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COVID-19…A Blessing in Disguise for Disney Investors

Recommendation: Long Disney (“DIS”) with a 2022 price target of of $187/share (+52% total upside) vs. downside target of $108/share (-17% down).

The market is currently not pricing in these 4 alpha drivers: including 1) faster DTC subscriber growth + higher ARPU power 2) Faster Parks recovery within “core” operations 3) the Disney “Flywheel” synergies a poorly run, low margin 21st Century Fox Studio and 4) upside to Hotstar International launch. 

In terms of current investor market set-up, the chance to buy the most valuable entertainment content creator in the world exists for a couple reasons with the biggest being that the longs and shorts are focused on different things!

1. Burn rate of the Parks and “core” EPS during COVID ~ Shorts are overly focused on wrong items vs. longs keeping eye on prize = DTC subscriber growth and closing the valuation gap with NFLX (never good when shorts & longs are focused on different data points)

2. Analyst Day by end of 2020 ~ Will create upward pressure on stock, squeezing shorts out (“Analyst Day V2 fears”)

3. Investors Need to work and look outside of traditional media for DIS comps [NFLX (internet) or Adobe (technology)] ~ There are no comps for what DIS is doing in traditional media making, making it very hard for these legacy investors to value DIS’s hybrid value + growth model. Investors need to do a SoTP, which is complicated and not as easily digestible for everyone. 

4. Business Model Transitions Present Opportunity ~ Will move from Value to Growth ~ Similar to a SAAS transition (think Adobe 2012), DIS is transitioning from a licensing business model with heavy 1x sales to a recurring financial model via DTC. Bears were too focused on 2012 while bulls got rewarded for looking out a few years. 

My investment thesis is predicated on the following 4 key catalyst levers:

• Above 2024 Consensus DTC Subs + Higher Pricing = Faster EPS profitability and Enterprise Value: This time last year, investors were pushing back on 20mm subscribers within the first year. DIS ended up adding 20mm in 2019 and is now at 60mm DIS+ and 100mm global subscribers. What makes the 60mm DIS+ subs compelling is that it was built on the legacy library alone, one original TV Show (Mando) and licensing deal (Hamilton). To date, I estimate that the DIS library alone made up 45mm subs, Mando 10mm and Hamilton 5mm. 

Once DIS begins to ramp up its originals to DIS+ (similar to NFLX), we will see convex subscriber growth. Given the sizeable content chest at DIS (and now FOX), DIS could at some point dream big…Imagine on Dec 2022 if DIS releases James Cameron’s new Avatar movie (The Way of Water) via DIS+. Assuming, $2bn in B.O. (similar to Avatar 1), $30 price (Mulan pricing) and removing 20% double counting for existing sub overlap, we get close to 53mm incremental subs on a 60mm base today. I think this is a small probability, but DIS doesn’t need to hit this home-run to win as they have a pipeline of doubles and triples as I lay out below.

Over the next 3-4 years, we have visibility to a large slate of new DIS+ originals and theatricals from its irreplaceable library of brands (Marvel, Star Wars and Live Action) including:

Marvel: 

2020-2021 ~ Phase 4 (10 new shows/movies including 4 original TV shows to DIS+)

2022-2024 ~ Phase 5 (10 new shows/movies confirmed with 2 DIS+ shows)

Star Wars (Directly to DIS+): 

Mando 2 (Oct 2020)

Mando 3 (being written now in pre-production ~ 2H21)

Rogue One Prequel (’21)

Obi-Wan Series (’21)

Bad Batch Animated Series (’21)

Leslie Headland Series ~ Russian Doll Director (TBA)

Non-Fantasy Live Action TV/Movie Releases (DIS+) planned for 2021 (at least 10 announced)

Mighty Ducks

Diary of a Wimpy Kid Reboot

Home Alone Reboot

Muppet Now

Rogue Trip Movie 

Night at the Museum Movie 

Short Circuit Movie 

Sandlot TV Series

True Lies TV Series

Monsters at Work Movie

Three Men and & Baby Movie (Zac Effron)

20% Higher for 2024 DIS+ Subs ~ In combination with a country by country HH broadband penetration model, we also perform a content slate analysis for sub growth. With the precedence from Mando 1 and Hamilton, we can extrapolate what the above originals can do for DIS+ globally. I estimate that in 2024 DIS+ will have 150mm subs on average in 2024 above consensus estimates of 126mm (20% ahead of the street). If Mando added roughly 10mm subs based on my math from the launch for one show and we know that DIS has 22 originals planned through 2023 (lets assume 7 more added to the total through 2024), we have potential for 30 releases. Consensus is modeling 65mm vs. our 100mm net subs adds over the next 4 years through 2024, implying a 21% attachment rate vs. Mando. We are closer to a 33% attachment rate after modeling in for some flops and netting out existing DIS+ subscribers who can’t subscribe twice. 

