Go Woke, Go Broke

The Fed may be slowing its tempo, retailers are enjoying upbeat earnings, Treasuries are rallying and oil is rising. Oh, and some crypto fanboy engineered a crash in “collateral” from $60 billion to $9 billion. Here’s what you need to know heading into the market holiday.

Bottom Line Up Front

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• Revolut announced that it has reached 25 million customers and now processes 330 million transactions each month.

• Spotify launches payment options with Google.

• Manchester United’s U.S. owners said they would consider a sale of one of the world’s most prominent sports brands. (They also just fired Instagram’s most-followed).

• HP will eliminate ~6,000 jobs over the next three years amid a declining demand for personal computers (shocker).

• Visa garnered attention during the World Cup with the introduction of face-validated payments and instant-issued prepaid cards with animated art in Qatar.

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Deep Dive: Go Woke, Go Broke

In one of the most public about-faces in recent history, Disney is admitting they’ve screwed up. Late on Sunday night, they announced CEO Bob Chapek was out as head of the company, to be replaced by Bob Iger. There wouldn’t even be a transition.

Iger is back in control immediately. Let’s dive into Chapek’s tenure and whether Iger’s return will be the fairytale ending the Disney board envisions.

From Iger to Chapek to Iger Again

The dramatic upheaval came 11 months after Iger left Disney, and days after Chapek said he planned to cut costs at the company. Chapek was parachuted into the burden of figuring out the swelling costs from its streaming service, Disney+. To no one’s surprise in this bear market, Disney’s earnings vastly underperformed Wall Street’s expectations. Even its theme park business, which reported a surge in revenue, delivered less than what analysts had projected.

Chapek wasn’t just parachuted into Disney’s streaming spending burden, but also the p-word: that pandemic. As a result, his tenure commenced what many consumers considered an excessive nickel and diming. FastPass was replaced with a paid-for Genie service. Resident Discounts were briefly removed for Florida residents. The overall theme seemed to be to squeeze every cent out of customers.

Now, it’s up to Iger to not only clean up the mess, but to get the House of Mouse back on track.

And a retired hype-mouse can fix all that?

That’s what Disney’s board hopes, but maybe their research team all took off for Thanksgiving already. For a refresher, Bob Iger is credited with Disney’s success over his 15 years running the company. In that time, they purchased Marvel and Lucasfilm. They improved and expanded many parts of their theme parks. Movies, shows, Disney+ and all the media that feeds the Disney machine were on overdrive.

In short: Iger oversaw (read: took credit for) a whole lot. It’s essential to look at Disney’s acquisitions under Iger to understand why the board may be reminiscing his time at the helm:

• 2012: Lucasfilm (Star Wars) $4.1 billion.

• 2014: Maker Studios $0.5 billion.

• 2016: BAM (streaming technology) $2.6 billion.

• 2019: 21st Century Fox $71.3 billion

Disney’s acquisition of 21st Century Fox included:

• The 20th Century Fox film and television studios.

• International operations of Fox Networks Group.

• Indian television broadcaster Star India.

• 73% stake in National Geographic.

• 30% stake in Hulu.

Disney’s YTD Performance…or lack thereof

Disney didn’t even let Chapek finish his turkey trot before giving him the ax. So was his performance really that bad?

Disney (i.e. The Walt Disney Company, “DIS”) recently reported its Q4 FY22 earnings report, ending September 2022. Here is a bird’s-eye view of the income statement.

Main highlights:

• Revenue grew +9% Y/Y to $20.1 billion ($1.3 billion miss).

  • Media & Entertainment declined by 3% to $12.7 billion

  • Parks, Experiences & Products grew +36% to $7.4 billion.

• Operating margin was 2% (+0.3pp Y/Y, -8pp Q/Q).

  • Parks, Experiences & Products had a stable 20% adjusted margin.

  • Media & Entertainment had a razor-thin 1% adjusted margin.

• EPS (non-GAAP) was $0.30 ($0.26 miss).

Cash flow:

• Operating cash flow was $2.5 billion (13% margin, -1pp Y/Y).

• Free cash flow was $1.4 billion (7% margin, -1pp Y/Y).

Balance sheet:

• Cash, cash equivalent: $11.6 billion.

• Long-term debt: $57.8 billion.

Chapek’s Q1 FY23 Guidance:

• Direct-to-Consumer's (“DTC”) operating results are expected to improve by $200 million.

• Disney+ is expected to achieve profitability by FY24, thanks to price hikes and a new ad-supported tier.

• FY23 revenue and adjusted operating profit are expected to grow at a high single-digit percentage.

What did the board make of this?

• It was not a good quarter for Chapek. Disney missed the top and bottom-line consensus.

• Disney’s long-term strategy of creative destruction is visible. DTC growth was more than offset by the decay in other media segments.

• DTC subscriber additions were strong. Disney+ added 12.1 million subscribers, above expectations for 9.3 million net additions. Across all three apps, they added 14.6 million subscribers.

