The Netflix vs. Disney conversation entered a new phase as 2020 got underway. Both streaming services (Netflix and Disney+) were launched and widely used in the United States. With the coronavirus pandemic and resulting economic shutdown now in effect, 2020 is something else altogether now. So, how should we look at Netflix vs. Disney in 2020? How should we compare the streaming services? How should we compare the stocks themselves? Which company is the better investment long-term? Let’s try to answer these questions a bit.
Netflix vs. Disney+
Much of this article will be about the business models of Netflix and Disney and how they are coping with 2020 and beyond, but since much of the discussion around these two companies is about the streaming platforms themselves, I’d be remiss if I didn’t talk briefly about Netflix vs. Disney+.
Disney+ had a wildly successful launch. There’s no denying it. But we knew it’d be successful. I remain intrigued about where subscribers will be a year from now once some of the shine has worn off and Disney has to settle into new content production, managing subscriber church and attempting to grow internationally (Netflix has had years to perfect all of this). I believe Disney vastly underestimated its estimated content costs for Disney+ when they announced the service. I believe those costs will go up dramatically over time. There’s just no way Disney can spend $2-3 billion a year on content for Disney+ while Netflix is spending $20 billion. Disney can justify increasing these costs as long as subscribers are growing, but it’s unclear how it will impact when the service turns profitable.
For all the talk of Netflix getting overtaken by the competition, I do find it interesting that anecdotally, all the conversation about what people are watching these days during quarantine seems to be about Netflix shows. Tiger King has become a cultural phenomenon, and the new season of Ozark seems to be quite popular as well.
I think Disney+ leadership will realize that the library of Marvel and Star Wars movies is incredible, but streaming platforms live and die by fresh content. Personally, I haven’t tuned into Disney+ (despite being a subscriber) since I finished Mandalorian (which I loved).
Both represent tremendous value and will be with us for many years. While I believe a number of the streaming platforms will not survive, Netflix and Disney+ will indeed survive and be successful.
Netflix’s Business Advantage
Primarily, Netflix has two key business advantages. The first mover advantage and the singular focus advantage. We’ll discuss both briefly.
While Netflix didn’t invent the idea of streaming and on-demand video, Netflix basically created the market for what is rapidly taking over our at-home entertainment. Streaming and on-demand television and movies is a major part of millions of lives. Traditional cable television, long the dominant entertainment format, has been in a major decline for years with truly no end in sight.
While today companies are trying to re-obtain full rights to their own catalog of content, up until just a few years ago, even companies like Disney were still selling just about anything they could to Netflix. For decades, this licensing model made tons of sense and was extremely profitable for companies like Disney. If you have old Marvel movies sitting in your vault, why not sell them to as many people as possible? It increases the ROI on each piece of content, after all. The problem was that while they were profiting from this, they were building a monster. That monster was Netflix.
The first mover advantage is not just about being first and becoming a major brand and synonymous with streaming (although that is still valuable). As streaming enters this new phase, the first mover advantage is mostly important for Netflix because of the size of its subscriber base and the capital that it generates to continue funding new content and growth. Building a streaming platform is incredibly capital intensive and expensive. Content is extremely expensive to produce and takes immense upfront cash. And remember, old media companies like Disney are having to forego revenue streams (licensing) in this new world, so the content they were already making is even more expensive than before.
As Netflix reported after its 2019 4th quarter, the company has 167 million paid subscribers which generated nearly $5.5 billion in revenue during the quarter. Netflix generated over $20 billion in revenue for the year. The Netflix flywheel effect means that by adding more subscribers, they add more revenue and can create more incredible content that leads to more subscribers. The flywheel is very powerful and to already be generating $20 billion in annual revenue means they’re well ahead of all competition, and the prospect of catching Netflix is not only difficult, but incredibly expensive.
Netflix also has the benefit of being singularly focused. We mentioned how older media companies have to forego licensing revenue when pivoting to streaming, direct-to-consumer offerings. Managing the transition from legacy business models to new business models is tricky as executives are still accountable to quarterly performance while investing heavily in the future. With Netflix, there are no profitable, legacy businesses that they’re trying to protect while investing in the future. They are all-in on the future, and their impressive execution reflects this singular focus.
