The Case for Disney Exiting the Streaming Wars

0:04Matt Belloni:This episode of The Town is presented by HBO Max. HBO Max presents Hacks, nominated for 25 Emmy Awards, including Outstanding Comedy Series. In the aftermath of mistaken news reports that Debra passed away, she and Ava returned to Las Vegas determined to secure Debra's legacy as a comedian. Don't miss the series Variety is calling one of TV's best comedies ever. Hacks is now streaming on HBO Max. Adobe Firefly is the all-in-one creative studio with AI-powered image and video editing for today's creative process. Built for creators of every kind, Firefly helps you generate, edit, and experiment fast.

0:43Matt Belloni:Because the asks aren't getting smaller, the budgets aren't getting bigger, and the timelines, oh yeah, still tight. With all the best creative AI models in one place, Firefly brings your ideas to life. Unlock a better way to make with Adobe Firefly. It is Thursday, August 6th. Disney released their latest earnings report this week, and the numbers were pretty good. Surprising growth of 3 % in attendance at the theme parks, especially right after Universal announced that its parks are struggling with attendance a bit. Toy Story 5 and the NBA Finals helped the entertainment division, though Moana and Mandalorian and Grogu, not so much.

1:21Matt Belloni:They announced that TikToks are coming to Disney +, and maybe some free ad-supported channels as well. Streaming revenue increased 11 % thanks to price hikes and ad sales gains. The Disney stock price popped a little too. But it's been languishing over the past few years, despite all that investment in streaming and the bundle successes with Disney Plus and Hulu in this country and ESPN. So much so that Josh DeMauro, the new CEO, he's been pinning his strategy to boost that stock on making Disney Plus the, quote, digital centerpiece of the company. We've talked about this before. DeMauro wants the streaming service to be a much bigger part of the Disney fan's life, which sounds interesting, but one top analyst is suggesting that DeMauro do the exact opposite and get out of the direct-to-consumer business entirely.

2:07Matt Belloni:Stephen Cahall at Wells Fargo, he argued in a note to clients that Disney should stop trying to be Netflix or YouTube and just focus on making great movies and shows and distribute them via the highest bidders, sort of like Sony or Lionsgate or other companies without global streaming businesses. It's an intriguing idea, and to be clear, it's not something DeMauro says he's interested in pursuing. But Cahill argues that the profit margins on licensing businesses are much better for Disney than trying to outspend and outgrow Netflix. And ultimately, bigger margins would be a bigger stock price boost.

2:41Matt Belloni:So today I've got Stephen Cahill on the show to discuss that plan. Should Disney get out of the streaming business? From The Ringer and Puck, I'm Matt Bellany, and this is The Town.

2:55Matt Belloni:All right, we are here with Stephen Cahall, an analyst at Wells Fargo and a returning champion to the town. Welcome back, Stephen. Thank you for having me on again. All right, Stephen, I want to talk about your idea about direct-to-consumer in Disney. But first, we got to hit this first. TikToks coming to Disney+. I laughed when I saw this because, of course, they are. I mean, this is what DeMaro wants. He wants Disney +, to be this digital hub for everything. They are looking at what their fans are doing on TikTok and singing songs and doing dances. And why not bring some of that stuff over to Disney Plus?

3:32Matt Belloni:Do you think this is going to be a game changer? Like a, not a game changer, something meaningful for Disney Plus? Yeah, you know, I don't know if I would call it a game changer. And certainly I think the initial deal they had with OpenAI around Sora was more exciting because that was, you know, consumers co-creating characters and just the interactive nature of that was exciting. This is interactive in a way, right? It's more live. It's people taking Disney content and doing things with it. I have no doubt it's going to be highly curated to make sure that what's on that is, you know, Disney appropriate, Disney branded, all those things.

4:11But they recognize that a lot of engagement goes on outside Disney and, you know, what bigger platform is there than TikTok right now. So to embrace, you know, the convergence between those two certainly can just probably drive some youthful eyeballs or time spent that they wouldn't get otherwise.

4:30Matt Belloni:It's going to be a lot of six-year-olds belting out Moana songs alongside the actual character singing the song, right? I would expect that. Yes. Yes. The streaming business seems to be going okay for Disney. They've cut a lot of costs. They're making fewer shows than they used to. They've raised prices. They're doing the bundles. They see, they're not telling us how many subscribers they have, but we think that they are growing in subscribers. So by all accounts, according to Disney, they're on the right path for streaming. And then you come along and you dropped this note a couple of weeks ago saying, actually guys, you should get out of the direct a consumer business and return to a licensing model that was making you way more money before.

