Barron's Streetwise - Disney Swaps Bobs, Again

Episode Date: November 23, 2022

Chapek is out. Iger is back. What does it mean for the stock? Learn more about your ad choices. Visit megaphone.fm/adchoices

Hey Spotify, this is Javi. My biggest passion is music, and it's not just sounds and instruments, it's more than that to me. It's a world full of harmonies with chillers. From streaming to shopping, it's on Prime. Hi, it's Jack Howe, and this is the Barron Streetwise podcast. We're taking a break for Thanksgiving, kind of. Disney made a surprise announcement that Bob Chapek is stepping down after just two years as CEO. Bob Iger has returned to replace him. We've had both Bobs on this podcast, so our audio producer, Jackson Cantrell, who's definitely

filling in as host this week, called me for some thoughts, which is why I'm talking now, even though i'm not podcasting i'm just doing some casual talking into this microphone coming up disney's latest bob swap and what it means for the stock welcome to the baron streetwise podcast we already did we already did that part we're up to the part where you play some news clips. You didn't let me finish. Welcome to the Barron Streetwise podcast, where we're up to the news clips part.

When Bob Iger sent the email to employees overnight, apparently many were at a Elton John concert where Bob Chapek was supposed to be introducing Elton John. Meet the new boss, same as the old boss, okay? I love the who, but are investors going to love the fact that Iger is back? I called Jack at home to get some quick thoughts. Here's Vacation Jack. Everybody knew there were some problems at Disney. I mean, obviously, the stock had fallen by half. So that's a bad sign. There were criticisms here and there about Shapic up through this past summer, but there was no sign of a major catastrophe for the company.

I mean, the earnings at the park had bounced right back. The parks department was earning basically where it was earning before the pandemic. If you're a park visitor, you might complain about rising prices. You might complain about some of the services that you used to enjoy having gone away. But for investors, there was no question that the margins at the park were riding high. At the streaming service, the profits just weren't there. But that's the nature of streaming still, is people are saying, well, we're spending money now on content because we want to gain a lot of subscribers. The profitability will come. So that's what the story looked like this summer. And then you got to the fourth quarter earnings call in early November. And that was a disaster.

This was somewhat of a shocking quarter from Disney. Three months ago, we were here talking about a comeback quarter from Disney. Now here is Disney today, missing on the top and bottom lines. Was anything particularly bad, or was it just slowing consumer spending? There was some weakening at the parks. That's not a great sign. Disney's line has been, hey, nobody minds the price hikes. Nobody minds the missing services. You know, customer sentiment is riding high. But the big

issue in the fourth quarter results was a monster loss for the streaming division, DTC, or direct to consumer. What Disney has said up until now is that Disney Plus, its flagship streaming service, would break even in fiscal 2024. We're already in fiscal 2023, so that means next year we break even. I just don't see any sign that that's going to happen because if you go back to this fourth quarter result, which is also the full year result for fiscal 2022, it's a $4 billion loss for the direct-to-consumer business. And we're already a couple of months into fiscal 2023. The estimate there is that they're going to lose another $3 billion. So how do you get to break even from numbers like that? I'm not so sure. If you go back a year ago when the stock price was riding high,

If you go back a year ago when the stock price was riding high, Wall Street said, hey, that's easily beatable guidance, that guidance to break even by fiscal 2024. Disney will have no trouble. In fact, they were projecting a tidy little profit there for the current fiscal year. But it's just not happening. Here's what it gets me thinking. Television used to be lousy. When you had your cable bundle, you paid a fortune for these thousand channels. You only wanted a handful. Most of them you never watched. You didn't see a lot of movie quality TV series. I mean, you saw some good shows, but a lot of lousy ones. And you watch shows when the programming

directors said to watch them and you watch what they said to watch. And then you had to sit through endless commercials. Hey, those commercials have turned into a number of streetwise references. So it wasn't all lost. What's that? You know, Hubba Bubba, New York City. They come up pretty frequently. So the commercials are content is what you're saying on this yeah yeah we've gotten some mileage out of them what do you have today endless choices for consumers the shows are great they're not all winners i get it but there are movie quality tv series

