Disney: One Key Change Should Be Made

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Mark Schiavo
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Summary

  • Disney+ is growing rapidly and ESPN+ is nothing to laugh at, but Hulu cannot seem to keep up with its competitors.
  • Many investors are calling for Disney to sell Hulu and acquire a new company, and the likely candidates are Roblox or Netflix.
  • Disney's parks and consumer product sales are exploding domestically and still has much more room to grow internationally.
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Disney (NYSE:DIS) reported somewhat disappointing earnings for the second quarter of 2022. The company missed on revenue and income expectations, but surpassed new Disney+ subscriber expectations. Although Disney+ is thriving and ESPN+ is growing at a steady pace, Hulu cannot seem to keep up with its competitors and many investors are calling for the company to sell the platform. Even though the company has its ups and downs with the streaming industry, its parks are starting to gain momentum again, especially domestically. Since it appears that Disney's stock could also be undervalued, many investors are looking at Disney as a worthy investment.

Second Quarter Earnings Had Positives and Negatives

In the company's second quarter earnings report, Disney reported lower-than-expected revenue and income figures. Disney reported adjusted revenues of $19.25 billion while analysts were expecting closer to $20 billion. Also, the company reported an adjusted EPS of $1.08 while analysts were expecting $1.19 per share. However, Disney+ is growing faster than many were expecting. In the second quarter of 2022, Disney+ added 7.9 million subscribers to reach a total of 137.7 million. This surpasses analyst estimates by about 2.7 million subscribers. The company's parks and consumer products sales also outperformed expectations with $6.7 billion in revenue, which is more than double the revenue from just one year ago.

Disney+ and ESPN+ Have Bright Futures, But Hulu is Not Growing Like Its Competitors

In the company's second quarter report, it was revealed that Disney+ has 137.7 million subscribers, Hulu has 45.6 million subscribers, and ESPN+ has 22.3 million subscribers. This may seem like Hulu is doing better than ESPN+ at first sight, but the platform's subscriber growth is not doing well. Since the end of 2019, Hulu has grown its subscriber base by only about 1.5x. Compare this with Disney+ subscribers growing by over 5x and ESPN+ subscribers growing by over 3x and it becomes clear the Hulu cannot seem to grow.

Growth rate of Disney's streaming platforms.

Growth Rate of Subscribers (Created by Author)

It is also important to mention that Hulu is slowly losing market share. Currently, Disney has about 24% of the total streaming market share. The biggest threats are coming from Warner Bros. Discovery's (WBD) HBO Max and Amazon's Prime Video (AMZN). Prime Video is becoming one of the largest streaming platforms and is on pace to surpass industry leader Netflix (NFLX). This is because Prime Video is free to anyone who has an Amazon Prime subscription, making up over 200 million consumers. As for HBO Max, it is the fastest growing streaming platform by far. In the first quarter of 2022, HBO Max grew its market share by about 2% to surpass both Disney+ and Hulu as the third most popular platform. Disney also has to be careful as smaller platforms such as Apple TV+ (AAPL) and Paramount+ (PARA) start to gain more market share.

Market share of each streaming platform.

Market Share of Streaming Platforms (JustWatch.com)

Some Investors are Calling for Disney to Sell Hulu and Make a Huge Acquisition

Due to Hulu's underperformance compared to its competitors, many investors and analysts want Disney to sell the platform. Since Hulu is only available in the United States and Japan, its viewers are largely U.S. based. This is causing investors to say Comcast (CMCSA) would be a great buyer of Hulu since Peacock is also only available in the United States. This would help both companies because Comcast would be able to further strengthen its U.S. presence and Disney would build its balance sheet to make a huge acquisition.

As for which company Disney is being asked to acquire, Netflix and Roblox (RBLX) are becoming the leaders. Netflix is currently the largest streaming platform and has a global presence. However, it does not have great content for kids, and this is where Disney could help improve the platform. With Disney's expertise in content for kids and creating high-quality original content, which is currently one of Netflix's main goals, both companies would be able to prosper from the acquisition. The only problem with this acquisition is the price tag. Netflix currently has an enterprise value of close to $100 billion. This means the acquisition of Netflix could be as high as $200 billion. Currently, Disney only has about $13 billion in cash and would likely lead to the company offering lots of stock for the acquisition. Since Disney's stock is down over 30% YTD, this would be very expensive for the company.

