Disney: It’s Bob Iger Vs. Hollywood

Summary:

• Disney’s mandate is to cut costs and bring its streaming unit to profitability.
• Bob Iger will need to address, first and foremost, above-the-line content budgets.
• He will also need to bring in extra revenue by selling some older streaming content on other platforms and physical discs.
• The Hulu question is also a concern, as although that might help to cut costs, it is nevertheless a valuable platform.
• Disney’s stock is expensive, but smaller purchases for long-term investors could be considered.

The Walt Disney Company (NYSE:DIS) CEO Robert Iger mused on his new tenure at the Mouse at the Morgan Stanley Technology, Media and Telecom Conference on March 9, 2023. One thing that was apparent for all to see: This isn’t the Bob Iger we used to know.

No, indeed not. Remember the Bob Iger who bought a lot of stuff? Well, he’s not going to be buying another Pixar-type company anytime soon. Not with the company’s current debt load and need to get back to a dividend-yielding state (which Iger says is on the way).

That’s okay, though. He can exercise the opposite skill this time around – reigning in costs and expenses.

It all centers around how much capital the company intends to deploy on filmed-entertainment originals. Can one spend a couple-hundred million dollars on an eight-episode Star Wars series? Depends on the data – which means it depends on the churn rates and whether or not it’s all worth it in the end.

I’ll be checking out his thoughts at the conference and will offer my own perspective on Disney’s current status in streaming, as sort-of an update to a previous article.

Before I get to that, let me also point out I am still a long-term owner of Disney and have been carefully buying small amounts on the dips. The company will weather the market turmoil and inflationary environment – the bigger question revolves around how Disney approaches content generation from this point forward, not only as it pertains to self-distribution at theaters and on direct-to-consumer platforms, but also as it relates to distributing some of the same content to other competing platforms.

On Content And Cost

Let’s pull a quote from the conference:

On the content side, I’m really pleased that the support that I’m getting from the content creators of the Company is significant and real. And it comes in the form of, one, reducing the expense per content, whether it’s a TV series or a film, where costs have just skyrocketed in a huge way and not a supportable way, in my opinion. They all agreed to that and also, which is, I think, as a result of whether you call it more aggressive curation or whatever or understanding how much volume we need, reducing how much we make.”

There are two very distinct concepts within that quote:

• Reducing the expense per content
• Reducing how much [the company] make[s]…the volume of content

Iger’s big challenge is going to be the first concept – reducing expense per content piece. And it’s not going to be easy. Why? Because how do you say no to Hollywood?

It’s a serious question, a conundrum, as I like to call it. In fact, let’s consider recent news over at one of the trades about Netflix (NFLX) recently telling Hollywood ‘no.’ Filmmaker Nancy Meyers wanted to work for the streamer with a star-heavy project that would have cost $150 million. Breaking that apart, $70 million would have been allocated to below-the-line production requirements while the rest – $80 million – would be earmarked for above-the-liners. Obviously streaming necessitates the buyouts of backends, but Netflix wanted a bit of rationalization injected into the process (very understandable). If you check out the logline of the project, it becomes clear that this is not one of those differentiated IP tentpole offerings, as Iger likes to term them these days (in opposition to general entertainment, for which Myers was aiming).

Netflix made the right move here, and it probably wouldn’t have during an earlier stage of the streaming wars.

Let’s dig deeper into the conundrum part, because Iger can’t simply cut costs and get a solid ROI on streaming just by using less computer time for special effects and switching a screenplay up by making it a modern piece instead of a period one – it’s those above-the-line items that really need attention. The challenge here boils down to paying stars less money, and that’s a puzzle because, arguably, high box-office revenue and billions of minutes of direct-to-consumer viewing time is highly correlated to celebrity talent. Robert Downey Jr. was a popular superhero during his day in the Marvel sun, as is Elizabeth Olsen now – but they have quotes, and the studio has to pay up for their services. If Iger wanted to change the casting process and go for lesser-known talent – read: more economically prudent – he’d have to sacrifice a bit on the revenue side while also contending with execs who have developed relationships with these stars; please recall the whole Scarlett Johansen debacle and what that probably meant to Marvel production chief Kevin Feige. He would not take being told to lower the compensation packages for Marvel thespians lightly – not only because he works with Hollywood heavyweights and wants to remain in their good graces, but also because he knows box-office top-line results might come down (although profitability would hopefully go up), thus impacting his reputation as a producer. He could have a point: recall the Solo movie project from Lucasfilm that didn’t have a major star attached in the lead…that film couldn’t even reach $400 million globally and generated a loss according to one trade. If Harrison Ford were in it, would it have been more of a success?