Relative to NFLX’s potential 300mm global subs in 2024, our 150mm DIS+ subs implies a 50% penetration of NFLX’s base. This feels conservative.  

Our higher DIS+ sub number should become closer to reality when DIS holds its recently announced Analyst Day before year-end. I believe they will guide to the below: 150mm DIS+, 55mm HULU, and 14mm ESPN, for a total sub 2024 number north of 200mm with the greatest variant viewpoint at DIS+ and Star (please note that close to 50mm of STAR bundled subs are also included in DIS+), equating to 260mm base case 2024 subs. 

ARPU Growth Modeled Lazy and Too Linear ~ On DIS+ ARPU, the street for US pricing is at $7.17 for 2024 vs. $5.33 at year end 2020. I am at $8 in monthly domestic ARPU in 2024 (13% higher than consensus). There are 3 reasons why I am higher than the 8% street ARPU growth, including:

1) DIS+ Much lower starting ARPU vs. NFLX ~ In 2014, NFLX was priced at $8 and has hiked prices 12.5% per year and now for a mid-priced option sits at $13. In contrast, DIS 1st year pricing is priced low to start at $5.

2) DIS+ Will Put in a few big price hikes during peak investment content roll-out ~ With a bulk of content releases in 2021/2022, DIS+ will use this window to put through NFLX type price hikes. I’m modeling NFLX style price hikes in the fourth quarter of 2021 and 2023 with essentially no price hikes in the other years (except some small mix shift pricing in non-hike year). 

3) DIS+ Content Library is a Stickier Product to Families ~ Given the family friendly content, I believe that DIS+ will be at least equally as inelastic as NFLX churn post price-hikes. Each time NFLX raised prices, the stock rallied, which I think will be another catalyst for Disney. DIS believes that they have over 1 billion fans globally and this will be able to help them close the pricing gap with NFLX.  

• Recovery in “Core” Business being overly penalized for COVID vs. other Consumer Companies: 

What is Pre-COVID Core EPS in terms of understanding Recover?

DIS hasn’t actually had a clean quarter post FOX deal closing. 

If we look at DIS pre-FOX deal and DTC spend, DIS did $7.08/share in EPS during 2018. Compounding this at DIS’ EPS CAGR of about 8.5%, we got to the $8/share of “core” EPS in 2020 pre-DTC spend. 2019 was the first year of the DTC spend (about $1.8bn or $1/share EPS hit) and year 1 of FOX dilution (I estimate at 40 cents or 5% dilutive), resulting in 2019 reported EPS of about $5/share (extra 50 cents hit from FOX studio miss). 

Looking to 2020, before the impact of COVID, DIS was on path to do roughly $8/share in “core” EPS as they hit their HSD EPS algo and get accretive on the FOX deal (claw back the 40 cents+). Consensus ’20 EPS, in late 4Q pre-COVID, was $6.50/share given that 2020 was going to be peak operating losses for DIS+/ESPN+ ($3bn or $1.75/share hit to EPS).  

2024 consensus at the closing of the FOX Deal, investors were at $10/share with 2024 DTC being breakeven. This implied that investors thought that the core business was going to be doing $10/share in 2024 (pre-launch DTC was breakeven in 2024), which makes sense given DIS’ HSD EPS algo on the $7.08 EPS in 2018 with FOX accretion is about $10/share. Now DTC breakeven is almost 2 years sooner to 2022, but COVID has made the core more of a v-shaped recovery vs. linear algo. 

Consensus doesn’t have DIS recovering its pre-COVID/FOX deal 2020 $6.50/share of EPS until 2024, which I think is overly penalizing in my view b/c:

- Parks Spend Per Capita Better than Expected + Pent Up Demand = Faster Recovery (30% of Revenues): In total, DIS’ 8 global attractions (Epcot + Hollywood studios) represent the Top 8 out of 10 Parks in the World. This deep loyalty showed in the customer response post openings. Shanghai reopening tickets sold out in 3 minutes. Through the 1Q of this year (March-end), per capita spending was at +13%. Historically, DIS had the ability to raise prices to the point each year where they could control demand and optimize revenues (5% CAGR on ticket prices over last 20 years & EBITDA growth between 8-10% in 2017, 2018, 2019). Additionally, on the last earnings call for the June ending period, DIS highlighted that the per capita spend for the reopened parks has been strong. This ties in with other consumer companies where pent-up demand has been up YoY (regional U.S. gaming, Nike China, off-price retail). 