pretty much on every platform and you have choice. You can start and stop subscriptions over here and over there. You can watch whenever you want. So it's a golden age for television viewing, but it's just not profitable yet for the companies. Look at Netflix. They started streaming in 2007 when the iPhone 1 came out. This is not a new business. By now, this business should be financially mature. The cash flow should be ramping up. Netflix is expected to clear just over a billion dollars in free cash this year. That's not a lot considering the vast billions they've burned to get to this point. So we keep pushing back these forecasts for when the profitability is going to come. I'm starting to think that maybe streaming is just never going to be as profitable as legacy television. And how are the projections so far

off? Did they just end up spending more money than they thought? I heard their subscribers are, the numbers are beating expectations. So are the subscribers paying less money? Yeah, it's just you don't get the combined profitability that you got when you were getting paid a bunch of different ways, including from advertising. And we'll see what happens when you introduce more advertising on streaming. But what you don't change is the amount of consumer choice. Before, you know, consumers with a cable bundle, they couldn't just say, hey, I'm going to cancel this, this and that channel because I don't really want them.

But now they can do exactly that with their array of streaming services. Something has to change. I hate to say it, but if you want to get the television world more profitable again, it has to get a little bit lousier for consumers. You need consolidation, right? You need consolidation. Now, companies will say, we're doing this to rein in our content spending. But really, there's so much choice out there for consumers that it's hard to keep them pinned down to one service and keep earning on them.

They can go anywhere they want. And it forces these companies to race against each other and spend a ton on content to try to attract the subscribers. And I don't blame these companies. They had to come up with something. They were losing legacy cable subscribers. And by the way, let's not pretend that that business goes to nothing overnight. That business still makes a ton of money, right? And it will for years to come. But it's eroding. their stock valuations were in the trash. And the answer they came up with was, we'll just migrate everything over to streaming and it'll be great. It'll be just like it was before. We'll make tons of money. In fact, we'll make it all around the world. So we'll take the same content spending and we'll get better leverage on it because we'll have a bigger consumer base. It just hasn't become

reality yet. They're spending too much relative to the money they're bringing in. So you can argue whether that was a good or bad decision from all these companies, but for a while, it seemed like that was what investors wanted. They were, you know, when interest rates were low, they were rewarding these huge subscriber gains. Is that really Bob Chapek's fault here? Like, why is he out every, you know, all these other streamer stocks are way down too. like why is why is he out every you know all these other streamer stocks are way down too no it's it's a good question i i don't think if streaming is being a good or a bad choice i think it's what everyone had to do and you're right interest rates have a lot to do with this because when they were near zero for the better part of a decade investors got chased into anything

growthy and they didn't mind if you told them a story hey you know you know, the profits will come seven years, eight years down the road. That's fine. They just wanted to see that you were bringing customers in. And that's what streaming was doing. And now the world has really changed. Now investors can get a few percent on their savings. They have no patience for story stocks. They want companies where all the big divisions are making money right now. And that is the situation that Bob Chapik stepped into. He can't reinvent the television business overnight. He's a guy with deep experience in the parks. He has used his experience there to make more money

from the parks for Disney to help offset these big losses in the streaming investment. So what were the missteps? Here's one thing I'm wondering. Based on what we know about Disney, you say, wow, this seems really sudden. Disney didn't give any kind of an indication over summer that they were thinking about making a big change at the top. So you look at the suddenness of this change, you say, OK, maybe everyone just lost confidence overnight with Chapek as a result of that fourth quarter earnings call.

Or maybe there's something else that we're going to learn. That's what concerns me a little bit. I don't know what that could be. I mean, my main thought is maybe there's just a worse deterioration at the parks than we would expect. More Streetwise after this quick break. Breaking news happens anywhere, anytime. Police have warned the protesters repeatedly, get back.