One would assume so, and that performance spooked the Mouse so much that it temporarily is favoring streaming on D+ for its Star Wars trademark as opposed to theatrical. (My quick take: keep making more Wars theatrical films and just learn from each one; keep building up the library.)

Still, every so often one sees a celebrity talent not making a deal that would have previously been assumed done. Besides Netflix and Meyers, another recent example would be Paramount Global’s (PARA) (PARAA) Scream 6 sequel. That franchise had to do without Neve Campbell in the recent entry, and that was a big loss considering how important her character is to the series. It doesn’t seem to have hurt the film, though, because the movie is closing in on $120 million in global box office at the time of this writing. (Of course, will Paramount be willing to cut any of the current stars of the series – e.g., Jenna Ortega – more immediately for the next entry if need be for economic reasons? That remains to be seen.)

It would be hard, though, for even a superhero chief exec like Bob Iger to stand up to Hollywood. Disney, as I have mentioned a few times before, actually does put forth a solid attempt to rationalize compensation economics within the model of filmed entertainment – it has a reputation for it (as an example, I believe the bonus structure tends to ameliorate the gross compensation structure, but I would have to see details and comparisons to fully evaluate that). Warner Bros. Discovery’s (WBD) David Zaslav seems to be leading the way in terms of taking a hard line on costs and compensation and, especially, residuals (which, per the latter, is what he is trying to avoid paying out to talent by removing content from HBO), and perhaps Iger will get some ideas from that (although it should be noted that I wonder how Zaslav will consider cost control as it concerns the wishes and desires of DC chiefs James Gunn and Peter Safran), but whenever I have some hope as a shareholder that studios will be able to keep more of the profits for their corporate selves, I read something like the following concerning super-agent Ari Emanuel’s thoughts on talent contracts:

When they say they’re going to cut back, they’re going to do 25-day shoots instead of 30-day shoots…They’re not [emphasis mine] paying Keanu Reeves or Mark Wahlberg or Matt Damon or Ben Affleck or Marty Scorsese. They’re paying those people. They have to figure out their cost-savings someplace else.”

He’s serious. He’s not fooling around.

Let’s hope Iger gets that memo and adjusts accordingly…

On Content And Distribution: New Paradigms Needed

Let’s consider the cancellation of Willow on D+.

I’m not sure what Disney’s plans are regarding this one-season set of episodes, but the project should be sold in the physical market as a Blu-ray, as well as a digital transaction.

The argument against this is that exclusivity serves D+ well, even for a minor part of the programming portfolio such as this particular adaptation.

While that is certainly true on some level, let’s think about why the show was only a one-season affair. The possibilities are that the data show only nominal engagement by viewers, as well as it perhaps being not much of a catalyst for sign-ups or retention. Also, maybe the talent behind the show, the above-the-liners, wanted too much for a second season. Disney may have reasoned that the investment wasn’t worth it; actually, that should go without saying, although I say it because recall that it wasn’t long ago when money was spent without regard on all kinds of projects to keep up with the Netflixes of the world, whether it be for backend buyouts, profligate overall deals, or vertigo-inspiring budget sheets.

The bottom-line point is: Willow is not a make-or-break series for D+. Because of this, and because Disney needs more money in its coffers to combat inflation and rising interest rates, a new model for D+ series should be that potential viewers who refuse to subscribe should be given the opportunity to watch the show. It makes plain economic sense. The IP could be on physical release, and it could also run on ABC, Freeform, Disney Channel, etc. Each run could be a slightly different product, with new extras, deleted scenes, and the like.

That’s Willow. What about something more substantial, such as The Mandalorian, or WandaVision?

As the content ages, with an appropriate window, the answer is…yes, all of that product should move over to broadcast/linear/physical.

All streamers could use this tactic. Certainly the smaller streamers have. An example of the latter would be Shudder releasing its Creepshow revival on disc.

Netflix released Stranger Things on DVD, and in a limited capacity if I recall. As content matures and no longer provides the sign-up catalyst – which is a naturally-occurring process, as all media is essentially new-content-driven – it should be repurposed in other ancillary channels to promote direct monetization beyond the collective subscription model. An article over at Deadline discussing streaming models and windows contained a very interesting observation from an industry insider, which I will quote: ” The minute a piece of content hits your SVOD, it no longer has any value.” Well, it does still have value, even if it hit streaming first; the process can simply go in the other direction.