5:20Matt Belloni:So I want you to give me your argument here that if you had, if I was Josh tomorrow, tell me your argument for why Disney should cut bait on its streaming services and switch over to the licensing model that you say will be more profitable. Yeah. So if we jump back to, you know, the days before streaming and media and Disney kind of began its initial existential reconsideration when ESPN started to lose subscribers. And, you know, if we wanted to give that a reason, it was because Netflix had emerged as a new place for people to spend time. It was outside of the linear bundle that they didn't have before.

6:05and by 2019 Disney had embraced you know the the streaming era fully and announced that they were going to direct consumer they held an investor day in April 2019 and they launched and they launched Disney plus and I think since 2019 some things that have changed that are different than those original assumption as to why to get into streaming the first was that it seemed like at that time that Netflix was going to be a force that almost no one could stop and so you know This was back when Disney had an output deal with Netflix, Marvel shows like Jessica Jones and Luke Cage and Daredevil or Netflix originals.

6:42They almost weren't going to get lost as to whether or not they were Disney at all. You could watch Marvel movies on Netflix. That's right. Yeah. So I think at that time, there was a recognition that, you know, if we, Disney, continue to feed the beast, the beast will, you know, be something that we cannot control at some point and will maybe even be subjected to their force as maybe the single buyer. and I think now, you know, looking back some years later, that's not the case. You know, there's more buyers. Apple entered this market. Amazon has remained in this market. We don't need to talk about Paramount Skydance and Warner Brothers merging, but we've assumed it's going to happen.

7:26Then that's, you know, another company that's going to be in the streaming market as a buyer of content. You always want to have competitors if you're selling content, And you're in Hollywood, you know this. So there's going to be more buyers longer term than I think we thought in 2019. The second thing is the margin profile of everyone's streaming business other than Netflix has been a lot harder to get to.

7:51Matt Belloni:Yeah. So that's another that's a that's an analyst way of saying that the cable bundle dollars have not turned into streaming service dollars. It's a lot less than they made before. Actually, at the top, they have the revenue dollars in streaming are impressive. You know, Disney's revenue dollars in streaming exceed 20 billion. They'll be close to 25 billion next year. Netflix is over 50 billion, but both of those you would call scaled businesses. It's just really expensive to run a streaming service because you have to constantly satisfy your subscribers because it isn't bundled with a bunch of other stuff.

8:27You have a lot of technology costs. you have a lot of marketing. And for Disney specifically, because the content is fed largely by the studio, which is more tentpole focus, if you have a couple of pieces of content that don't work, like say the Mandalorian and Grogu and Moana, then all of a sudden your streaming service doesn't have the new freshest content coming. So this volume game, which is really churn management, this volume game is harder to play than I think any of us expected, certainly in 2019 and during the COVID bubble in 2020. So better market to sell content, worse market to manage streaming.

9:07Matt Belloni:Right. And you argue in your note that Disney is not equipped to battle Netflix and YouTube on the volume front. Yeah. And that is not necessarily a dig at the way Disney manages content. That's very much like stating what Disney is and is not. And it's a very, very high quality, relatively low volume production. And first to take YouTube, no one can compete with YouTube on content because it's user generated. And so it's like infinite by definition, there is always something new on YouTube. And Netflix has a very different strategy. And it has production and licensing all over the world in order to feed that mix of volume and quality, not that they're, you know, looking for stuff that isn't quality, right, but you just look at the range of content that they produce.

9:56and Disney is not set up to do that. And so the question is, can you keep X hundred million subscribers happy month in, month out with a relatively low volume? That means you need a high hit rate and that is probably a lot to ask of any studio.

10:12Matt Belloni:Well, or Beloved IP, which is what Disney has. And you see the numbers on some of their older library titles are still performing just as much as the Netflix originals, particularly in film, where you could see a title like Moana or Encanto or Turning Red pop up on the top 10 list for years and years after they are first released. No doubt. And I think where then you get to on this sort of treadmill is most likely Disney has a base of subscribers who are almost, you know, infinitely price-inelastic. They'll pay whatever. They love the library. They love the content or maybe they have kids and they can just churn through it and churn through it and churn through it.

