This weekend the eyes of the media industry will be on Disney's D23 festival in the Anaheim Convention Center, just steps away from Disneyland. Its location is fitting as the company is set to make a series of announcements which it hopes will give it a happy ending after months of steep declines in its stock price.
Appearances by A List actors and footage from upcoming films are expected at the glitzy event. There's no doubt Disney will also reveal theme park plans there which could even include the creation of a fifth outpost at its Walt Disney World complex in Orlando as we have reported. Disney's third quarter earnings statement yesterday revealed that "upcoming attractions and experiences" will be showcased at D23 but it failed to enchant investors. Disney's stock slumped by 4.5% to close at $85.96 yesterday and barely moved today. There is good reason for this malaise.
For a company which claims to be built on magic, Disney's timing has been far from spellbinding since the onset of the pandemic.
As Covid-19 began spreading around the world in early 2020, Disney initially appeared to have the ideal trick up its sleeve. In November 2019, just one month before the first case of the deadly disease was reported, Disney launched its long-awaited Disney+ streaming platform which became an overnight success thanks to its smash hit Star Wars spinoff series The Mandalorian.
Disney+ was seen as a parting gift of the company's longtime chief executive Bob Iger who had championed the platform and stepped down in February 2020 to be replaced by Bob Chapek, the head of Disney's parks and resorts division. Even during the darkest days of the pandemic, Chapek shared in the sparkle of Disney+.
On its first day alone, the platform had 10 million sign-ups, far outstripping projections of 14.3 million by the end of the year. That was nothing compared to what was to come.
Lockdown led to millions of consumers getting stuck indoors all day with little more than television and the internet to keep them company. The popularity of Disney+ surged in line with this, hitting 60 million subscribers after eight months and 100 million after 16 months. It was more than Disney initially forecast to have within five years and stockholders couldn't get enough of it.
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With many movie theaters still shuttered, streaming seemed like the way of the future and Disney's deep archive of content put it on the crest of the wave. Its stock price hit an all-time high of $197.16 in March 2021 giving it a market capitalization of $357.2 billion. The studio saw the potential for even greater growth.
Disney's first major release after the pandemic began was the Marvel movie Black Widow in July 2021. The studio took the controversial decision of releasing it simultaneously in theaters and on Disney+ where subscribers could access it for a month through its Premier Access service at a cost of $29.99.
The National Association of Theatre Owners blasted the decision and blamed it for a 67% fall in box office receipts in the movie's second weekend, making it Marvel's worst performer in that period. Theaters typically retain around 50% of box office takings with studios receiving the remainder so Disney was taking a risk competing with some of its biggest customers.
Blinded by the prospect of keeping 100% of the takings from Disney+ the studio put its chips firmly on streaming and commissioned a string of shows and films which could only be found on its platform. It even released some films exclusively on Disney+ at no extra cost even though they were originally meant to be shown in theaters.
One was Artemis Fowl, Kenneth Branagh's 2020 adventure movie about a 12 year-old criminal mastermind, which was intended to become a franchise but ended up a one-off. That's perhaps no surprise as this release strategy cannibalized Disney's own revenue stream.
If a family of two adults and two children wanted to watch a new movie at the theater they previously had to buy four tickets with Disney getting 50% of the takings. However, all it took with Disney+ was one streaming subscription which initially cost just $6.99 per month and in October is due to rise to $15.99 which is still less than 50% of four theater tickets.
Theaters were under so much pressure during the early days of Disney+ that it didn't seem like such a great gamble to compete with them so Disney went all in on streaming. Its content costs ballooned and reached a record $29.9 billion in 2022. Then came a disturbance in the force.
The emergence and widespread adoption of the Covid vaccines caused governments to lift lockdowns and workers returned to the office. It left them with less time to watch streaming shows so Disney+ subscriber numbers began to fall just as its slew of new content was coming online. The timing couldn't have been much worse and Disney paid the price.