Disney is in a great position to engage physical releases since it can turn any disc debut, or re-release, into an event at retail. Recall when the company used to sell new releases of classic cartoons from its vault in special collectible editions, usually for a defined time period…well, Iger should do that for D+ material.

Thankfully, there is a hint – a slight one, admittedly, and on a different topic, that of theatrical versus the physical sell-thru window – in his comments that he may be thinking along these lines:

In some cases, we made a lot of films just for streaming. In some cases, we made films with shorter exhibition windows. In almost all cases, we made films that no longer had the sell-through window in it, which home video at one point, as we called it, was extremely lucrative for our company. So, we’re looking at all of that.”

It wouldn’t be a stretch to see that evolve into physical releases of streaming productions.

Going back to platform rotation, Zaslav over at WBD also gives us a recent example. HBO’s Silicon Valley and True Blood will migrate over to platforms TBS and TNT for airings in redacted form. Note that this trade article points out that this is hardly anything new, as other shows from HBO have hit syndication and licensing deals – Sex and the City, Curb Your Enthusiasm are two shows that not only have physical releases but have been seen in the past and the present on other channels.

Iger can transform the D+ model to better help profitability achievements not only at direct-to-consumer, but within the whole company as well. By shifting content around and selling the portfolio on disc, a tradeoff is made that I believe can be worth it given the company’s current challenges: exclusivity can be kept for only fresh filmed-entertainment while aging content can be syndicated to the ancillary channels for purposes of creating higher ultimate profit. Disney has mentioned in the past that to do all of this, to sell content to itself and thus increase intercompany eliminations, it needs to have talent on board by limiting profit participation exposure – thus reducing the exposure to sweetheart-deal lawsuits. This brings us back to the ultimate conundrum of reimagining talent compensation practices; we’ll have to wait for Iger’s take on that.

I’ll add as a final note that Disney could even syndicate its aging streaming offerings to competitors. Would some of Comcast’s (CMCSA) cable channels want a Mandalorian? A Willow? (Think SyFy Channel with those two.) That’s nothing new, either; companies routinely license content to each other. And especially with that method of distribution, the company must be careful not to create too many backend opportunities for talent, otherwise full value cannot be extracted from the process and costs will again become an issue (and costs are the reason for Iger’s vaunted return).

More From The Conference

One thing that should fascinate shareholders is the whole reversal of course in over-the-top services as far as financial goals are concerned. Iger summed it up thusly during one exchange:

… I’m generally bullish on streaming as a great consumer proposition, as a really robust platform to deliver high quality content under easily used circumstances. And I am extremely bullish on some of our streaming prospects, notably Disney+, which grew to just such an — at such a meteoric rate.

We know in terms of delivering profitability and growth to that platform, that we have to better rationalize our costs.

…In our zeal to grow global subs, I think we were off in terms of that pricing strategy. And we’re now starting to learn more about it, and to adjust accordingly.

And while I’m pro consumer, generally, I think we have to take a look at how easy it is for the consumer to not just sign on, but sign on sometimes under promotional circumstances where it’s not only less expensive, in some cases, it’s free, and the signing you get for three months, you get one month free, watch all you want in a month, so sign off that and go to another one that’s doing the same thing.”

I’ll take the latter part first. What Iger is getting at there, implicitly to some degree, is the issue of churn – hopping on, hopping off, which is what I feel is the greatest threat to any streaming service not named Netflix. He also speaks to the value – or lack thereof – of the free-trial system. I never liked free trials, as a shareholder anyway, never saw the worth in them. Some services have rid themselves of the practice, and in my opinion, it is the correct strategy, since as Iger points out, it can be gamed quite easily by the consumer.

Churn and promotions do not work in a streaming era where profits count. Of course, on the former, we can say that as long as we’re getting at least one month of payment, then it can be considered a glorified pay-per-view transaction, albeit a very inexpensive one (I wouldn’t mind seeing the company use its Premiere Access platform on D+ as a way of charging a lot of money for a theatrical film close to its opening date – say double or triple the $30 Disney charged during the height of SARS-CoV-2 – and then including a few months of D+, perhaps with advertising; be a worthwhile experiment, at least, although Bob Iger might be hesitant to resurrect that particular relic from the time of Bob Chapek). The latter just never made sense to me, as one wants revenue from a subscriber as soon as possible – and if a company absolutely insists on a free-trial paradigm, then attach a heavier-than-usual advertising load. Besides: if Disney, or any company, routinely sold aging streaming content to other platforms, that in itself would serve as a free trial…if one could watch the first two seasons of The Handmaid’s Tale on FX linear, what more could one want in terms of sampling?