10:59But then they also have a layer of subscribers like me who jump around from service to service. I don't have children. I'm looking for whether or not there's a new season of Alien Earth or The Bear or Shogun. And the library is not that valuable to me. No one's is. Maybe Christopher Nolan's, maybe A24's, you know. But so every streaming service has this higher churn cohort and then like the diehards. Disney's diehards are more diehard than any other media company. But churn management is about keeping the folks that, you know, you know, jump around a little bit.

11:35Matt Belloni:Right. And so your argument is that Disney would be better off taking all of its branded IP and its content and its studios and just turning into a content behemoth, not a distribution behemoth. And you do the math and you look at, you know, what Sony is getting for its film output on Netflix. They're getting about a billion dollars a year, you estimate, for their first pay one window on Netflix. You're looking at Disney's film slate. They get about three times the box office. You're looking at pay two window and all these other windows that are out there. And you say Disney could get about$15 billion a year for streaming rights to its catalog alone.

12:19Yeah. And the way I think about it is we're in a world where the platforms are very competitive. The ones that we just mentioned are Netflix, Paramount Skydance, maybe Proforma for Warner Brothers, Apple and Amazon as a basic set. And then, you know, you have YouTube as an extra on there. They don't really pay for external content. We'll see if that ever changes. But even within those four, how valuable is the Marvel library? How valuable is the Star Wars library? How valuable is the Disney library? And how valuable is something like pay one, you know, from a studio like this? And when you start to look at it under that context, and when you see values of, you know, things like Mad Men, which was resold to HBO recently, there has been a very significant growth in the value of this high value content.

13:14So, you know, I feel like that$15 billion is, if anything, a slightly conservative number. Now, one thing I would say, Disney is showing progress on streaming. And I think Josh DeMauro certainly has earned the right to continue to move down the path that he's on and see where it gets to. But there is an alternative here, you know, and I don't want to hide behind my conviction that that alternative could be pretty compelling depending on where we are. And you believe the margins would be much higher,

13:43Matt Belloni:more akin to the heyday of these studios in the cable bundle times? I mean, certainly the margin profile, just intuitively you can think about running a streaming service is very intensive on technology. It's very intensive on marketing and it's pretty intensive on personnel. And employees, God, I hate to think how many people would be fired if they implemented your plan. Because a lot of people work at these streaming services. That is certainly true. There's no doubt about that. You know, to the extent which we're talking about sort of creative talent, it's indifferent to that, right? And if anything, it could support the boosting of more spending on the creative side, you know, in order to offset that.

14:28Matt Belloni:Yeah, the only thing, the challenge on that, and I like your argument, but I've talked to so many producers in town about the peril of not owning your own destiny. And the Walt Disney Company, one of the original Hollywood studios, been around for more than 100 years. It's tough to see them just squander the right to determine their own destiny. And DeMauro, he called the licensing business lumpy. And I think I know what he means by that, in that you're a seller. You've got to be at the whim of the platforms. And right now, there's a robust market. But maybe at some point, these whittle down, and there's two or three buyers.

15:14Matt Belloni:And Netflix doesn't want to buy your content because they would rather own what they put in front of their customers, and they have the market power to do that. I think the high-end Disney content will always be valuable and in demand. but maybe some of the lower end stuff that Disney does get value on, maybe there's a buyer for that stuff. Yeah, so first I'd say the destiny is the content. And if the content is good, the destiny will be good for any content producer. Me as a research analyst, you as a content creator, or Disney. And so you could argue that distribution doesn't make content more valuable.

15:58distribution is a very, very taxing business to be in. The second one is that if a lot of content gets devalued over time, I'm not sure that it's going to matter that it's on Disney Plus or somewhere else. Maybe not. If X years from now, whether it's AI or something else, has completely changed the value of content, then this is still a tough business to be in. Finally, you know, just a take on their earnings would be, I think that you probably need to see streaming getting to about a 20 % margin to justify it as a standalone business. And where are we today? This year, there'll be low double digit.

16:42And the question is, how does that expand over the next couple of years? And, you know, our note math would say you probably need to get to about a 25 % margin to sort of be equivalent to be the licensing opportunity. Now, I think you could make this argument that being in the streaming business gives you this customer relationship. It maybe gives you something in the parks. It's more interactive. It helps you sell merchandise. It helps you monetize sports. So that 25 % is too high and something closer to 20 kind of brings in that network company-wide effect. Yeah. And DeMauro calls it a global touchpoint

17:18Matt Belloni:for consumers. And that's what he wants Disney Plus to be. And he addressed this. He talked about this. You asked him a question on the earnings today. And he said that the shift to a purely licensing model could sacrifice all of that strategic value. He's talking about the global brand and touchpoint of Disney Plus. Content licensing by nature is a lumpy business. It's subject to supply and demand dynamics in the marketplace at a given time. It's not to say that there isn't a role for content licensing. We do license some content to third parties today, but exiting direct to consumer for licensing exclusively would likely lead to both inferior strategic and financial positions for our company and our shareholders.