Disney’s Business Advantage (and 2020 Risk)
While the Netflix vs. Disney conversation has been a big one and isn’t going away any time soon, the reality is that Netflix and Disney are very different businesses. Obviously, Disney wants Disney+ to be a smashing success with 100 million subscribers eagerly paying a monthly fee. But Disney has always been mostly about two things mainly: incredible intellectual property (IP) and an ecosystem that monetizes that IP. This is what has made Disney an incredible company.
While the volume of Netflix content is incredibly impressive, few people would argue that Netflix owns the same caliber of brands and IP as Disney (especially after the string of acquisitions by Disney in the last decade which landed Disney both Star Wars and Marvel). Disney has addressed the “library concern” by acquiring Fox assets. This lets Disney offer a more complete offering and full library on its Disney+ product. But Disney is still mostly about its marquee brands, franchises and IP, and understanding the Disney business model will make it clear why.
When consumers connect with Disney brands whether it be Star Wars, Marvel’s Avengers or Frozen, the viewing of the movie is just the first part. Disney more effectively monetizes this connection over the long-term than anyone else. This is done mostly through its immensely popular theme parks and resorts and of course with merchandising. Disney doesn’t just want to sell you a movie ticket or a Disney+ subscription, they want to leverage those into you spending thousands of dollars at theme parks. And they’re extremely effective at doing just that.
Disney+ brings a new and interesting wrinkle into this ecosystem play because for the first time, they will have incredible data on individuals. If you subscribe to Disney+, Disney will know what movies and shows you watch. If you’ve been binge watching Mandalorian, then perhaps you might be interested in a Disney Cruise next summer that has all the Mandalorian characters? The marketing ability powered by Disney+ data has the potential to be extremely effective for Disney.
But this also takes us to the massive risk for the current year. All of the above explains why I love Disney as a long-term stock, but I’m massively concerned about the short term. As of writing, the Disney theme parks, resorts and cruise lines are shut down. From Disney’s 2019 annual report, the Parks, Experiences and Products business unit under Disney was responsible for over $26 billion in annual revenue and nearly $7 billion in operating income. This business segment is going to take a massive 2020 hit. Eventually the parks and resorts will re-open once coronavirus is under control, but will it open with restrictions? Will people want to visit theme parks and jam into crowded lines as they await their turn on Space Mountain? These are some very serious questions for Disney. It’s hard to know what the hit will be financially, but will revenue be down 25% this year for this segment? 50%? Is it possible that that the segment loses money? As of now, it’s just speculation, but it’s not going to be pretty.
And that’s not it. The Studio Entertainment business unit was responsible for over $11 billion in revenue last year and nearly $2.7 billion in operating income. This was powered by big Star Wars and Marvel movies at the box office (among other titles). Hollywood is effectively shutdown currently, and Disney has already pushed most of its major movies back to the next year as a result of movie theaters being closed. Again, this business unit will take an enormous hit in 2020.
Still there’s more. The Media Networks business unit is the segment of Disney that owns and operates TV and cable networks, most notably ESPN and ABC. This business unit is also taking a major hit currently, and it’s not necessarily because of the decline in cable subscriptions. In fact, Disney has been able to weather the secular cable decline somewhat by getting higher carriage fees from remaining subs (Media Networks revenue was up in 2019 at just about $25 billion from just under $22 billion in the previous year). The more urgent problem for the short-term with this business unit is advertising revenue. Due to the lack of sports and other must-watch TV events currently, television advertising is reported to be way down. This unit will still be profitable most likely, buoyed by subscriber revenues, but profitability will like decline due to the advertising revenue hit.
Lastly, we have the direct-to-consumer business unit which houses Disney+, Hulu, etc. The problem here is that this unit loses money. This is intentional as its a long-term investment (and a wise one in my opinion), but this does not help Disney in the current crisis. Moreover, the Hollywood shutdown means Disney can’t be producing content needed to keep content fresh on Disney+. Additionally, with Disney facing reduced profitability and the potential need to cut costs, will Disney be shy about increased investment into Disney+? Again, this ecosystem advantage that Disney has might turn into a drag during this unusual time of economic shutdown. While this ecosystem provides a long-term advantage to the Disney business, Netflix’s singular focus will benefit more during this specific time period.