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Conditions apply. Offer ends January 31st, 2025. Visit td.com slash DI offer to learn more. Job number one for Bob Iger, I would think he has to do a lot of things, right? He has to, he has to figure out ESPN, which doesn't quite fit with the rest of Disney. And some people want him to sell it so that ESPN could maybe become more valuable if they had a big gambling component because sports gambling is taken off. He'll either have to make the case that that belongs in the Disney world or that they could

make better money by selling it. He'll have to figure out what to do about the one third of Hulu that Disney doesn't own. It's owned by Comcast. But the one thing that I think he has to do right away is he's got to allay concerns that are out there about, is there something that we're not seeing? Is there another shoe to drop? Is there something that caused this sudden change that investors don't yet know about? You know, if there's bad news out there, I want all of it now. And if there's not, I'd like to know that there's not. So I'm hoping

that he will become visible pretty soon about that. You mentioned the parks experience. You've recently been to Disney parks. Do you want to elaborate on that? What was it like? Well, look, I'm careful not to become one of these people who say, well, the good old days and the good old days when I was young, blah, blah, blah, blah. You know, that's usually misguided thinking. Things, you know, usually get better over time. We went to Disney a lot. We loved it. We had loads of fun. We stopped going during the pandemic and we just made our first trip back. I have to say, I'm trying to think about this with as little bias as possible, but the prices were like way up and not just way up. You felt like you were paying two and three times

for the same thing. You have to pay a lot for the tickets to go into the parks. Then you have to pay extra for these passes that let you go on the fast line instead of the slow line for most of the rides. Then you have to pay a third time for that same privilege, but for the really good rides, right? Because the other one doesn't include the really good rides. So now you've paid three times for the same thing, which is going to the parks and getting on some rides, which, you know, it kind of feels a little bit insulting after a while. And you can't not pay because what has happened is

all these systems that allow you to take the fast line, they blow out the wait times in the slow line. So they've created a problem and then they are charging to solve it. It's a race to the bottom. Yeah. And there's little things that we like. When we first started going to Disney, we would give over our luggage at the airport in New York with these special Mickey Mouse tags. And the next time we would see our bags would be in the hotel room down at Disney World. Now, it sounds like a little thing, but if you have little kids in carriages,

it's a big deal not to have to grab bags going through the airport. Then when we get down to the airport in Florida, you go right on the Mickey Mouse bus that would take you right over there. You didn't have to worry about running a car. You didn't have to get an Uber. So now both of those things are gone.

So is that a price hike? Well, I don't know. I have to pay to get my own transportation now from the airport. So that that a price hike? Well, I don't know. I have to pay to get my own transportation out from the airport. So that's a price hike. And it's just a little bit more of a pest to have to handle my bag. So those are, I get that those things were expensive for Disney. I get that they had to make some tough choices during the pandemic. And let's remember how difficult the pandemic was on that parks business. But boy, everything just feels a lot more expensive, a lot more work and a little less fun. They got to have a new name for like services shrinkflation. Like I went to a

brunch the other day and they it was like, you know, you get your own water, you bust your own plates. There's no menus. You got to use the QR code on your phone. So everyone looks like they're just on Instagram or something when they're ordering. you know, the prices weren't too bad, but everything was just worse. Like what's next? I got to go into the kitchen. I got to fry up my own fajitas. Like what, you know, where, where do we go from there? I'd wash my own plates for 15% discount. You might, you might be onto a new opportunity there. All right. So what's next for Disney? Can, you know, Chapex out, Iger's coming in. Can these problems be fixed? Well, it's a good question, but what are the problems? This is my concern. Obviously,

the one problem is the stock's down. It's lost half of its value from the top. Okay. So you got to get that working again. How do you do that? Well, free cash flow is half what it was at the peak before the pandemic. Okay, so now we have to fix that. How do you do that? Well, you're not going to wring any more money out of the parks. Not right away, I don't think. There's room to bounce back in the theaters,

but the main thing you have to do is you have to get streaming earning. If Bob Iger knows how to do that, I can think of a half dozen other streaming platforms that would love to hear about it because everyone is trying to figure it out and it's just not happening. Netflix has been around for so long, I feel like if there were a point of financial maturity, it would have hit for them already and it hasn't hit. There's no one out there with more talent in that business than Bob Iger. So if anyone can figure it out and fix it, it's him. But the question of can Bob Iger fix Disney? I don't know. Is it broken or is it just structurally less profitable than show

