Will Disney Cave To Amazon's Pressure?

| About: The Walt (DIS)


Although Disney is one of the largest entertainment companies in the world, it's not immune to being pushed around by Amazon, a big seller of newly released Disney DVDs.

Previously, Time Warner's Warner Bros. faced the same threat and struck better terms (in Amazon's favor) with the e-commerce king, which could be a blueprint for Disney's scenario.

While Disney and Time Warner are similar in nature, Disney is less reliant on DVD sales and might be different enough to stave off Amazon's threat.

On Aug. 10, news broke that e-commerce giant Amazon (NASDAQ:AMZN) had halted pre-orders of upcoming releases made by The Walt Disney Company (NYSE:DIS) such as Maleficent and Captain America: The Winter Soldier. The most likely explanation is that Amazon is using this ploy as a way to extort more money from the entertainment behemoth which allows for its upcoming titles to be sold via Amazon's network. Although the company was successful in striking a deal with Warner Bros., a subsidiary of Time Warner, Inc. (NYSE:TWX), for more attractive distribution terms, there's no guarantee that it will succeed to pressuring Disney to cave to its demands.

Disney and Warner Bros. are in similar boats

While the idea that Amazon, the world's largest e-commerce website, won't allow Disney's big-name pre-orders to be made might come across as frightening to some investors, the fact of the matter is that DVD sales have, in recent years, been a small and shrinking part of Disney's revenue stream. Between 2011 and 2013, for instance, sales coming from the Home Entertainment category of the company's Studio Entertainment segment declined by 28% from $2.44 billion to $1.75 billion.

Disney's Home Entertainment and Television and SVOD Categories
(dollars in billions) 2013 2012 2011 Change
Home Entertainment $1.75 $2.22 $2.44 -28.3%
Television and SVOD $2.36 $2.13 $2.18 +8.3%
Home Entertainment % of Sales 3.9% 5.3% 6.0%
Home Ent. + TV and SVOD % of Sales 9.1% 10.3% 11.3%

In truth, there could be several factors at play here, but the biggest explanation appears to be that more and more of Disney's Studio Entertainment revenue is coming not from Home Entertainment sales but, instead, can be chalked up to its Television and SVOD Distribution category. During the same three-year period, sales from this area grew 8% from $2.18 billion to $2.36 billion.

Unfortunately, the sale of digital content through Pay-Per-View, Pay Television and Free Television does not garner the same revenue numbers as DVD sales. It does, however, result in higher margins, as demonstrated by the segment's operating profit margin rising from 9.73% in 2011 to 11.06% by the end of its 2013 fiscal year.

Time Warner's Warner Bros. is in a similar boat. Over the past three years, sales of the segment's Home Video and Electronic Delivery category fell a more modest 14% from $3.74 billion to $3.23 billion. It should be mentioned, however that this isn't necessarily comparable with Disney, which separates its Home Entertainment and Television and SVOD Distribution categories while Warner Bros. lumps the two together. By doing the same with Disney, both categories' sales dropped just 11%.

Warner Bros.' Home Video and Electronic Delivery Category
(dollars in billions) 2013 2012 2011 Change
Home Video and Electronic Delivery $3.23 $3.33 $3.74 -13.6%
Home Vid. & Elec. Del. % of Sales 11.6% 11.6% 12.9%

Of course, the other factor to consider is what this all looks like as a percentage of sales. In 2013, Disney's Home Entertainment and Television and SVOD Distribution categories made up 9.1% of the company's consolidated sales compared to Time Warner's 11.6%. Disney's Home Entertainment, by itself, accounted for just 3.9% of Disney's total revenue for the year.

What are the long-term ramifications of this?

No matter what kind of deal is or is not agreed to between Disney and Amazon, the fact that sales in the Home Entertainment category of Disney's Studio Entertainment segment are declining suggests that the business is committed to developing its digital content distribution even more. Right now, Disney has an exclusive distribution agreement with Starz (NASDAQ:STRZA) for its domestic Pay 1 and Pay 2 windows but, beginning in 2016, that contract will move over to Netflix (NASDAQ:NFLX).

Assuming that Disney can keep pressing its distribution down the digital road and if the company's content does not decline in popularity (which doesn't appear even remotely likely in the foreseeable future), then DVDs could be phased out entirely. This will ultimately yield higher margins for Disney but will result in lower sales. For Amazon, this is bad no matter how you stack it, but given how little of Disney's revenue comes from its DVD sales, the impact shouldn't be material in nature.


Right now, Disney appears to be finding itself in a bit of a pickle. With Amazon, likely one of the company's largest sellers of its Home Entertainment products, trying to squeeze it for cash, there's no doubt that a deal will have an even greater downward impact on sales. However, Disney does have a great deal of negotiating power heading into this fight.

In addition to having larger sales than rival Time Warner, the company can argue that losing Amazon's business would have a de minimis result on its sales because of the fact that only a small portion of its revenue comes from this relationship. This, combined with the fact that the business is moving more toward digital content distribution provides little, but not necessarily no, incentive for management to cave to Amazon's demands. However small sales may be though, the fact that Time Warner ended up striking an accord with the e-commerce king suggests that an agreement isn't out of the question.

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