Two Disney News Items Before Earnings: 'Guardians' Sequel And The Evolution Of Maker Studios

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Shareholders know the sequel to "Guardians of the Galaxy" is going to be a hit; Marvel is one reason why Disney is a buy.

Not everything Bob Iger bought turned to gold: Maker Studios is slimming down and turning into the Disney Digital Network.

Iger needs to focus on the new digital initiative and develop franchises from it.

Disney is still a great long-term stock idea, but the company must always be thinking of capturing that extra dollar and not take its success for granted.

Disney (NYSE: DIS) will report earnings next week. Until then, there are two items in the news that I think are worthy of examination and that will help pass the time.

The big item on the agenda for shareholders is Guardians of the Galaxy Vol. 2. This is a sequel to Guardians of the Galaxy, a film that was released in August 2014. According to Box Office Mojo, the first Guardians grossed over $770 million at worldwide theaters. More notable is the domestic gross of over $330 million. It may seem funny now, but some people (including myself) weren't sure how Guardians would perform; the main thing about the picture was the fact that it was Not-Spider-Man, Not-Captain-America, Not-Iron-Man, and Not-Thor. I've never seen these films (that includes Guardians), but I am obviously aware of how well they did at the box office, and Guardians seemed to me something of an experiment, one that needed to be performed. The experiment was executed, and it was a great financial success. A new brand was born in the Marvel Cinematic Universe.

This time around, Guardians Vol. 2 is coming out May 5. This is a very favorable starting point compared to the beginning of August. The brand is strong enough to merit an early-summer start. It actually is already out in some international territories. As of this writing, the movie has grossed over $100 million. According to Deadline, the domestic debut could possibly capture some figure between $140 million and $160 million for the three-day period. Last time around, the opening was at $94 million. Even the smaller side of the predicted range would represent solid growth. After coming off of an impressive performance with Beauty and the Beast, which sold over $1 billion in ticket sales around the world, it can be seen that Disney's tentpole business is extremely healthy. Only thing now for the company to focus on is perhaps expanding the number of tentpoles it releases in a fiscal year, and to market them more cheaply.

Perhaps economical marketing was on the minds of execs when the Disney Digital Network was announced. Remember the Maker Studios acquisition? If you don't, you're forgiven; however, I'd argue it is important for shareholders to think about this topic. Marvel is a more significant financial component to Disney, but Marvel pretty much takes care of itself; sometimes opportunities in the quieter areas of the media conglomerate should be the focus of corporate strategy. Let me make my case.

Maker Studios was acquired by Disney for a price of $500 million in 2014. In addition, the ultimate price could have risen to $950 million if specific statistical milestones were achieved. Articles like this one seem to indicate the milestones achieved did not add up to a full payout; the final price was apparently closer to $675 million. This kind of cash isn't necessarily a large sum to a company like Disney, but on an absolute basis, it is absolutely large, and at the very least represents an opportunity cost compared to other things in which the company could have invested.

It's unclear to me whether the actual Maker Studios brand identity is going away (I'm not sure how much of a brand it actually was anyway) but the reports indicate that the number of creators involved with the company has been radically reduced. There are now about 300 creators as opposed to thousands of creators.

Content from Maker Studios was on YouTube and a website. Obviously the YouTube presence probably received more views, and I imagine Disney saw this important destination as a way to keep up with the times, so to speak. But I think buying this network was an expensive way of connecting with a demographic that didn't necessarily watch ABC or The Disney Channel. Disney is a content-is-king play, both in terms of the stock and the company's mission statement, and one would have thought (in my opinion, at least) that Disney would have solved that problem by creating more compelling content and placing it on YouTube properties built from scratch (or by placing them on Disney's main consumer site). As the argument goes, though, sometimes acquiring something is more efficient than building it. Sure, that can be true. But the Maker asset just seemed too large to properly integrate.

That size must have been its eventual undoing as indicated by the recent reduction in creator count. I approve of such strategy and hope Disney can use it to do what it should do: attempt to incubate new franchises from it. These would be small ideas to start, but The Disney Channel also had some smaller ideas that eventually turned into big intellectual properties. Hannah Montana and High School Musical are two brands that branched out and went beyond being simple cable programs. If the Disney Digital Network is to have a mandate, it is this: find the next Montana, the next Musical. From there, it can move to cable, theaters and retail shelves. This Seeking Alpha article from 2008 mentions those two properties.

The Disney Digital Network can also do something else: market stuff. Yes, if you look at the initial offerings from this asset, you'll note cross-promotional connections to Star Wars and Disney itself. However, as I alluded to before, Disney, like all media concerns, should be aggressively reducing the cost of bringing a tentpole picture to the attention of potential ticket buyers.

There is a chance that Disney might make good with Maker, but it will remain an acquisition I wish the company had not made. Bob Iger should be questioned about this next week on the conference call. Iger has a chance to use his executive imagination to picture what a digital network can actually do for the company -- create movies exclusive to the platform, connect with fans (beyond mere comments), solicit screenplays, audition new talent...the proverbial sky is the limit. I hope it's not going to be a bunch of unboxing videos (although they have value as a marketing tool, again, too much money was spent to just be that).

The problem with trying to launch a digital network is that one wonders on where Iger's attention span is directed -- is it on building platforms and franchises, or is it on finding a new CEO? I'm not bearish on the stock -- Disney is a great buy because of all that it is, which is: a compelling company that sells content, merchandise and theme-park experiences that consumers seem to be unable to ignore in the marketplace and that appear to be very dominant compared to other brands. This is the point in the piece where I write iconic brand equity, because frankly, it's accurate in the case of Disney.

Guardians Vol. 2 will make $1 billion worldwide if everything goes according to plan (I'm not necessarily into making predictions, but if the first one grossed well over $700 million worldwide and Beast recently grossed over $1 billion on the same basis, I'd say that this is a fair statement to make). More movies are coming, as well as merchandise tied to it. Disney's business model has momentum to it, and if you can ride out ESPN issues, then you should enjoy owning the stock over the long term. What I'm ultimately getting at with my bearish take on the Maker transaction is that Disney's game at this point is centered on getting the absolute best out of all its assets, and avoiding purchases that should be avoided. It can make many mistakes and still increase earnings and cash flow and dividends. I want that extra penny per share, though, on all counts; that is Disney's opportunity. Management should never take for granted its position in corporate America just because Luke Skywalker has Iger's back.

Disclosure: I am/we are long DIS.

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.

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