Disney Vs. Netflix: The Content War Begins

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Includes: AMZN, APPL, CBS, CMCSA, DIS, NFLX
by: Crispus Nyaga
Summary

Netflix and Disney are two of the biggest media companies in the world.

Fears of Netflix losing users to competitors are overblown.

I explain why I am long the two companies.

Introduction

In recent years, investors in the media industry have focused on the disruption brought about by Netflix (NFLX). The company has continued to grow and attracted foes both in media and in the telecommunication industry. AT&T has acquired Warner Media to expand its streaming business while Comcast (CMCSA) launched Xfinity Flex last year and is expected to launch a free ad-supported streaming service next year.. Apple (OTC:APPL) is building its subscription service that will feature big stars like Oprah and Steven Spielberg. CBS (CBS) All Access has been around since 2014 while Amazon (AMZN) has Prime Video. While all these companies have their strengths in the media industry, none matches the might of Walt Disney (DIS), which owns Hulu and plans to launch its Disney+ in November. This article will compare Disney and Netflix and conclude with one that makes a good investment.

The Companies

In terms of operations, Netflix has one of the simplest business models in corporate America. The company licenses movies and series from other studios like Disney and Warner. It also spends billions of dollars every year in producing its own Netflix Originals like Master of None, The Patriot Act, and Chewing Gum. It then makes money from the money subscribers pay every month. In the US, this price ranges from $10.99 to $15.99 per month. In the most recent quarter, the company has more than 148.8 million global members. Of these, 60.2 million are from the US. In the quarter, the company had revenues of more than $4.52 billion. It now has a market capitalization of more than $150 billion and more than 7,100 employees.

Disney, on the other hand, is a more diverse company that makes money from tens of places. In 2018, the company made more than $59 billion from its four segments. The media networks generated $24.5 billion while parks and resorts, studio entertainment, and consumer products generated $20.2 billion, $9.9 billion, and $4.6 billion. The main challenge for Disney is that its traditional bread and butter business in television are slowing down as many Americans cut the cable. To pivot, the company has moved to streaming in a number of ways. In the UK, it owns Disney Life, which is a streaming service with most of its titles. It now owns Hulu, which has more than 25 million subscribers. It also owns ESPN+, which has more than 2 million members. Analysts at Barclays believe the service could have more than 1170 million subscribers by 2025. It now has a market cap of more than 237 billion and 201k employees.

Financials

In recent years, Netflix has seen its revenues grow as more people have joined its platform. The annual revenues have grown from $1.6 billion in 2009 to more than $15.79 billion in 2018. Investors expect the revenues to reach $20.2 billion this year and $25.1 billion and $30.4 billion in 2020 and 2021. In total, the number of subscribers has grown from 20 million in 2010 to almost 150 million this year.

Disney has been growing too. Its annual revenues have jumped from more than $38 billion in 2010 to more than $59 billion in 2018. Part of the reason for this growth has been excellent acquisitions such as the 2012’s acquisition of Lucasfilm and the recent investments in Bamtech. It also completed the acquisition of 21st Century Fox this year. The chart below shows the quarterly growth of the two companies.

To fund the content and acquisitions, Disney has seen its total long-term debt skyrocket from $12 billion in 2010 to more than $56 billion. In the past ten years, it has returned more than $15 billion to shareholders through dividends and more than $50 billion in share repurchases.

Netflix too has increased its debt from nothing in 2010 to more than $10 billion. It has mostly used these funds to produce its original content. This year, it is expected to spend more than $15 billion on content to counter the content that has been taken back by studios like Disney. This amount is $5 billion less than what the company will bring this year.

In total, Disney has total assets of $214 billion and total liabilities $110 billion. Netflix has total assets of $27 billion and total liabilities of more than $21 billion. The chart below shows the two companies debt and cash and equivalents.

When looking at companies, it is always important to look at the margins. This is because the margins determine what is left to the shareholders. Comparing the two companies, it is clear that Disney has better margins than Netflix. This is partly because Netflix is in the growth phase of its business and is focused mostly on growth. In recent years, as the number of members have increased, the company has been able to boost its margins. EBITDA and operating margins have increased from 3.55% and 1.39% in 2014 to the current 11.37% and 9.75% respectively. Disney’s EBITDA margin has increased from 21% in 2010 to the current 36%. Operating margin on the other hand has been weakening from 26% in 2016 to the current 23%.

The Future

Netflix and Disney are at an important point in their business lifecycle. On the Netflix side, the company is set to lose some of its most important shows as rivals create their own subscription businesses. Some of the content to be lost are the most viewed on the platform like NBC’s Parks and Recreation, Warner Media’s Friends, and Disney’s Grey’s Anatomy. To bridge this gap, the company has increased its production costs, with hopes of producing hits like Orange is the new black and Stranger Things. In fact, the company’s content costs have increased from $5 billion in 2015 to this year’s $15 billion.

Source: WSJ

To maintain the momentum, the company needs to attract more international subscribers to its platform. Presently, the company has more than 90 million international subscribers. With the world’s middle class expanding, the company’s has a large TAM. Therefore, it needs to increase the amount and quality international content available on its platform. For example, in the African market, the company produced Lionheart, that featured Genevieve Nnaji, one of the biggest stars in the continent. With the popularity of native Nigerian movies in Africa, the company can do more to have the content on its platform. The same is true in other regions of Asia and South America. If it does this, its logical to see the company reaching more than 250 million users in the next ten years.

The biggest fear among investors is that the exit of popular shows from Netflix will cripple its business. However, based on the company’s brand, it is highly likely that most subscribers will not jump ship to other platforms. In fact, I believe that Netflix will co-exist very well with other upcoming rivals.

The future of Disney’s media arm will depend on the success of its new streaming service, which the company is pivoting on. Already, the company is in the business through its investments in Hulu and ESPN+. The company’s key advantage is the vast amount of content it has because of its investments in Pixar, Marvel, and National Geographic among others. Some of its most popular content in Disney+ will be Star Wars, High School Musicals, The Simpsons, and Malcom in the Middle.

With the popularity of these titles, coupled with the cheap subscription package that starts at $6.99, the company will likely gain millions of users in the next few years. As mentioned, analysts believe that the service could have more than 170 million subscribers. If it reaches this milestone, and with the current pricing structure, the company could generate high-margin revenues of more than $11 billion by 2025. The company expects to spend more than $2.5 billion a year on content by 2024. While this is much smaller than the $15 billion Netflix is spending, it makes sense because of the company’s vast library and its expertise in production.

Valuation and Conclusion

This year, Netflix and Disney’s stock have continued to move up. The two have gained by 28% and 24% respectively and are currently valued at more than $150 billion and $237 billion. Netflix is valued at 58x this year’s earnings compared to Disney’s 20x multiple. The two companies have an EV to EBITDA ratio of 83 and 13 respectively, which is above the S&P average of 11.

Unlike most analysts who expect Netflix to lose a significant share in the market, I believe the company will remain the market leader, especially if it continues to boost its investments in international content. However, I believe that at the current valuation, the company is relatively overvalued given that it has to spend more money on building its own library. As with other technology companies, investors will continue to value Netflix on the basis of growth, which makes it difficult for shorting the company on the basis of its valuation. Therefore, I would recommend having a small exposure to the company.

Trading at 20x this year’s earnings, I don’t believe that Disney is overvalued. However, investing in the company is having hopes that the management will execute well on the switch to streaming. Unlike Netflix, Disney can afford to fail because of how large its other segments are. Therefore, Disney remains one of my biggest bets on the media industry.

Disclosure: I am/we are long DIS, NFLX. 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.