• DTC reached “peak operating losses” of $1.5 billion on an adjusted basis, offsetting the profit from the Linear Networks segment, illustrating the zero-sum impact of the transition.

• ARPU (average revenue per user) declined. The company continued to offer aggressive discounts and bundles. Half of the decline was due to currency headwinds. A lower per-per-view at ESPN+ was also to blame due to different UFC match schedules.

• Parks & Experiences rebounded with favorable COVID comps.

  • Unfortunately for Chapek, if you compare the segment to Q4 FY19 (pre-COVID), it grew only +12% Y/3Y. That’s a 4% CAGR in the past three years – not even keeping up with inflation.

• Chapek’s FY23 guidance was a mixed bag. He implied a continued demand for parks but a slowdown in DTC growth due to tough comparisons and the price hike.

Was Chapek’s business sustainable?

Chapek leaves Disney with a relatively weak balance sheet. To be fair, he had maintained positive free cash flow through Disney’s transition to direct-to-consumer. While Disney’s sustainability isn’t at risk, they’ve been closer to Donald-Ducks-diving-in-gold in the past.

The Iger Hand-Off, in Chapek’s Words

Little did Chapek know that the Q4 earnings call was the nail in his coffin. That being said, key quotes help summarize a state of Disney bad enough the board didn’t hesitate to parachute Iger back into. Key quotes from the earnings call include:

• “Reached peak DTC operating losses, which we expect to decline going forward. That expectation is based on three factors: first, the benefit of both price increases and the launch of the Disney+ ad tier next month; second, a realignment of our cost, including meaningful rationalization of our marketing spend; and third, leveraging our learnings and experience in direct-to-consumer to optimize our content slate and distribution approach to deliver a steady state of high-impact releases that efficiently drive engagement and subscriber acquisition.”

• Ad-supported tier: “1 month [out] from the U.S. launch of Disney+’s ad-supported subscription offering, which is a win for audiences, advertisers and shareholders.”

• “Total company advertising portfolio and advertiser interest has been strong…Disney+ has secured more than 100 advertisers for our domestic launch window, spanning a wide range of categories and our company has over 8,000 existing relationships with advertisers who will have the opportunity to advertise on Disney+.”

  • Disney signed a deal with The Trade Desk (TTD) for targeted automated ads across Disney properties.

• Near-term impact: “We do not expect the launch of the advertising-supported tier of Disney+ in December to provide a more meaningful financial impact until later this fiscal year.”

• DTC subscriber net additions won’t be linear, starting in Q1 FY23: “We expect core Disney+ subscribers to increase only slightly in the quarter, reflecting tougher comparisons against Disney+ Day performance…subscriber growth will not be linear each and every quarter, and the trend is driven by several factors, including content releases and promotions.”

• Parks are unaffected by the challenging economic environment: “We are still seeing robust demand at our domestic parks and are anticipating a strong holiday season in Q1.”

• Overall picture for FY23: “We currently expect total company’s fiscal 2023 revenue and segment operating income to both grow at a high single-digit percentage rate versus fiscal 2022.”

What to watch looking forward

Let’s zoom in on direct-to-consumer (“DTC”), Iger’s most important strategic initiative before he left and Disney’s chief concern since. While a company like Netflix is benefiting from the DTC trend, legacy giants like Disney have struggled to fend off the zero-sum shift from its declining segment (linear TV) to a growing one.

Headlines will tout the rise of the DTC segment, but you can’t look at it in a vacuum. As earnings under Chapek clearly conveyed, the success of DTC often comes at the expense of other legacy segments. Unfortunately for Chapek, those segments happened to be the silent majority of Disney’s revenue and profits.

Iger Inheriting Back His Baby

The headline might say that Disney has more subscribers than Netflix, but that would be misleading. Disney’s numbers do not adjust for subscriber overlap brought on by the Disney Bundle (all three services for $13.99/month in the US).

While the subscriber growth is impressive, an often overlooked aspect is the average revenue per subscription. Disney+ numbers include:

• Disney+ Core: 103 million subscribers at $6/month.

• Disney+ Hotstar (India): 61 million subscribers at $0.58/month.

For comparison, Netflix has a $12/month average revenue per membership.

Acquisition, retention, and monetization

On December 8:

• Disney+ Basic (ad-supported plan) will launch in the U.S. for $7.99/month.

• Disney+ Premium (no ads) will increase from $6.99 today to $10.99/month.

The first big question Iger will have to answer concerns user retention. Do the bundles and discounts artificially inflate the subscriber numbers?

Chapek had his own opinion: “We believe our churn implications of taking up the price…will be negligible.” If Disney follows in the footsteps of Netflix, churn might only be a temporary issue.

The jump in Disney shares Monday shows investors believe the company is back in proven hands. Iger has a multi-year challenge ahead, with significant investments in DTC combined with the steady decay of legacy linear TV. While DTC can cannibalize its way to success, Iger will be forced to soon wonder: at what cost?

Too late…and also too soon but:

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