature. It’s less about finding new space to play and more about Disney, Fox, and Warner Bros. Discovery protecting what they’ve already got. In some ways, it mirrors the creation of Hulu, which was also a joint venture formed by previously competing networks. And, just like Hulu, which suffered from owner infighting for years until Disney bought a controlling stake, this new venture's biggest risk may well come from the inside rather than the outside. So we’ll have to wait and see whether Disney, Fox, and WBD execs can get along well enough to deliver clear strategic direction or whether they just fight instead.
While defensive in nature, it’s also an essential move for these businesses to proactively decouple sports from a declining broadcast business model, and doing it together is smart, as there’s real value in not going it alone here. The timing may also be surprisingly good. For example, the rights to the Super Bowl aren’t up for re-negotiation until 2033, and Disney-owned ESPN just locked up the college football playoffs in a massive $7.8 billion deal that runs until 2031. So, even though it’ll be a tough road to climb and the price to the consumer will likely be steep, they’ve given themselves runway to achieve scale. And, if it is successful, the as-yet-unnamed new venture will likely be significantly value-additive, especially if it can become the dominant streaming gateway for live sports.
Second, the most exciting announcement was the Epic Games investment.
Where the new streaming sports service is fundamentally defensive in nature, investing in Epic and having it develop an immersive gaming and entertainment experience that’s interoperable with Fortnite is a huge, offensive move.
For context, video games are a massive component of the entertainment sector. While definitive stats seem to vary, it’s either the most valuable or second most valuable entertainment category after television, with total revenues somewhere around $282bn, depending on which data source you pick, with very healthy revenue per user and around 9% CAGR (Compound Annual Growth Rate) projected through the middle of the next decade.
It’s literally a business Disney cannot afford not to be in, so doing this via strategic investment and partnership is very smart. Historically, Disney has failed to find success in developing its own video games, more recently relying on a licensing model. However, that model would be far from ideal in developing, launching, managing, and continuously innovating a persistent gaming universe.
What I love is that Fortnite is arguably the video game Disney should have made for itself already anyway, which the success of Lego Fortnite only reinforces.
We hear a lot these days about “flywheel business models,” but few realize that Disney had a flywheel long before the term was popularized. At its core, the Disney business is a flywheel that sits atop its creative IP (think everything from Mickey to Star Wars to the Marvel universe). Its success as a business then comes from how well it monetizes this IP across a broad range of product types that all reinforce each other - movies, television shows, toys, merchandise, theme parks, cruises…and now persistent gaming.
I’m not going to make any predictions as this looks like a long-game play, but if it’s successful, look out for Disney potentially shifting from an equity investor to a buyer of Epic. (Also, its $1.5bn investment looks to be well timed since, at a $20bn valuation, Epic is now valued at half what it was during the pandemic).
This deal also appears to have a lot of strategic range to it. At a minimum, it instantly turns Disney into a major player in persistent online gaming, and in a best-case scenario, it positions Disney to take advantage of the Metaverse should it ever really take off.
Finally, and last but not least, Disney+ will be the streaming home for Taylor Swift’s Eras tour. This is neither offensive nor defensive but opportunistic. Taylor Swift is unequivocally the biggest pop star on earth; her Eras tour has already grossed in excess of $1bn globally, and the concert film that’s been playing exclusively in theaters just crossed the $260m mark.
It looks like Netflix and Universal were also in the mix, and I'd be surprised if Apple and Amazon weren’t also in the bidding. However, it’s equally clear that relative to its family-friendly brand, fan/customer overlap, and need for a big positive news story amid a proxy battle, Disney almost certainly needed this the most.
I’d be lying if I said I could put a value on having Taylor Swift on Disney+, but what I can say pretty definitively is that it is an important mechanism for keeping Disney+ in the game, keeping it in the news cycle, and keeping Disney culturally relevant as it seeks to get stumbling franchises like Marvel and Star Wars back on track.
So, there you have it. I’m not going to pretend that Disney is in a great place because it has a big hill ahead of it. It remains reliant on a cable TV business model that’s in rapid secular decline; it’s suffering soft movie attendance that’s at least partly its own fault as tentpole superhero blockbusters plumb the depths quality-wise, and big tech remains a fearsomely well-capitalized opponent.
Yet, Bob Iger has proven to be one of the most savvy CEOs in media history, Disney owns the best creative IP portfolio on earth, has a sprawling commercialization empire, a great family-friendly brand, and these recently announced strategic moves have the potential to materially position it for its next act.
So, yeah. What a lovely opportunity. It’s not often you see a major corporation making what look like really smart defensive, offensive, and opportunistic moves. All at the same time.
Now, the question is whether investors will buy it, and if they do, how good a job Disney can do at executing.
But, as a strategy lesson for you and me? Bravo, Disney. Bravo.
Note: I own three shares in Disney that I’m currently taking a bath on. You should never, ever, under any circumstance, even remotely consider anything I say as investment advice. I am about as good at picking stocks as I am at keeping plants alive. And my cactus just died.