Disney (NYSE:DIS) is turning into a battleground stock. That may seem a bit surprising. After all, what’s too controversial about Disney stock? For investors, though, the media and entertainment giant has entered a turbulent time.
Analysts give Disney a pass for the earnings freefall since the novel coronavirus hit. That was clearly an unpredictable event that Disney’s management couldn’t have realistically planned for. Still, it’s absolutely battered the company. Think about Disney’s various businesses. A ton of them are being pounded by the lockdowns and lack of travel. There’s the theme parks and cruises, of course. But it’s also Disney movies, and live sports on ESPN among others.
With Disney’s cash flow stream diminished to a trickle, there’s great debate over how Disney should proceed. Some people want cost cuts and a return to the normal dividend and share buyback approach. Some folks want Disney to dump underperforming assets such as ESPN. And now you have a new entrant into the discussion, famed activist investor Dan Loeb, who is urging Disney to ramp up the streaming wars. So what are investors to make of all this excitement?
Disney Throws in the Towel on a Quick Recovery
Recently, Disney shocked the world with one of the single largest Covid-19 firings to date. Disney will be laying off 28,000 employees, or fully a quarter of its theme park staff. Until now, Disney had kept those employees around in hopes of being able to reopen the parks in a speedy fashion. But with travel rebounding slowly and guest numbers low for attractions that are open, Disney couldn’t take the operating losses anymore.
The head of the Disney Parks division, Josh D’Amaro, explained the company’s move: “As heartbreaking as it is to take this action, this is the only feasible option we have in light of the prolonged impact of Covid-19 on our business, including limited capacity due to physical distancing requirements and the continued uncertainty regarding the duration of the pandemic.”
There’s been a lot of hope around Disney recovering quickly from Covid-19. But until the vaccines are widely available, it seems Disney will struggle to get back on track. It’s one thing to get parks and movie theaters physically open again, it’s another one altogether to get guests to come back.
Activist Urges Ambitious Strategy
Adding to the drama, on Wednesday, well-known activist investor Dan Loeb announced his vision for Disney. And he made a surprising pitch. Usually activist investors want more profits now. The normal activist playbook is to slash operating expenses, sell off unneeded assets and use the extra cash to buy back stock and pay fat dividends.
However, in this case, the activist is urging Disney to run larger losses in the near-term. This counter-intuitive proposal does have some logic behind it. He believes that by doubling Disney’s content budget, the company can become a true streaming competitor to Netflix (NASDAQ:NFLX) rather than just being another middling player in a crowded field.
Loeb notes how Disney is spending just $1 billion annually or so on its content for Disney+ at the moment. Meanwhile, Netflix is spending roughly $17 billion per year on its own content budget. Loeb suggests that by foregoing the dividend payment for the foreseeable future, Disney can free up several billion a year to add to its content budget to attract and retain more loyal paying subscribers.
Will It Work?
It will be fascinating to see if Disney takes Loeb’s view seriously. From the 1990s onward, Disney paid a steady or rising dividend every year. It was understandable why Disney temporarily suspended the payment during the peak of the Covid-19 crisis, but investors had assumed the dividend would resume as soon as the parks started opening again.
If investors give up the dividend, what will they get? Loeb believes that Disney can eventually generate a jaw-dropping $500 billion in revenue from streaming. Further to that, Loeb notes that Disney’s streaming service is woefully lagging Netflix in value. He claims that Disney’s average lifetime subscriber is only expected to bring $100 of value to Disney now. He thinks this should be closer; Netflix, he contrasts, is valued at more than $1,000 per subscriber now.
If Loeb’s vision is correct, this would be a true transformation for Disney, and ensure the company’s prosperity for decades to come. On the other hand, if Disney bets the franchise on streaming and it doesn’t pay off, the stock price would plummet and investors that relied on Disney for income would be furious. The company’s board of directions now faces a nerve-wracking decision.
Disney Stock Verdict
Disney stock is unusually popular among the group of old-school blue chip names. Growth investors like it for the streaming, value investors like it because it looks cheap, and the dividend satisfied income investors as well. As often happens, however, a product that aims to please everyone can end up failing on all fronts.
Disney’s growth simply isn’t going to come close to the pure-play streaming companies. Anyone buying the stock primarily for Disney+ will likely be disappointed. The value investors are bound to be underwhelmed as well. It took Disney’s earnings five years to get back to normal during the Great Financial Crisis. And that didn’t shut down Disney cruises, theme parks, or box office ticket sales in nearly the same way this mess has.
And now this activist investor adds even more uncertainty. If Loeb gets his way, Disney’s operating profits will be reduced for years as Disney invests more capital into a content library that may or may not pay off. It’s not necessarily a bad strategy. But it’s one that adds more risk to what was already a complicated situation.
On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.