Saddled with huge start-up costs, Disney+ hadn't yet made a profit and the surge in content spending drove up its red ink sending its stock price into freefall. Operating losses from Disney's streaming business hit a high of $1.5 billion in the three months to October 1, 2022 and by then its stock price had fallen 52.2% off its high to just $94.33. Disney's board took decisive action. One month after its disastrous results announcement, Chapek was fired and Iger was tempted back to the hot seat. He hasn't been the dream ticket that the company hoped he would be.
One of Iger's first decisions was to return to the model of new releases in theaters with a solid window of exclusivity to protect that lucrative revenue stream. Again, Disney's timing was terrible because the damage had already been done.
"People have become conditioned to expect that things will quickly appear on Disney+,” said Neil Macker, a senior equity analyst for Morningstar Research Services. It explains why the 2023 global box office of $33.9 billion was 15% down on the average of the three pre-pandemic years from 2017 to 2019 according to Gower Street Analytics.
What made Iger's timing even worse is that his announcement about a return to exclusive theater releases came just before actors and writers went on strike in Hollywood for more than six months from May last year in a bid to boost the royalties they receive. It delayed the release dates of many movies from this year to 2025 and put theaters in jeopardy again.
Just two months after the strikes began, Cineworld, the world’s second-largest theater chain, entered Chapter 11 bankruptcy protection in the US. Although it has since emerged from this, its UK operation is still trying to do a restructuring deal and has announced the closure of six theaters in the past two weeks alone. The more theaters that close, the lower Disney's box office take becomes.
Prioritizing theaters wasn't Iger's only trick. He also slashed Disney's spending and the number of productions in its pipeline as part of a $7.5 billion cost reduction plan. In March last year he told a Morgan Stanley conference that he had begun "reducing the expense per content, whether it’s a TV series or a film, where costs have just skyrocketed in a huge way and not a supportable way in my opinion."
According to recent filings, he is targeting $4.5 billion of annualized entertainment cash content spend "primarily from slate / volume reductions and lower spend per title." He cut down the upcoming Disney+ content slate and, testimony to this, Kevin Feige president of Disney subsidiary Marvel Studios admitted that "the pace at which we're putting out the Disney+ shows will change so they can each get a chance to shine." He added that this means both having more time between projects and putting out fewer each year.
Feige's world-building has led to Marvel mining the depth of its superhero stories to churn out sequels featuring increasingly obscure characters. Movies about several of them were released last year despite Iger's insistence that fewer films would come out. Instead of scrapping them and getting a tax write-off, as Warner Bros. did with its Batgirl movie, Marvel released a string of flops last year.
The finale of its Secret Invasion show suffered the ignominy of scoring just 7% on Rotten Tomatoes making it the single lowest-rated episode of any Marvel streaming series. As we revealed, the series cost a staggering $211.6 million to make contributing to Disney's direct to consumer streaming business burning up $11.4 billion of losses since Disney+ was launched. Indeed, as the graph below shows, it only turned a profit in the latest quarter and even then, its entertainment segment still made a $19 million loss.
On the silver screen, Ant-Man and the Wasp: Quantumania and The Marvels cost even more than Secret Invasion. As we revealed, data derived from Disney's filings shows that they lost $157.9 million at the box office. In the wake of this debacle, Iger admitted to CNBC that Disney has "made too many" sequels but the curse of bad timing struck yet again as the damage had already been done by then.
The performance of Disney's 'Experiences' division, which includes its theme parks and cruise line, has been a fairytale in comparison. When lockdown ended consumers had tremendous pent-up demand to travel and were flush with furlough cash so they could pay a premium in order to visit theme parks.
Disney took advantage of this and increased ticket prices whilst limiting attendance, thereby lowering costs and increasing both revenue and profit. This magic formula led to Experiences accounting for just over a third of Disney's $88.9 billion revenue and more than two thirds of its $12.9 billion operating income last year. However, the glow is even coming off this now.
In May Disney's stock began a steep decline after its chief financial officer Hugh Johnston warned of a softening in theme park attendance due to "a global moderation from peak post‐Covid travel". In short, the furlough money has long since been spent and the travelers who wanted to visit parks have now done so. There have been widespread reports about the high cost of visiting Disney's theme parks which explains why Johnston added that "relative to the post‐Covid highs, things are tending to normalize."