Note that ESPN has just announced that it is moving up the release of “The Last Dance” which is a 10-part documentary on Michael Jordan’s Chicago Bulls. It’s one of the most anticipated sports documentaries in years, and ESPN has smartly moved up the release to coincide with a lack of live sports on TV during this time. The ratings will be off-the-charts.
But it’s also an incredibly missed opportunity, in my opinion. If Disney were truly focused on the future, wouldn’t they put this exclusively on ESPN+ and market the heck out of it? I’d subscribe to ESPN+ if I had to in order to watch this!
What’s even more fascinating is that guess who owns the international streaming rights to this Michael Jordan documentary? You guessed it. Netflix! Just incredible. A great example of how Disney’s transition to its streaming future is not perfectly seamless and downright complicated at times.
So, I love Disney long-term. I’m extremely concerned about it short-term. So much so that I could argue it’s a worthwhile short, especially if you’re pretty much entirely long in your portfolio. Disney will be harmed more than the average company if the coronavirus shutdown lasts longer than we think.
Netflix vs. Disney Stock Performance
2019 saw Disney’s stock outperform wildly with the successful and popular launch of Disney+. But since the coronavirus shutdown and 2020 stock market crash occurred, Disney’s stock has suffered immensely. Netflix stock is actually up during this time period. Let’s look at a two-year chart for comparison:
I believe long-term, both Netflix (NFLX) and Disney (DIS) represent great investments. They will both be very successful. For the short-term, Netflix is the clear winner, but deciding how much of that is already priced in is the difficult question.
Are all of the problems Disney is facing currently with park closures, down TV advertising and a shutdown Hollywood priced into the stock? The stock has lost about a third of its market cap after all. Certainly, the best time to short the stock would have been earlier in the year, or even when CEO Bob Iger stepped down in late February.
After the recent bounce off the March lows, I do think that the stock could be a good short here. I believe more bad news is coming including furloughed workers. It could be a useful hedge against your mostly long portfolio. If another leg down occurs in the market, your Disney short will hedge your losses a bit. I would not encourage any long-term shorts. I’m looking at this for about a month, max. Once the move happens, I’ll either cover the short for a gain or a loss and be done with it.
What to watch in the days ahead
- Netflix subscriber growth during its next couple quarterly releases will be interesting because it will give us some insights into subscriber growth during this time when usage is most likely up as more and more people stay home. However, you also have economic pressure related to cut wages and job loss that could potentially increase subscriber churn (though many analysts argue that other things will get cut before someone cuts his or her Netflix subscription).
- While subscriber growth is always first and foremost with Netflix quarterly reports, there are two other important metrics to watch. First, Netflix’s cash burn is a constant conversation piece for Netflix analysts and investors. Netflix says negative cash flow of -$3.3 billion was the peak in 2019 in terms of annual negative cash flow. This should improve in 2020. If it doesn’t, the stock could get punished. Second, the operating margin target for 2020 is 16% (up from 13% in 2019). Executives might have some cover to miss this target due to unusual circumstances of the coronavirus, but still as an investor, I’d like to see this target hit. Currency fluctuations could impact some numbers as well as all markets have been quite volatile this year.
- Disney recently announced that the theme parks will remain closed indefinitely. It’s been reported that Disney is not allowing resort reservations through May, so many are starting to believe theme parks and resorts will be closed for at least two more months. As this is extremely fluid, it’s hard to say when this might end. But, monitoring the park re-opening timeframe is a huge factor short-term for Disney.
- In conjunction with the Disney park announcement, they mentioned they will continue paying hourly employees that are not working through April 18. Disney, just this week, also announced that executives are taking pay cuts until this crisis is resolved. My guess is that the timing of this is intentional and there’s a good chance that after April 18, Disney begins furloughing employees to cut costs. By cutting executive pay before furloughing employees, it gets ahead of the PR situation a bit.
- In normal times, much like Netflix stock in recent years, the Disney+ subscriber counts each quarter would move the stock quite a bit. Previous CEO Bob Iger successfully changed the narrative with Disney to where much of the focus was on the subscriber growth of Disney+ regardless of how much money the streaming business was losing currently. The problem is that this subscriber growth number will likely not be the focus until the coronavirus situation goes away. My guess is financials are a bigger focus in the forthcoming quarters. Still, we’ll want to see how Disney+ subscriber growth is coming since Disney has staked much of its future on this new business.