This leads us to the other most popular option of acquiring Roblox. Roblox would help bring Disney into interactive media and video games. Also, Roblox's main audience is children and Disney is already strong in this area. It is important to note that Disney has acquired gaming companies in the past and failed, notably Club Penguin. After Disney acquired Club Penguin, its popularity started to steadily decline and eventually shut down in 2017. Many blame the reasoning for the decline in popularity was because of Disney's inability to adapt to mobile gaming. However, Roblox has already done all of this for Disney and has lots of expertise to prevent a repeat of Club Penguin's failure from happening again. Roblox is also attractive because of its much lower price tag. Roblox currently has an enterprise value of about $16 billion, making it cheaper than Netflix by $84 billion. The issue with Roblox is its small fundamentals compared to both Disney and Netflix. In 2021, Roblox generated about $1.92 billion in revenue. This is much smaller than Disney's revenue of $67.42 billion and Netflix's revenue of $29.7 billion. Therefore, if Disney did acquire Roblox, it would take years before it actually had a noticeable effect on the company's fundamentals.

Disney's Parks are Gaining Steam Again

As the pandemic fades, Disney's parks and experiences are reopening and becoming very popular among consumers again. In the second quarter of 2022, the parks generated $6.65 billion in revenue, up from $3.71 billion when compared to one year earlier. Most of this is due to the company's domestic parks which made up about $4.9 billion in revenue.

Disney's parks revenue of 2021 vs. 2022

Disney's Parks Revenue (Created by Author)

On the other hand, Disney's international parks are still not doing well. The international parks are still reporting a net operating loss because many are still temporarily closed, namely in China and Hong Kong. While this may seem like bad news at first, it shows that Disney's parks and experiences still has lots of room to recover and generate the revenue needed to make an acquisition if management sees a sufficient opportunity.

Valuation

By using typical multiples of EV/Revenue, P/S, and EV/EBITDA and combining them with analyst consensus estimates for FY22, a price target of $150.70 can be calculated after adjusting for the company's cash and debt. This gives the stock an implied upside of about 48.41% at the time of writing this article. This price target is also in-line with consensus analyst price targets of $154.70.

Average multiples for Disney's competitors

Price target for Disney

Price Target for Disney's Stock

What Does This Mean for Investors?

Disney's second quarter report had both positive and negative aspects to it. The company missed estimates for revenue and earnings but outperformed with Disney+ subscriber adds. While Disney+ and ESPN+ are doing well, Hulu cannot keep up with competitors and many are calling for Disney to sell the platform to Comcast. With the cash from this sale, Disney may be able to acquire a new company to help it grow and the most popular candidates are Netflix and Roblox. The reopening and growing popularity of the company's parks can also help build the cash to acquire a huge company if needed. Since it seems that Disney has a promising future and its stock appears to be undervalued, I believe applying a Buy rating is appropriate at this time.

This article was written by

Mark Schiavo profile picture
526 Followers
Ever since I was young, I have always been fascinated by the stock market. Over the years, I have continued to expand my knowledge by reading books related to the market, taking courses that help improve my skills (such as Valuation, Corporate Finance, etc.), and listening to meetings from historically successful investors.*Disclaimer: Mark Schiavo has a shared association with another Seeking Alpha author named Chase Fida.
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Disclosure: I/we have a beneficial long position in the shares of AMZN either through stock ownership, options, or other derivatives. 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.

Additional disclosure: Disclaimer: Mark Schiavo is not a Registered Financial Advisor or Financial Planner. This article is purely for informational purposes only. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transactions. The information in this article should not be considered as investment or financial advice on any subject matter. Mark Schiavo disclaims all liability in respect to actions taken based on any or all of the information in this article. Given the volatility of the markets, consult with a financial advisor.

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