Disney: The Force Was Not There

| About: The Walt (DIS)


Star Wars was not enough to save DIS’s latest quarter with bleak ESPN outlook.

ESPN will continue to see subs erosion due to OTT substitution and decline of pay TV ecosystem.

Prefer LGF over DIS given LGF’s more diversified business model.

The force was certainly not with Disney (NYSE:DIS) in its latest quarterly result. On the first look, the company beat on revenue, EBITDA and earnings driven by the growth in its Studio segment thanks to "Star Wars" and Consumer and Interactive division. However, this is not enough to offset the ongoing weakness in ESPN, which saw 2% subs decline during the quarter and continues to face uncertainties involving the secular decline of the pay TV ecosystem. The stock sold off 3.5% following the earnings and I believe there is additional downside risk given the migration of content to OTT and the declining TV ad landscape.

To be fair, I like DIS for its content ownership and IP, which I believe positions the company favorably in the digital age as multiple OTT platform providers will turn to DIS for content rights. Given the near-term challenges the company is facing, I am recommending investors to switch out of studios with pay TV exposure and focus on studios with a more diversified reach. That said, I am sticking only with LGF until there is visibility with the pay TV landscape.

Revenue of $15.2b, +14% y/y, was above consensus $14.7b, driven by +52% y/y growth in the Studios segment. The success of Star Wars was well documented by the street ahead of the print, but the more concerning aspect of the quarter was DIS's reliance on the pay TV ecosystem. CEO Bob Iger continues to defended the value and the positive growth outlook for the bundle (vigorously if I may add) and pointed to ESPN's immense scale, viewership, engagement level and ad growth (all of which I agree). He even pointed out the restatement of the subs decline by Nielsen (1m vs. prev 3m) as evidence of strength.

In my view, a decline is a decline, and even with a decline of 1m household, the pay TV ecosystem is still in a structural decline. This is the single biggest headwind that ESPN is facing and the only thing that the market cares about. Put it differently, DIS will be an ESPN-centric company going forward. No matter how well the other segments are doing, if ESPN continues to see eroding subs and slower ad growth, DIS will continue to trade down on the news. This is an important concept that every DIS investor should be aware of.

Conclusion, Iger is optimistic on the potential success of the light package distribution deals and highlighted the success of subs on Sling TV (NASDAQ:DISH). I hope the growth in these verticals can offset the weakness in pay TV, but we are still in the early innings of this viewership migration. Ultimately, DIS needs an OTT strategy and should contemplate on how ESPN can position itself in a digital world. The segment certainly has the right assets but execution has been sloppy. That said, investors are better off staying away from DIS for now. My preference is only on LGF given its diversified business model.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.