Disney (NYSE:DIS) has been part of a group that is slowly slicing up the market segment that Netflix (NFLX) formerly had all to itself. Streaming certainly does compete with other forms of entertainment. So, there is no thought of a competitive moat that would unequivocally withstand competition of various kinds. Rather, the entrance of more streamers enriches the viewer choice in ways that were unimaginable just a few years ago.
Apple (AAPL) had a film that won for Best Picture. Such an event had been the territory of Netflix alone in the past. It will take some time, but there is going to be a lot of possibilities rather than only Netflix in the future.
The scent of profits appears to be attracting far more competitors than market growth can handle in the future. Therefore, the consumer variety is likely to increase while the cost to the consumer continues to decline. There have been some clear efforts by some streamers to establish a “premium” subscription. That tactic is unlikely to succeed unless the streamer has an incredibly long run of programming good luck. A more likely path to success is lower costs to consumers while allowing some advertising.
The other part is that streaming is likely to be part of a diversified company’s arsenal to woo customers. Oftentimes, the accounting for such activities is determined by some market value allocation. Therefore, it is possible for streaming business in a diversified company to show a loss while company profits increase from that “losing activity”. Accounting can be very confusing that way in a diversified company.
Such a situation also limits the ability of a standalone streaming company like Netflix to compete in the streaming business. It has no affiliated divisions to share the production or purchase cost with. That probably puts Netflix at a competitive disadvantage as more diversified firms enter the market.
While some would measure the Disney value of a streaming customer using the figures above, that is likely to prove to be a big mistake. Disney has of course been working to improve the value of streaming customers as shown above. But a diversified company that picks up a customer in any division often picks up a likely customer to which other divisions can sell. So, the improvement shown above may not be nearly as important as the additional divisional benefits from these streaming customers.
I am hoping that, at some point, Disney management talks about this and puts a rough figure on the benefit because it is extremely important to projecting company profits. There is a decent possibility that Disney would never have to show a streaming profit because other divisions would benefit so much from streaming that the overall company profitability would benefit materially.
That makes the Disney management projection of declining losses less of a priority than is the case for climbing enrollments. This can certainly be a slippery slope that can lead to less profitability. But Disney has been known for excellent management for some time. So, it is very likely that management can navigate that slippery slope to the benefit of shareholders.
The above possibilities also means that Disney may not hesitate to expand the streaming business while that business shows a bigger loss when customers are added. The growth above is likely to be healthy for some time to come. Any down quarter can be met with additional marketing costs because any customer gain through streaming is likely to become a Disney customer of other services. Note that the reverse is also true. A Disney amusement park customer is more likely to become a streaming customer.
For a standalone company like Netflix, this situation is very bad news. Netflix has to justify its outlandish stock price through adequate profits and cash flow that competitors may not need. The upcoming first quarter report is going to be important for many competitors in this market.
Disney can offset bad news in the streaming business with good news elsewhere in the corporation. The second quarter report will likely feature easy comparisons because the company is recovering from the 2020 shut-ins. Business is returning to normal and nonrecurring start-up costs are declining.
Most likely, all the low-cost competitors will be able to grow the most assuming that the necessary quality of the product meets the necessary level. Sooner or later the market will mature as the consumer only has so much time for fun projects (and there is only so many consumers even if the number grows slowly). That means that the current entrance of competitors for streaming will at some point lead to a shakeout.
Most analysts agree that Disney has some extra cash flow coming online because the parks are now open. There are exceptions and likely to be more exceptions as the coronavirus becomes less important. But the fact is that the open theme parks will be a cash flow boost. So will planned movie releases.
Movies are also getting back to normal. Disney has long been a cash flow generator. Now it is becoming a bigger cash flow generator as the situation returns to normal.
The result of the above statements is there is going to be a whole lot more free cash flow in the current fiscal year. The simple explanation is that free cash flow from movies declined because the movies had to be made before they were released to the public after the 2020 shutdown. It is a similar story with the theme parks.
The first quarter of the company had a fair amount of cash uses. That money will come back as the costs are recovered in the various divisions. Hopefully there will be a lot more cash in addition to the cost recovery as is usually the case.
Disney’s free cash flow is obviously somewhat seasonal because some of the businesses have prime seasons. Therefore, cash flow does not happen evenly throughout the year. Now admittedly a blockbuster movie (for example) could potentially change that scenario in any given year. But it would have to be quite a movie as Disney is a huge company.
All of this means that Disney will have cash to increase competitive pressure in any division management chooses to do just that. Netflix, throughout its history has rarely generated any cash flow nor has it ever sustained free cash flow. Therefore, the best scenario is likely to be the sale of stock to be able to finance increasing competitive pressure. Lessor choices for Netflix would include more debt (but it already, as of the fourth quarter, had negative cash flow. So, it really cannot afford that option.) or a steady decrease in the programming budget as competition heats up (or at least not an increase).
The market is likely to have a different view how it values all of these stocks. A diversified company like Disney may not suffer much from a lower valuation of streaming by the market because other divisions will factor into the market vision and evaluation of Disney. A company like Netflix, has nowhere to hide and will be valued solely on a streaming business whose value is likely to decrease with more competition.
As Disney, Apple and Amazon (AMZN) have proven that it is pretty easy for large companies to enter this business in the hunt for profits. Investors can bet that more competitors are on the way besides all the large and small companies already there. Those large entrants can handle whatever happens easily as this latest venture is a relatively small part of the business. A worst-case scenario would be a write-off followed by a change in direction to a more profitable strategy. Again, a standalone pioneer like Netflix does not have that flexibility.
Therefore, the odds favor the stock of Disney eventually climbing to a far higher price from this diversification attempt. The large companies entering the market are likely to be survivors. Other survivors would include those that manage to find some sort of profitable specialty niche. That would be hard to imagine in the streaming business. But it certainly would be an imaginative (and speculative) possibility.