After crunching the numbers, Brandon Nispel of KeyBanc Capital Markets forecast that Disney’s domestic park business “will be pressured for the rest of 2024” and it was no exaggeration.
Yesterday Disney announced that in its third quarter to June 29, the company generated $4.3 billion of operating income on $23.2 billion of revenue, which was up 4% on the same period the previous year. It was a respectable result but a deeper dive into the data revealed a worrying trend for Disney's Experiences division.
Higher guest spending at Disney's domestic parks and cruise lines, as well as increased spending per-room, drove up Disney's Experiences revenue by 2% to $8.39 billion. However, it is a sharp decline on the 13% increase in the revenue of the relevant segment over the same period in 2023 compared to the previous year. Worse still, the operating income of Disney's Experiences division declined by 3% to $2.2 billion in the latest quarter compared to the same period last year. It was driven by costs climbing at Disney's domestic parks which perhaps explains why it recently held out for so long to give a pay rise to the workers at its parks in California.
The increase in costs came at just the wrong time as Disney's earnings statement revealed that "we expect that the demand moderation we saw in our domestic businesses in Q3 could impact the next few quarters. While we are actively monitoring attendance and guest spending and aggressively managing our cost base, we expect Q4 Experiences segment operating income to decline by mid single digits versus the prior year, reflecting these underlying dynamics as well as impacts at Disneyland Paris from a reduction in normal consumer travel due to the Olympics, and some cyclical softening in China."
Johnston described it as "a bit of a slowdown that's being more than offset by the Entertainment business" and there is evidence for this.
On the face of it, Disney's entertainment division appears to be on a roll as it recently became the first studio to cross $3 billion globally in 2024. Animated sequel Inside Out 2 is the highest-grossing movie of the year with takings of $1.6 billion according to industry analyst Box Office Mojo. Marvel's Deadpool & Wolverine moved into second place in the past few days with a haul of $903 million though revenue isn't the only metric that investors are watching. Their yardstick of success is profit and Marvel's sky-high production costs don't do it any favors in that respect.
Then there are other, more specific, problems. Deadpool & Wolverine is Marvel Studios' first R-rated movie but it has no others in its pipeline which makes it tough to build on this success. Even if it announces more R-rated movies at D23 they will take years to come to theaters which isn't music to investors' ears. Indeed, Marvel's next movie stars a red version of the Hulk which is hardly aiming at the same adult audience as Deadpool. It recently announced that Robert Downey Jr will return in a future film but even this is might not be as punchy as it sounds.
Downey Jr. is famous for playing the heroic Iron Man character but will return as the villainous Doctor Doom causing his former co-star Gwyneth Paltrow to ask on social media "I don't get it, are you a baddie now?" Investors may well share her confusion and wonder whether it is a step too far, especially as Downey Jr. is reportedly being paid significantly more than $80 million.
Disney has no reason to be complacent about the performance of its Entertainment division. In the latest quarter, its operating income trebled to $1.2 billion, largely thanks to the losses of Disney+ narrowing. However, that is only part of the picture as Disney still needs to recoup the $11.4 billion of accumulated losses generated by the platform so far.
Netflix reached profitability in 2016 and had a 21% operating margin in 2023. Assuming that Disney+ hits a similar level from the start of 2025 – and there is no guarantee of that as Iger told CNBC earlier this year that he expects double digit profit margins "eventually" – it could still take years for the platform to clear its accrued losses.
Disney+ has generated average annual revenue of $17.1 billion so far, though this could decrease as although its top line has been growing, it has been driven by a torrent of new content which is slowing down under Iger. A 21% margin would yield annual operating profits of $3.6 billion bringing Disney+ close to break even in three years.
It means that Disney's Entertainment division has a lot of catching up to do which puts even more importance on Experiences to deliver profits. As we recently revealed in British newspaper City A.M., Disney's cruise line hit record revenue last year but it represents just 6.8% of the total Experiences revenue. Moreover, the cruise line's net profit of $180.5 million was less than half of its peak of $406.2 million in 2019 so it is still not firing on all cylinders.
