2 ways Disney’s big gamble on streaming could still disappoint investors

By most measures, the new design is working on all cylinders. Walt Disney‘S (NYSE: DIS) the Disney + streaming service added another 16.2 million subscribers during the quarter ended October 3, bringing the total to 73.7 million. It’s incredible, given that it only launched in November last year, but it’s also just the beginning. Industry analyst Digital TV Research estimates that Disney’s flagship streaming product will serve more than 194 million customers by 2025, making it second only to Netflix (NASDAQ: NFLX).

Shareholders who praise Disney’s extended gamble on streaming, however, may want to prepare for the worst even if they hope for the best. The pricing power that Walt Disney enjoys with Disney + has yet to be truly tested, and the streaming service’s bottom line may never completely replace the income currently generated by the same movie and cable business that is contributing to to shift.

Disney’s management faces a price catch-22

The company’s stock price recently suggests that investors appreciate Walt Disney’s growth potential outside of a COVID-restricted environment, and most shareholders hailed management’s recent decision to prioritize streaming. It looks like this is the future of the film and television industry.

However, Walt Disney’s accounting team is likely charging less for its Disney + product.

The company reports that it raised, on average, $ 4.52 per month per subscriber for Disney + during its fiscal fourth quarter (ending October). It’s less than the $ 6.99 per month cost quoted on the Disney + website, and even less than the $ 5.83 per month cost when dividing the full year subscription price of the $ 69.99 service by 12 months. The discount reflects the Disney + prorated portion of a package that includes ESPN +, Hulu, and Disney + that retails for $ 12.99 per month. More importantly, that actual price of just $ 4.52 per month makes Disney + the cheapest streaming service of its kind. The cheapest plan Netflix offers starts at $ 8.99 per month, and at that price, consumers aren’t getting much. Its top-notch service sells for $ 17.99 per month. AT&T‘S (NYSE: T) the new HBO Max is priced at $ 14.99 per month.

Priced at under $ 5 a month each, Disney’s streaming services collectively brought in sales of $ 16.9 billion in the year just ended. But it still took an operating loss of $ 2.8 billion.

Both were improvements, for the record. The top line increased 40% year-on-year, and the operating loss was $ 171 million lower than the prior-year comparable quarter loss. And given his young age, perhaps a more relevant comparison would be this year’s second calendar quarter numbers. However, those aren’t particularly encouraging. For the three-month period ending in June, Disney’s direct-to-consumer service and its international division turned $ 3.9 billion in revenue into an operating loss of $ 706 million. The top line improved sequentially by 23%, but the loss was only reduced by 18%.

Fans of Disney’s new focus will argue that its streaming services simply need more scale – more paying customers – to cover relatively fixed costs like production and promotion. Digital TV Research’s estimate that Disney + subscribers could reach 194 million in the short term would do the trick. A higher price would work just as well.

However, both ideas present challenges. A higher price tag would make its streaming services less marketable to an unknown extent. But to get more members for a lower price, you may need to spend more on content.

Income cannibalization

Investors should also keep in mind that every streaming client Walt Disney brings on board is a client who is less likely to remain a cable TV subscriber or even a viewer.

This trend is already underway. Leichtman Research Group suggests that the linear cable television industry in the United States lost about 1 million customers in the last quarter. That’s another million cable customers who no longer contribute to the transportation costs Disney charges cable customers for access to its programming.

It matters simply because cable television is still the company’s largest and most profitable business. For the full year that ended in September last year, media networks accounted for $ 24.8 billion of the company’s $ 69.6 billion in revenue and $ 7.5 billion of its $ 14 operating income. 9 billion. Studio Entertainment added $ 11.2 billion to the top line and generated $ 2.7 billion in operating income. Last year’s cable business produced full-year revenues of $ 28.4 billion and operating profits of $ 9.0 billion.

As noted earlier, Disney’s streaming business generated $ 16.9 billion in sales in the year just ended. Not bad. But with an operating loss of $ 2.8 billion, it’s hard to see it replace the level of earnings produced by the cable TV itself and film industry it ultimately aims to replace.

Keep the bigger picture in mind

Sure, Walt Disney may somehow be able to orchestrate the growth of streaming that doesn’t completely shift its media networking businesses, even selling streaming services at prices that completely replace the operating profits produced by its TV and movie arms. Everything is possible.

But that’s not likely and this could be a problem. Until the company clarifies its streaming growth plans and the impact of streaming on other initiatives, investors should think about business-wide trade-offs and not stay focused on its best growth engine.