Specifically, DIS spent $2bn building Star Wars land in 2019 building its largest parks expansion ever. In Feb ‘20, Iger flagged that Star Wars’ Rise of the Resistance Ride has boosted total domestic spend per capita by 10% (Make your own Droid for $200/Light Saber for $100). Over the next few years, Star Wars land could add close to $500mm in EBITDA in a few years.   

Consensus doesn’t have the parks reaching 2019 levels until 2023 whereas based on the above intel, I believe it happens in 2022. I am at $27bn in revenues for PECP vs. street at $25.5bn and EBITDA of $9.3bn vs. $8.4bn, essentially 10% higher in 2022 than consensus. 

Estimates vs. Consensus Below (10% above ’22 EBITDA)

• FOX Deal Underappreciated: Expect DIS to exceed $2bn synergies and Generate Revenue Growth Opportunities not in Consensus within Studio Segment: Given the Murdoch family ownership and legacy nature of FOX, there appears to be upside to the stated synergy target. DIS’ culture as one of the most efficient companies in the world (based on past M&A track record and speaking with former employees). Combining the two largest film studios in the world will result in above average cost savings given the precedence we’ve seen in prior studio combinations (lower distribution costs, better theater splits given scale, elimination of Blue Sky Studios Animation and lower corporate overhead.

Pre-FOX deal, DIS was doing $10bn in Studio revenues with $3bn in EBITDA (31% margin) vs. FOX doing $8bn in revenues with $1bn of EBITDA (13% margin). This translates into an 18% margin gap for the largest two movie studios or $1.5bn cost savings opportunity. Combining this with FOXA’s legacy $1bn of corporate expenses, I believe there is a clear line of sight to exceed $2bn in announced synergies (DIS confirmed they are on track in August 2020). 

With the incremental cost savings and expectation for much higher cross-selling revenue opportunities with FOX (think Marvel expansion/getting back X-MEN from FOX), I believe that Studio EBITDA will be about $1bn higher in 2022. 

2022 “Core” EPS Walk ~ Given shorter DTC burn, faster Parks recovery and FOXA cost/revenue synergies at the studio, we arrive at a DTC breakeven in 2022 and EPS (which is effectively core given DTC is close to breakeven) of roughly $6.74/share in 2022 vs. consensus of $5.25. 

For ’22, I am higher by: 

- $4bn higher on Revenues $87bn vs. $83bn. 

- $1.5bn higher on EBITDA (including $700mm of equity income)

- 25% tax rate

- 6% cord cutting p.a.

- STARS launch is carved out into SoTP (w separate model walk)

- DIS is a HSD top line revenue grower post 2021 with an EPS CAGR of 15-20%

• STAR SVOD Launch Internationally Will Close the Gap with NFLX similar to U.S. ~ DIS announced on the 3Q20 earnings call that they will launch STAR SVOD (Hotstar India parent) instead of taking HULU international as they believed that the brand was more recognizable internationally than Hulu. This catalyst is another major leg of competition for Netflix as DIS will be able to bring all of its brands and new local original content to the world. 

As background, DIS gained Hotstar India through the FOX merger. Launched in 2015, the ad-supported OTT platform, Hotstar is an Indian streaming service with 300mm active users, 8mm paid users and about $200mm of revenues. Paying customers currently get charged ₹399 per year for a VIP plan or ₹1,499 for a Premium plan.

More important than the existing Indian service is the roll-out of this platform internationally. As we think about the Total Addressable market, we use NFLX and DIS+ international sub estimates to better understand penetration. 

Currently, the street is NOT modeling in Star into estimates b/c the Analyst Day DIS has hinted at hasn’t occurred yet. Based on my checks, it appears the bar is 50-75mm subs vs. my expectation for 100mm 2024. 

How do we get to 100mm Subs? We don’t know yet the pricing or the package structure, but it safe to assume that DIS similar to the U.S. will bundle Star with DIS+ and other a stand-alone.