18:00Matt Belloni:So there. So there. Take that. So there. This episode is brought to you by Accenture. When your advertising operations fall out of sync, campaigns slow down, insights get buried, and opportunities get missed. That's why Spotify and Accenture are working together to reinvent the rhythm of ad sales, using automation, analytics, and smarter workflows to simplify campaign delivery and access better data across the business. The result? Less time spent on operations, more time connecting brands with the moments and fandoms that matter most. To learn more, check out Accenture.com. This episode is brought to you by Accenture.

18:41Matt Belloni:When your advertising operations fall out of sync, campaigns slow down, insights get buried, and opportunities get missed. That's why Spotify and Accenture are working together to reinvent the rhythm of ad sales. Using automation, analytics, and smarter workflows to simplify campaign delivery and access better data across the business. The result? Less time spent on operations, more time connecting brands with the moments and fandoms that matter most. To learn more, check out Accenture.com slash Spotify. This episode is brought to you by Netflix, presenting Beef. Now nominated for 16 Emmy Awards, including Outstanding Limited or Anthology Series.

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19:46It's definitive in terms of how they see this choice right now, right? There is no doubt about that. I think...

19:53Matt Belloni:They want to be a player. They want to take on Netflix. The idea of someday, you know, they're not being buyers for their content, and maybe the Disney channel on YouTube is the biggest channel on YouTube. They don't want that. Right. They don't want to be a great business for you too, and they get paid. They want to be you too. They do. And what I would say as an analyst is in three years from now, if that margin is 13%, 14%, then you have to ask, is it worth it? Is it worth it? And can you really point out the way it's driving the other parts of the businesses? Because I would say that Disney's parks and cruises are great business, irrespective of what has happened to the distribution model over the last decade.

20:42Matt Belloni:Yeah, you think these other businesses can be just as good if there is no Disney Plus or Hulu. That if we're all watching the latest Marvel movie on Netflix or on YouTube, that we'll still buy products and go on cruises and all the other things. And we can certainly pick out pieces of content that have become more remarkable by being on larger reach platforms as well. I mean, Suits, you know, the other examples of things that have been on Netflix. Oh, wait, but you just said distribution doesn't matter. I'd argue in that case, distribution does matter. The second you put an old show on Netflix, it shoots to the roof.

21:20Right, and so it's all about getting that escape velocity of a distribution platform, right? It's being something that people go to when they don't know what they want to watch, as opposed to probably HBO and Disney. I think it's fair to say we usually go to because we know what we want to watch and we have a high expectation for it. And so changing people's minds that there's so much content here that you don't even have to know what you're looking for and we'll have something for you. That's the part that's that's hard to do and that probably only Netflix and YouTube is done. So I think we we wait and we watch and see kind of how this progresses.

21:56Yeah, I just, I don't see Disney abdicating its role as brand first.

22:04Matt Belloni:And they see brand first as being a destination. Used to be television, used to be the Disney Channel and all of their outlets. Now it's streaming and it's direct to consumer. And I just, I don't think that tomorrow is ever going to, you know, Unless the stock is dragged down, because you argue that over the past few years, this lack of margin has contributed to the stock price being so stagnant. That is the motivating factor. And frankly, that is the very fair scoreboard around this whole thing. Yeah. And ultimately, that's Josh's job, is to raise the stock price. That is 100 % right. And if Josh and his team have a very successful streaming strategy, then people like me should shut up and go away and talk about how well it's worked.

22:57And I am happy to do that.

22:59Matt Belloni:Yeah, you're only bringing this up because they don't. Because those margins are not as good as they were in the cable era. And they need a narrative. Like all these media companies, they need some narrative. And you look at what Sony has been doing. We don't know the particulars of Sony because they don't break it out as well. but we know that they're doing well with their arms dealer strategy and maybe that's maybe disney could be the biggest arms dealer of them all and and certainly i think all you really ask as a shareholder is have you thought about this and have you weighed the pros and cons and you know stock price kind of tells you what they're thinking about and what they're doing and you know we know from the earnings call today it's at least something they've considered and turned down for out pretty, pretty authoritatively.

23:46Yes.