Disney Is Willing to Lose Billions to Compete With Netflix

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Walt Disney (NYSE: DIS) revealed the details of its much-anticipated Disney+ streaming service at its investor day. After highlighting a few details about the growth of Hulu and ESPN+, its other streaming services, Disney presented all of the great content coming to Disney+.

The important thing for investors, though, are the finances of Disney's push into direct-to-consumer streaming. The company is planning to expense about $2 billion on content next year, spending about $500 million more on a cash basis. And that's just for Disney+. The company is also spending big bucks licensing and developing content for Hulu and ESPN+, which are both unprofitable.

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But Disney is clearly looking to scale its services as quickly as possible. That's evident in its pricing for Disney+, just $6.99 per month. The company expects to reach 60 million to 90 million subscribers by the end of fiscal 2024. It also expects to grow Hulu to 40 million to 60 million subscribers and ESPN+ to 8 million to 12 million subscribers in that same time frame.

If Disney can reach those goals it will not only have a profitable business with massive amounts of cash flow in five years, it will have insulated itself from the cord-cutting trend that continues to threaten its core media networks business.

Losing billions in the short-term

Disney told investors ESPN+ will lose about $650 million in operating losses this year and next year, and Hulu will lose about $1.5 billion. It didn't provide any estimates for Disney+ operating losses, but they ought to be pretty massive for the first few years of the service.

Disney+ is designed to scale just like Netflix (NASDAQ: NFLX). The company plans to continuously expand its slate of original content while taking back the streaming rights to some of its best films from Netflix over the next few years. Disney's films and kids series are some of the most rewatchable content available. Even Netflix's head of content Ted Sarandos has praised Disney's films in the past, "Disney is a solely differentiated brand among movie studios. They have some key franchises with consumers," he said at an investor conference in 2015.

The broad appeal of Disney's content library means Disney+ has the potential to reach tens of millions of subscribers. If Disney didn't do everything it could to reach as broad an audience as possible, it would be leaving money on the table and doing a disservice to investors. In the short-term, however, that requires massive expenditures on content and marketing before it has a sizable user base.

Looking at the whole company

During Disney's first quarter earnings call, McCarthy provided some details about the impact Disney+ will have on other segments. She said foregone licensing revenue will result in a $150 million decrease in operating income this year at its movie studios and media networks. That number will climb as more Disney content comes off of Netflix over time, but Disney+ will be paying out licensing fees by that time.

Disney expects to pay itself around $1.5 billion in licensing fees next year and somewhere in the mid-$2 billion range by 2024. These are real costs for the Disney+ service, but due to the internal nature of the transaction, it doesn't need to have cash to pay those licensing expenses. Disney just adjusts some ledgers to show a credit for the movie studios and media networks and a debit for its direct-to-consumer businesses.

That's a much stronger position than Netflix, which has continuously tapped the debt market to grow its service. Last year, the company burned $3 billion in cash as it invested in thousands of hours of original content. The good news for Netflix investors is the company believes it's reached peak cash burn.

Disney will still spend a ton of cash on original content and marketing to launch and scale Disney+, but the ability to license content from itself gives it a massive advantage over Netflix. That leaves Disney with a very compelling product at launch, so it can scale quickly and efficiently. It should be able to cover its marketing and original content costs much sooner than 2024, which reduces pressure on cash flow.

At 60 million to 90 million subscribers, Disney+ should be breaking even if not profitable by 2024 despite about $4.5 billion in content expenses. Subscribers beyond that level should produce very high marginal profit increases.

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Adam Levy has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Netflix and Walt Disney. The Motley Fool has a disclosure policy.