DIS+ Star Bundled Service ~ Catered towards Intl families who want SVOD and also value the DIS vault/pipeline. Roughly half (50mm) of our 100mm subs come from the bundle ($3/share bundle ARPU boost). We use DIS+ International Sub estimates as our TAM (~100mm in 2024 vs. 200mm for NFLX ‘24) for the bundled service and then assume a penetration rate growing from 10% in year one to 50% in year 4. Given these are already DIS+ subs, it is important to recognize that we don’t double count them but only value the incremental ARPU of $3 per month EV uplift. 

DIS+ Star Stand-Alone Service ~

Catered towards individuals who want just the SVOD service (comparable to NFLX). Roughly half (50mm) of our 100mm subs come from the bundle. We model the low end ARPU of the traditional HULU service to be conservative at $5.99 per month, but without ads this could go up to $11.99 potentially. In terms of estimating the TAM, we use our country by country household penetration data from our DIS+ model in conjunction with a NFLX international penetration analysis. NFLX currently has 200mm global subs with about 150mm today being international (including Canada). For the stand-alone service, we assume that Star can penetrate 24% of NFLX’s sub base by 2024 (52mm for Star vs. vs. NFLX at 217 intl. steaming).

This adds up to $5bn roughly in sales in 2024. Assuming 5x EV/sales (discount to current NFLX valuation of 9x), we get $11/share in our base case or $25/share in our bull case (discounted back 2 years). Based on the latest earnings move, I believe that only about half of the $10 rally (so $5/share) was tied to Star announced while balance was tied to core burn rate. 

Business Overview

DIS consists of 4 Segments: 1) Media Networks 2) Parks, Consumer Products and Experiences 3) Movie Studio and 4) Direct to Consumer. With the launch of DIS+ and combination with FOX, DIS has reduced its exposure to linear ESPN.

• Media Networks (29% of 24’ Revenues = $30bn) – Encompasses the vast array of TV networks, cable channels, distributed content and the O&O (owned and operated networks). ESPN and ABC are the two primary drivers in this category

• Parks, Experience and Consumer Products (28% of 24’ Revenues = $28bn) – There are six major parks spanning Orlando, Anaheim, Shanghai, Paris, Tokyo and Hong Kong. In addition, DIS operates cruise lines and a vacation club. The only park that is currently closed is Disneyland. Within PECP sits consumer products (licensing fees paid to DIS) with revenues of $5bn (5% of total ’24 sales). 65% of PECP revenues is domestic parks (Orlando and Anaheim). 

• Film and TV Studio (13% of ’24 Revenues = $14bn) – Represents 13% of sales and is the largest film studio is the world. Major assets include Walt Disney Studios, Disney Animation, Pixar, Marvel, Lucas Film, Fox Studios and Searchlight). 

• Direct to Consumer (30% of ’24 Revenues = $30bn) – Encompasses DIS+, Hulu, ESPN+, Star India (now being launched internationally instead of Hulu International). DIS+ has worked with certain distributors for the product, including Verizon (which I estimate contributed 20% to the 60mm sub base). 

Valuation & Risk/Reward

Risk/Reward – DIS offers a 3x R/R using a probability weighted average of our base and upside SoTP vs. our downside estimate. 

Price Target – We use a SOTP approach to value DIS given the business consists of a “core” regular DIS and a fast-growing DTC business. I then use 2022 for core as that is when it should recover from COVID and fully incorporate the FOX synergies. 2024 works best to value DTC given that the goalpost for DIS from the analyst day to best understand the ramp. 

Base Case Upside ($187/share)

Core Business ($118/share – Base Case) ~ In terms of core, we use 17.5x P/E multiple (in-line with DIS’ 10 year average and a 12.5% discount to S&P vs. its 10 year average of in-line) on our ’22 EPS of $6.74/share to get $118/share. Based on this approach, we are paying $12 currently for the DTC business. 

Put another way, we are paying $21bn for the DTC business, which is .7x EV/Sales $31bn in sales in 2024 (ex-STARS). 

DTC ($69/share – Base Case) 

- DIS+ ($27/share) ~ Using our 2024 average DIS+ subscriber estimate of 150mm (above consensus of 126 ~ 19% above) and Global ARPU of $6.34 (10% above), we get to $11.4bn of revenues. Next, we apply an EV/Sales multiple based on NFLX (5x in base vs. 9x for NFLX today) to our 2024 revenue estimate to generate $57bn in EV. Lastly, we discount this back 2 years at 8% p.a. 

