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Disney's Magic Streaming Kingdom

The Child in Disney Plus's 'The Mandalorian'
(Image credit: Disney)

Who would have thought five years ago, when former Disney chairman and CEO Bob Iger told analysts that the then-relatively new phenomenon of cord cutting was starting to erode its pay TV subscriber base, that the saving grace for the company would be embracing the very thing -- streaming video -- that was destroying it?

At the time, the company’s direct-to-consumer offering, Disney Plus, wasn’t even a twinkle in old Bob’s eye. But five years later -- Iger is now executive chairman and Disney is led by former theme parks division chief Bob Chapek -- it not only is one of the more successful DTC streaming services on the planet, influential media analyst Michael Nathanson, who like others adopted a conservative stance in the streaming service’s early days, now believes the sky's the limit. In a research report released earlier this week, Nathanson estimated that Disney Plus subscribers will reach 50 million domestically and 155 million globally in the next four years.

Nathanson pointed out in the report that he remains neutral on the stock, but that is mainly because of the pandemic’s effect on its theme park business (which laid off 28,000 workers earlier this week), its theatrical movie business (production is only just beginning to ramp up and no one is going to theaters) and its sports channels. Disney Plus remains the bright spot, and Nathanson rightly points out that the success of that business has shifted investor attention away from the eroding pay TV subscriber base.

The evidence is in the stock price. Disney shares tanked in August 2015, when Iger let it be known that cord cutting was in fact affecting ESPN’s pay TV customer base -- dropping 10% in one day and dragging down the entire sector. 

The stock made a big recovery in the past few years and was priced in the $140 per share range before the pandemic hit. That, coupled with continued pay TV subscriber erosion (traditional pay TV customer losses have broken records for eight straight quarters) have chipped away at programming shares in general. Disney stock fell as low as $91.81 each on March 12, but have gained ground since, closing at $123.31 each Oct 1. That reversal appears to have come solely on the back of the streaming business. 

Related: Brave New TV World 

In his note, Nathanson wrote that Disney stock has effectively “decoupled from the usual historical pattern witnessed in prior economic downturns where negative earnings revisions and multiple contraction generate meaningful market under-performance. This time around, the once in a generation, pandemic-driven disclosure of theme parks and movie theaters plus the acceleration in cord-cutting has been largely ignored as investors gravitate to a Sum of the Parts valuation approach using Netflix’s price to sales as a valuation comp for DTC.”   

Aggressive pricing (it launched at a very attractive $6.99 per month), strong programming from its recently acquired Fox library and a little luck (The Mandalorian), continues to drive the business. Disney Plus also should have a halo effect on Disney’s other streaming properties -- Hulu and ESPN Plus. Nathanson estimated that Hulu subscribers will grow to 66 million by 2024 (up from earlier guidance of 55 million) and ESPN Plus customers will rise to 18 million in the same time frame (up from previous estimates of 12 million).

Related: Everything You Need to Know About Disney Plus 

That’s pretty impressive, given that at the end of 2019, Disney Plus had about 26.5 million subscribers globally. At the time Nathanson estimated that 24 million of those subscribers were domestic, meaning that in just two months (Disney Plus launched in November 2019), the streaming service accounted for about 20% of the broadband subscribers in the U.S. Now, Nathanson, who last year estimated that Disney Plus would reach 25 million subscribers by 2024 -- predicts the streamer will grow to 42% of U.S. domestic broadband subs, not far from the 57% he expects to be Netflix subs in the same time frame. 

Disney said in August that Disney Plus had about 60.5 million subscribers, reaching the low-end of its five year guidance of between 60 million and 90 million customers in one year. 

“Disney has proven to the Street that Disney Plus is a big enough lifeboat to help the company reach the other side of this media landscape upheaval in a strong position,” Nathanson wrote. 

But it will come at a price.

Nathanson estimated as Disney Plus rises, most of its other assets will be severely weakened. At the Parks, he estimated that pandemic effects will bleed into fiscal 2021, which will continue to be impacted by capacity restrictions and discounting to incentive travelers. At ESPN, the analyst believes that traditional pay TV declines will reach -9% this year, and that he expects cord cutting to remain at around -5% in the out years.

“Given these secular pressures, ESPN’s linear channel business will have a hard time maintaining its level of profitability over the next few years even if no major sports rights are dropped,” Nathanson wrote. 

He added that even if ESPN manages to successfully renew its affiliate deals over the years, he doubted it would be at a rate high enough to offset the cost of escalating sports rights. As a result, he’s forecasting a 100- to 200-basis point drop in affiliate fees in the out years, with margins shrinking from 30% in 2019 to 27% this year and 22% by 2024.