business has been in the past? What if they just make more sequels? The sequels are doing just fine. They had the Black Panther sequel. I think it's called Wakanda Forever. I hope I'm getting that right. It did 540 something million dollars in the first 10 days. It was a solid number. So there's no problem with superhero sequels. And there are plenty of those to come. They're going to do a Guardians of the Galaxy. They're going to do a Captain America. They've got some of Ant-Man. And then they've got some reboots. They've got this Avatar,

new deal for Avatar movies. And they've got an Indiana Jones reboot, which I'm intrigued by. You know, the film slate looks better going forward than it has for about the past four or five months. I think the studio business will bounce back to better economic productivity.

I should tell you this. There is room to cut costs in streaming without dialing back on content too much. You can look at the non-content spending for Disney in streaming, and it is too high relative to the revenue. It's higher than it is for Netflix by a couple billion dollars, and Netflix has a lot more streaming revenue than Disney. So there's something going on in non-content spending where you can save some money, but you're just limited to how much you could pull back on the content spending, I think. Non-content spending is that like the data storage, the technology behind their streaming platform, that kind of thing, the algorithms. I think it's that and a lot of other

stuff. But all of it is stuff where you say, wait a second, if we're not spending on the things that customers are buying, is there any room here to make cuts? No one out there has better assets in entertainment than Disney does. So they have a lot to work with. If Disney can't make it work, I don't know who can, but I don't really know if anyone can make it work to the degree that they made it work during the age of lousy television, because lousy television was a huge moneymaker. Oh man, maybe I'm going to have to start reading books. Well, don't let it come to that. Come on, don't fall into despair.

Reading? Come on. I guess last question, are there any signals that would convince you that Disney stock is now a buy? What are you looking out for? Let me pull it up on the old machine here. So you're over 30 times free cash flow,

which is not obviously cheap. And then you say, well, wait a second, free cash flow is only half what it was at the peak. So if you get back to peak numbers, now you've got a decent price stock. You're mid to high teens, multiple of free cash flow. But A, I don't know how you intend to get back to peak free cash flow when you've got this streaming beast that you have to spend to support at a time of incredible competition.

So that's not going to happen. You know, I don't want to sound flippant, but the stock is certainly a better deal than it was now that it's fallen by half. There is room for Bob Iger to make more money from Disney in the near term by cutting down on some of that non-content spending going on in the streaming side. That could boost free cash flow pretty quickly. And I think that the starting point for the stock, if you get free cash flow moving again, you know, you can probably get a decent return out of Disney stock.

I don't think it's going to race ahead or race back to where it was in a hurry. And I actually think it's more challenging for Bob Iger now than it has been in the past. A lot of his past success, he did many good things at Disney, but he made three transformative deals at the company, buying Pixar and buying Marvel and buying Lucasfilm, which gave Disney most of the big entertainment properties that you see in the movies today. And then he layered those properties on at the parks so that you have this really cohesive storytelling company. And that's what he has always said is that storytelling is at the center of the company. But I don't know, are there more transformative deals to be done?

Every step of the way, there's been people who are saying, you're paying too much for Marvel, you're paying too much for Lucas. And it turns out he wasn't paying too much because he knew what they didn't know, which was that he could make money on those properties in 12 different ways. Not just movies, but like I said, you know, things at the parks, consumer merchandise, and so on. As impressive as he has been at Disney, I think the job for him is much tougher today. All right. Well, thank you so much for that summary. What are you doing for Thanksgiving? Are you cooking?

I just like to get every holiday catered now so that we can just relax and focus on fun. We have some family coming over. It's going to be a nice time. We're going to relax from not having to do any cooking, and then we're going to argue about politics. That sounds very fun and relaxing. Well, happy Thanksgiving, Jack. Same to you. Talk to you soon.

Thank you, Jack, and thank all of you for listening. If you have a question for the show, please tape on your phone, use the Voice Memo app, and send it to jack.howe at barons.com. That's H-O-U-G-H. Happy Thanksgiving, and see you next week.