Nevertheless, Disney has realized that the cruise line's popularity is surging and has commissioned a number of new ships with more to come as we recently revealed. Generally, they don't come cheap and Johnston noted that "we do have some expenses attached to our ships coming in, and that will affect us a bit in '24 and a bit in '25" which is also not what investors want to hear.
Likewise, Johnston yesterday gave insight into the perfect storm facing Disney's domestic parks as "the lower-income consumer is feeling a little bit of stress. The high-income consumer is traveling internationally a bit more. I think you're just going to see more of a continuation of those trends in terms of the top line." He added that "we saw attendance flat in the quarter" with a "flattish revenue number" forecast for the fourth quarter and a slowdown expected for "a few quarters."
It doesn't sound like the ideal time to announce a raft of expensive expansions to Disney's theme parks but that is exactly what it will do this weekend. Disney has been contacted for comment on its reasoning for this decision and any response will be inserted into this report in an update. Disney's stock performance is the clearest evidence of what investors think of its decision to heavily invest in its Experiences division.
In September last year Disney announced that it would spend $60 billion on it over the next decade. It cast a dark spell on Disney's stock price as it fell 3.6% to close at $81.94 on the day of the announcement. It wasn't a one-off.
Two months ago Disney signed a deal with the local government in Orlando paving the way for it to spend some of the $60 billion on building a fifth theme park at Walt Disney World. Instead of having a magic touch on its stock price, it fell below $100 for the first time since February.
Disney's stock has fallen a further 15% since then and it has forecast a slowdown in its Experiences segment over the coming months so it is easy to understand why investors might not be thrilled at the prospect of Disney announcing how it will spend billions on it. Theme park attractions cost hundreds of millions of Dollars and take years to build so they are far from a short term win for investors. That's just the start.
Although theme park guests can buy queue-cutting passes for specific attractions, they don't have to do so as they get access to them through their general attendance ticket. In other words, theme park attractions cost hundreds of millions of Dollars to build but customers don't have to pay directly to use them. It limits their potential to generate revenue and therefore profit so not only do they take years to come on stream, they take years to pay off. Operators can make a faster gain by increasing the ticket prices when new attractions open but that's not a walk in the park for Disney as its prices are already high which is why attendance is thinning out. Again, that's not the kind of news which boosts a company's stock price.
That can clearly be seen in Japan where Tokyo Disney Resort is run under license by listed leisure operator Oriental Land Company (OLC). In June it opened a new land called Fantasy Springs which cost a staggering $2.1 billion, making it the largest expansion in the resort's history. As we have reported, OLC's filings state that it expects Fantasy Springs to boost its consolidated net sales by approximately $490 million (¥75 billion) annually and although it doesn't say how much of that will fall to the bottom line, OLC's overall operating margin is 26.7% so, again, it could be many years before Fantasy Springs breaks even.
Against this backdrop, OLC's stock price has dropped by a staggering 13.5% since the new land opened just two months ago which shows what investors think of it.
Even if theme park attractions did directly generate revenue, the fattest margins are to be found on the high-priced food, beverage and merchandise. The higher the attendance, the higher the spending on them so the secret to keeping investors sweet could be getting more guests through the turnstiles without spending vast sums on new attractions.
It could also be smart to open inner-city attractions as it once planned to do. They would attract travellers who can't afford to visit its theme parks, would cost less to build and would take less time to come on stream. Disney's arch rival Universal is doing just that as well as opening fully-fledged parks close to Disney's outposts in Paris and Orlando. In May, Iger described this as not being "distracting or anxiety provoking" but his desire to expand Disney's parks in the face of investor apathy suggests otherwise.
"We wouldn't be making capital investments in an accelerated way if we didn't expect to accelerate growth out of those businesses," said Johnston yesterday. Although investors might not be enamoured by it, no doubt fans will lap it up. Many of them are investors too but it won't give the stock price a boost over the weekend as trading doesn't take place then.
The announcement about the slowdown in Experiences did affect the stock price and, bizarrely, Disney even engineered the circ*mstances to do it. Until its previous quarter, its earnings announcements had taken place after the market closed but from May, when it first revealed the softening in demand, it switched them to before the market opened. As a result, the shares slid throughout the day on the news. Timing doesn't get much worse than that.
