The Walt Disney Co. investors welcomed the return of Bob Iger as CEO. In November 2022, Disney’s board announced that CEO Bob Chapek was being replaced by the beloved former Disney CEO. Chapek had a tumultuous 11 month tenure at Disney during which the stock price declined by 40%. Chapek’s time as CEO of Disney was wrought with controversy including the criticism of his handling of Florida’s anti-gay bill, passing on an opportunity for digital rights to Indian Premier League cricket tournament, and a failure to control the narrative around the DTC business and adequately outline a strategy for profitability.
Disney investors cheered the news of Iger’s return with the stock rising ~20% since that time. Iger plans to remain CEO for two years with the search for his successor beginning now.
Iger’s return comes after his retirement from a 15 year period at the helm of Disney during which the company increased in value from $50 billion to nearly $250 billion. Iger’s time was decorated by transformational achievements at the company including the acquisition of Pixar, Lucas Films, Hulu and Marvel. These moves positioned Disney as a media powerhouse and strengthened Disney’s core brand of characters, the benefits of which resonated across the company and established the foundation for Disney+. Iger also oversaw the growth of Disney’s parks business including the opening of Disney’s park in China as well as the acquisition of 21st Century Fox and launch of Disney+ before his departure.
The first opportunity to hear and gauge the potential impact of his return came during Disney’s first quarter earnings release.
Q1 FY23 Results
While Disney’s results for the quarter do not reflect the efforts of Iger, the story surrounding the Q1 fiscal 2023 earnings results was not dissimilar from my previous article. For the quarter, Disney’s revenue and EPS grew 8% and 11%, respectively. Disney’s parks segment continued to thrive with revenue up 21% and operating margins improving nearly 100 basis points to nearly 35%. Disney’s largest segment, Media and Entertainment Distribution showed a 1% revenue increase for the quarter as revenue growth for the DTC business offset continued deterioration in the Linear Networks business.
However, the segment operated at a loss for the quarter as the DTC business continues to be a drag on overall results. Excessive content spending resulted in an over $1 billion operating loss in the DTC business. While DTC revenues were up 13% primarily driven by increases in subscription pricing, operating losses “reflected higher programming and production costs and increased technology costs” similar to previous quarters.
Despite the high content spend, total subscriber numbers may have plateaued for Disney+ declining 1% driven by Disney+ Hotstar users declining 6%. This is most likely attributable to the loss of cricket rights under Chapek and increases in subscription prices. ARPU continued to be under pressure for Disney+ Core declining 3% from the previous quarter to $5.77. The bright spots for the DTC business were ESPN+ and Hulu growing each seeing growth in subscribers and ARPU.
Source: Disney Q1 FY23 Earnings Presentation
Iger’s Plan
These results demonstrate Iger’s undertaking particularly in the media business. During the conference call, investors were given the first glimpse into Iger’s plan to address Disney’s issues.
Here is Iger’s plan in a few bullet points:
- Disney will report earnings in three segments – Disney Entertainment, ESPN and Disney Parks, Experiences and Products.
- Iger announced $5.5 billion in cost savings. This will include $2.5 billion reduction in SG&A expenses, primarily through headcount reduction and marketing spend over the next two years. The remaining $3 billion will come from a reduction in non-sport content spending over “the next few years”.
- Disney will now focus on profitability over subscriber growth aiming for profitability by the end of fiscal year 2024.
- Improve guest experience at parks to add more value.
- Iger proposed that the board will bring back the dividend by the end of 2023.
Iger’s plan outlined a vision to reshape the business focusing on reducing expenses and the profitability of the DTC business, a plan sounds very similar to that proposed by former CEO Bob Chapek. Iger has begun to take action, though, announcing cost savings including a 7,000 employee headcount reduction. These cost savings are expected to have a high single digit impact on operating results in 2023.
While this may be accretive for Disney, the story has been and continues to be the impact of Disney+ on operating results. This is depicted in Disney’s return on capital employed (ROCE), a measure of the company’s ability to generate profit from capital invested in its operations, which remains low at 3.5% per year.
In an effort to improve the overall profitability of the company, Iger’s plan includes $5.5 billion in cost savings. In addition to the $2.5 billion in cost savings in SG&A, Disney will spend $3 billion less on non-sport content spending in the coming years which is a direct action to achieve profitability in the DTC business.
Source: Disney Q1 FY23 Earnings Presentation
To do this, Disney will focus on core brands and focus their advertising efforts. To put this into context, Disney lost over $4 billion in its DTC business in 2022 spending nearly $33 billion on content. A $3 billion reduction in content spend will still mean that Disney is spending multiples over its competitors including Netflix.
It will be interesting to see how this plays out, though. Streaming subscribers are a product of the content on a streaming platform. A reduction in content spend could impact subscriber numbers, especially at a time when streaming competition is fierce and subscriber numbers for Disney appear to show signs of plateauing.
Recognizing this, Iger attempted to address the issue by changing the narrative, a feat Chapek failed to do, by stating that Disney will now focus on profitability over subscriber numbers. This, however, epitomizes the paradox that Disney finds itself in. In order to have any chance of reaching profitability in the DTC business, Disney must cut content spend. The problem is cutting content spend could impact subscriber growth. Losing subscribers without raising prices will invariably impact profitability, a conundrum exacerbated by the poor economics of the streaming business.
Dividend Reinstatement
As part of Iger’s plan, he mentioned that he will ask the board to reinstate “a modest dividend”, a move that panders to Disney’s shareholder base despite challenged free cash flow figures, and the details for which are incredibly vague. Still, one could argue that any free cash flow that Disney does earn in the near term would be better spent improving the balance sheet particularly in the face of potentially difficult economic times ahead. Disney currently has nearly $40 billion in net debt which is 4x the company’s EBITDA in 2022.
The Iger Premium
On the day that Disney announced the first quarter results, the stock popped demonstrating the market’s approval of the results. As mentioned, there were certainly some bright spots such as the parks business, strong DTC revenue growth, the Linear Networks business holding up relatively well despite secular headwinds, ESPN+ and Hulu growth, and perhaps the announcement of the dividend reinstatement. However, the jump that day can probably more so be attributed to an Iger premium.
Disney’s stock is not cheap. Even after the stock has fallen 50% from its peak in 2021, the company still trades at 30x 2022 earnings and 25x 2023 earnings estimates. Prior to the introduction of Disney+ in 2019, Disney traded around 18x. At these levels, the market is pricing in a premium for Iger and successfully achieving profitability in the DTC business over the next couple of years. While the valuation is not egregious, there is execution risk as previously discussed. Iger will need to reach his goal for profitability in the DTC business by 2024 to not only to justify price appreciation, but to maintain the current valuation.
Conclusion
Iger has a storied history at Disney, but his legacy will be marked by his current efforts to improve the profitability of Disney. Given his history at Disney, we can argue that there is no one better for this job. While there does not appear to be much novelty in his plan, that is probably because the actions that need to be taken are clear – Disney is spending too much on content for the DTC business and profitability needs to be prioritized. While the recent ascent off the stock’s lows can be attributed to a reasonable quarter, it is hard to ignore that some premium is being given to the return of Bob Iger.