- HULU ($25/share) ~ In terms of HULU, we need to value the two different offerings. On the SVOD service, we use 50mm subs on average in 2024 and a blended subscription and advertising ARPU to get revenues of $8.4bn. Next, we capitalize this number in-line with its closest comp NFLX (5x sales vs. 9x for NFLX today to get $42bn in EV. As it relates to the VMVPD, using a sub estimate of 4.2mm and an ARPU of $66, we get a revenue base of $3.4bn. Next, we apply an EV/Sales multiple based similar to DISCA and FOXA (3x sales) to get a value of $10bn EV. In total, our EV is $52bn or $45bn in 2022 terms or $25/share.

- EPSN ($3/share) ~ Using our 2024 average subscriber estimate of 14mm and ARPU of $5.86, we get to $1.2bn of revenues. Next, we apply an EV/Sales multiple based on NFLX (5x in base vs. 9x for NFLX today) to our 2024 revenue estimate to generate $6bn EV. Lastly, we discount this back 2 years at 8% p.a to get a $3/share value. 

- Intl Channels ($3/share) ~ 1x 2024 Sales of $5.5bn spanning over 500 international DIS and FOX.

- Star Expansion ($11/share) ~ We apply our DIS+ multiple to our combined bundled/stand-alone STARs international subs of 91mm (roughly half between the two categories). This equates to a $24bn valuation and we discounted back 2 years, we get to $11.6/share value. 

Downside Valuation ($108/share)

Core Valuation ($78/share) ~ Use a 10% discount to consensus EPS of $5.25 and a 16.5x multiple, we get an $78/share value for the legacy business with FOX.

- DTC ($30/share) 

• DIS+ ($11/share) ~ 130mm subs at $5.64 ARPU equates to $8.8bn in revenues. Next, we capitalize this at 2.5x (50% discount to our base case 5x) to get to $21bn of NPV (discounted back 2 years). 

• Hulu ($12/share) ~ On the SVOD service, we use 45mm subs on average in 2024 and a price of $13.89/share. to get revenues of $7.5bn. Next, we capitalize this number with a 50% discount to our base case (2.5x) to get to a $19bn EV. As it relates to the VMVPD, using a sub estimate of 3mm and an ARPU of $60, we get a revenue base of $2bn. Next, we apply an EV/Sales multiple based similar to DISCA and FOXA (2.5x sales) to get a value of $5bn EV. In total, our EV is $20bn in 2022 terms or $12/share

• ESPN ($1/share) - Using our 2024 average DIS+ subscriber estimate of 12mm and ARPU of $5, we get to $1bn of revenues. Next, we apply a 2.5x EV/Sales multiple our 2024 revenue estimate to generate $2.5bn in EV. Lastly, we discount this back 2 years at 8% p.a to get a $1/share value. 

• Intl Channels ($3/share) ~ 1x 2024 Sales of $5.5bn spanning over 500 intl. DIS and FOX 

• Starz Expansion ($4/share) ~ We apply our bear base DIS+ multiple to our combined bundled/stand-alone STARs international subs of 67mm (roughly half between the two categories). This equates to a $9bn valuation and we discounted back 2 years, we get to $4/share value

Comps

NFLX trades at 9x 2020 revenues and 5x 2024 revenues; however traditional media trading at 10x P/E. DIS has always traded at a premium to traditional media. Today though, without legacy FOX, Parks growth and DTC ramp, DIS now has zero peers in traditional media, except for maybe CMCSA, which traded cheap relative to S&P given conglomerate discount. Post COVID, DIS will be growing revenues HSD and EPS in the mid-teens. That algo should trade north of the S&P 500 at 20x in my view. 

Downside Risks

• DTC Sub Bogey ~ Inability to get to 200mm subs (120mm DIS+) after the new investor day across all three products 

• FOX Synergies ~ On the 3Q20 call, DIS confirmed that they are still on track, but any derailing is an issue

• 2019 Parks Recapture ~ Recovery in the parks volume takes longer to come back. Domestic Parks are 65% of PECP ’19 revenues 

• Theater Reopening ~ New normalization linger on movie theater re-openings and DIS’ ability to capture largest share of Box Office 

• STAR Launch Flop ~ DIS’ misses the opportunity to capture SVOD subs internationally on bundled basis or stand-alone

• Content Cost Rising ~ With the number of new shows being produced at a record level, the cost for writers and talent could continue to climb resulting in lower profitability of DTC business

Catalyst

1) DTC strategy undervalued relative to growth and peers

2) Core business value too low due to pandemic

3) Synergized FOX studio will highlight incremental value

4) STAR launch will be highlighted at Investor Day