The Walt Disney (NYSE: DIS) company has entered a period of massive change, but it will come out the other side in better shape than it's currently in.
In its most recent quarter, the company reported a 5% decrease in year-over-year earnings per share (EPS). On top of that, through the first three quarters of its fiscal year, the Mouse House saw EPS drop from 4.63 in 2016 to $4.55 in 2017.
Those are modest dips, but there are concerns about the company's long-term health largely because of to how cable television is changing. Cord-cutting, the practice of dropping full-priced cable for streaming alternatives, has picked up speed. That's very bad news for Disney's ESPN, the channel that commands the highest carriage fees of any cable network (the amount the cable companies pays the channel owner per subscriber), and it has deeper implications for the company.
How does cord-cutting hurt Disney?
Currently, when you subscribe to cable, you have very little choice as to what channels you receive. You pick from various packages, sometimes having to get a lot of things you don't want in order to get a few you do.
Now that consumers can subscribe to alternative sources of entertainment like Netflix (NASDAQ: NFLX) or Hulu, they don't necessarily need cable. That has caused ESPN to see its subscriber count drop 98 million in 2012 to just 90 million at the end of 2016, according to an article by my Motley Fool colleague Leo Sun. In addition, other Disney cable channels dropped as well, with the Disney Channel going from 98 million to 93 million subscribers.
While it varies by system, every cable subscriber pays about $9 a month for the various ESPN channels (whether they want to or not). So, dropping 8 million subscribers costs Disney roughly $72 million each month. Even at a company that has had $42 billion in revenue through nine months, the ESPN and cable drops hurt, and it's going to get worse in the short term.
Why is Disney still a buy?
While cord-cutting presents a short-term revenue problem for Disney, it also creates a longer-term opportunity. The company has already announced plans to start two Netflix-like streaming services in 2019. One of these will be sport-driven, and the other will lean on its family, Marvel, Pixar, and Star Wars content.
Those services should eventually make up for any continued drops in cable subscriptions. Disney has an unequaled treasure trove of content it can mine. That has actually helped Netflix as the streaming leader has developed a family of shows from characters related to Daredevil.
It seems very likely that Disney can duplicate that success and lure people to its entertainment service. Families with young kids will come just for the library of family movies and shows, while older folks can be tempted with things like the first live-action Star Wars television show, or a new Marvel series.
On the sports side, the audience won't be as big, but Disney will be able to lure in diehards with college sports, exclusive content, and even sports that don't get televised elsewhere. And of course, Disney can also bundle subscriptions to both not-yet-priced services to drive value for families.
It's all about content
Disney will move past its cable struggles, and it also has a bright future in other segments. Its movie division can release about three Marvel films each year, two Pixar movies, a Star Wars film, a Disney animated movie, and a live-action redo of a past-animated classic. Those are all near-certain blockbusters that in many cases drive consumer goods sales and push theme park attendance.
In 2019, Disney also has theme park expansions planned both in California and Florida based on Star Wars. Those openings, plus some improvements at Florida's EPCOT and Toy Story Land opening at Disney Hollywood Studios should drive record levels of traffic.
Disney's struggles are more due to an evolving system of how people consume content than any problems with its content. That may take years to shake out, but in the end, content is king, and Disney has stronger intellectual property under its control than any of its rivals.
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