When Disney first launched its streaming service, Disney+, in November 2019, Wall Street applauded its decision to get into the fast-growing streaming industry. It proved to be an exceptionally well-timed decision. The streaming service has helped the company weather the pandemic over the past 12 months. It has also helped Disney stock outperform even though most of the company’s parks have been closed. These closures have cost the business billions of dollars in losses and lost income.
It’s fair to say that Disney+ has been a stellar success since its launch in 2019. And it does not look as if the growth of the service will slow down anytime soon. The company blew past Wall Street expectations for growth in its most recent quarter. The streaming service added 8 million new subscribers globally, sending Disney stock up 2.2% immediately after the results were announced.
However, the market is now placing a significant premium on this growth. Shares in the entertainment company are trading at an eye-watering forward earnings multiple of around 75. This suggests investors are putting a considerable amount of weight on the growth of Disney+. They may also be overlooking the company’s other operations, namely its theme parks and films, which have been significantly impacted by the pandemic.
The big question is, are investors over-inflating the company’s subscription streaming service value? Could this have a significant negative impact on Disney stock in the future?
The birth of streaming
Over the past 15 years, the global media landscape has gone through a tremendous transition. In 2007, an upstart called Netflix, which was previously associated with DVD rentals, started a video streaming service.
In its early years, the company was attacked by analysts and critics who believed it would never be able to make money from this service. They believed the company’s low subscription charge coupled with its high cost of acquiring content would ultimately prove to be terminal.
Nevertheless, despite these concerns, Netflix continued to defy expectations, and it went on to become the dominant online streaming player. As of the fourth quarter of 2020, the company reported just under 240 million paid subscribers worldwide.
As well as revolutionizing the streaming market, Netflix also revolutionized how viewers consume content. One of the challenges the company has always faced is paying for content. It pays billions of dollars every year to content owners to offer shows to consumers. That has continually sapped its underlying profitability. To get around this problem, Netflix has been investing tens of billions of dollars developing its own content. It published its first original series in 2013 and has since pioneered the development of the binge-worthy television show.
As subscriber growth has ballooned, Netflix has ramped up spending. This has caused the business another headache. With a Netflix subscription, a fraction of the cost of a traditional pay-TV service, the average revenue per user is low. The company has become reliant on debt as a result. At the end of 2020, it had $16 billion of long-term debt and a further $19 billion in “obligations” to other production companies.
So, how does this relate to Disney stock?
Netflix vs. Disney stock
Since Netflix pioneered online streaming in 2007, every single media company in the world has rushed to get in on the action. One figure puts the total number of streaming services in the United States alone at over 300. Every single one of these services is jostling for consumers’ eyeballs.
None of these companies have gone as hard and as fast as Disney. The company arrived on the scene with an existing backlog of content, which it did not need to pay for. It also arrived with the creative and financial clout of some of the most respected movie theatres in the world, such as Pixar and Lucas Film.
The competitive advantage Disney has over other companies cannot be overstated. The Disney+ service provides unrivalled access to some of the most successful films of all time, especially children’s movies. Many of these films can’t be found elsewhere without paying for each one individually. A subscription to Disney+ provides access to this quality content without any further payment.
These qualities seem to support new research from Digital TV Research. The latest report claims that Disney+ will be the world’s largest streaming service by 2026. The report estimates that by 2026, Disney will have a global total subscriber base of 294 million compared to Netflix’s 286 million.
According to the report, these two companies are expected to be the only streaming services that manage to surpass the 200m+ subscriber mark.
Much of the company’s success from here will be determined by growth in the Indian market. India is a battleground for streaming services as the country, and its’ one billion+ consumers are the largest single market globally, outside of China.
The company’s strategy in this market has been to partner up with an existing business. Hotstar streamer is the firm’s partner in India, which is already established and has exclusive streaming rights to the highly popular Indian Premier League cricket competition.
However, while Disney’s expansion across India will power the growth of the streaming service for the next five years, according to the report, due to the lower subscription cost, global revenues for Disney+ will only be at $20.76 billion – half of the $39.52 billion made by Netflix by 2026, the report speculated.
Placing a value on Disney stock
Breaking this all down to try and develop a valuation for Disney stock is not easy.
On a monthly basis, Netflix has a revenue run rate of about $2.2 billion, compared to Disney+’s $382 million. Based on this figure alone, Disney’s $347 billion market cap, $100 billion more than Netflix, looks expensive. But this is just part of the story. The streaming service may have powered the performance of Disney stock over the past 12 months, but it’s currently accounting for just 7% of revenue. Disney-owned Hulu is actually generating more than twice the revenue of Disney+.
There are some other things to consider here as well. Unlike Netflix, Disney has always been a content business. It owns the content it can sell to consumers, which means it does not have to try and outbid other outlets for content rights. That suggests a dollar of revenue generated by Disney+ is far more valuable to investors than the same dollar generated by Netflix.
Disney stock may seem expensive today, but the real power of streaming services lies in the ability of the service to increase prices.
Netflix has successfully tested this model over the past decade. The company has been able to raise prices steadily without losing a large number of consumers. In doing so, the business has moved to the position where it is now seriously considering returning cash to investors. Disney may be able to do the same.
If the company can increase costs to consumers by 5% to 10% every year, with a subscriber base of more than 200 million, Disney+’s revenues could grow exponentially.
In this situation, when coupled with the resumption of its other activities such as cruising and theme parks, the stock may actually be undervalued at current levels compared with its potential over the next decade.