On the former point about initial pricing strategies: in hindsight, sure, Iger can admit that perhaps the service wasn’t priced high enough. It was the subscriber-count-multiple that – and maybe this is putting it too strongly – corrupted rational thinking. Strongly or not, perhaps the CEO, considered one of the finest in our time, should have had a more complete vision of direct-to-consumer that took into account potential future vagaries in the model.

The other discussion point I’ll mention from the conference centers on something on many analysts’ minds: Hulu. The big Hulu problem.

There’s now a war between two ideas in Bob Iger’s mind: differentiated content versus general entertainment. Differentiated content is basically entertainment that has added value because of brand equity – Marvel, etc. General entertainment is stuff that isn’t necessarily backed by a franchise context – it might be more one-off material in some cases, and in others, art-house-type fare or adult-targeted stories.

And as Iger essentially said, those definitions lead back to Hulu.

I myself was bullish on Hulu helping to drive the streaming bundle of D+ and sports and general entertainment – Hulu also offers a live-television component if cord-cutting consumers so desired.

I’m sensing, though, given the macro environment and its current challenges, that Iger may want to divest the company of this general-entertainment vehicle.

So what we’re doing right now is we own two-thirds of Hulu, and we have an agreement with Comcast that may result in us owning 100%, is that we’re really studying the business very, very carefully, all those competitive dynamics with an understanding that we have a good platform in Hulu.

But the environment is very, very tricky right now. And before we make any big decisions about our level of investment, our commitment to that business, we want to understand where it could go.”

Yeah – I think we all see where this may be leading. Does Iger want to float more debt at potentially higher rates to increase Disney’s investment in content that does not sync up with D+’s programming portfolio? Again, I see the value of the bundle – as The Entertainment Oracle argued for in this article – but if the CEO seems to be heading in a different direction, it might be worthwhile to consider a post-Hulu Disney.

Disney certainly could attempt to strike a deal with Comcast, and it might involve content-swapping or a lower price or a deal where Comcast gets the asset but is obligated to license Disney content for several years going forward.

The problem with a sale of Hulu is it creates excess capacity with non-Marvel/Pixar stuff that the company basically has from the Twenty-First Century purchase. The company can use that label, as well as arthouse brand Searchlight, to populate Hulu; otherwise, it doesn’t really have a streaming home. Disney could revert back to distributing Fox IP to competitors and to intercompany locations, but that essentially becomes a new bet on linear.

Iger’s personal conundrum is this: he made a significant bet on streaming, and now he is, possibly, starting to unwind it to one degree or another (I add the term ‘possibly’ to denote the potential Hulu sale in addition to the simple act of cutting streaming costs). He’s made seemingly contradictory comments on volume needs over at D+. He has mentioned that he wants to steer the company in a way that will position it to more easily adjust to future economic disruptions, whether they be internal relative to the industry or external in a macro sense. (A bit strange on that last part, given that I thought something like the Fox IP acquisition was supposed to have possessed such resistance to bearish conditions.)

I suppose, in one sense, that this is really nothing new…companies merge, split apart, buy assets, sell them, scale, de-leverage, and so on…Wall Street loves a stream of deals, a trove of transactions. Fair enough.

I would, however, counsel the CEO to perhaps better think about what his vision for the company is, one that can stand the test of time and future CEOs once he leaves (will he leave?). If he wants to divest Disney of Hulu, he should announce that to shareholders sooner rather than later and get going on the process…better to concentrate on D+ and E+ without that distraction.

Conclusion

I have been buying small amounts of Disney stock during the volatile trading sessions we’ve all experienced, averaging in to improve cost basis. SA rates the stock as expensive, but gives it high ratings on other metrics such as growth. I rate the stock as a long-term idea that is risky over the short term, hence my very small additions to my overall position. I can’t say when the bulls will return, which is why I want to keep at least some money flowing into this big media brand.

Going back to the qualitative issues I’ve discussed here, Disney retains some flexibility in how it can handle current challenges thanks to Wall Street – the big institutions no longer care about parabolic changes in subscriber totals. They want profits.

That actually should give Bob Iger some comfort; after all, there won’t be as much pressure on the company to have hit after hit on the service – instead, volume, as well as costs, can be rationalized.

But the main, most critical point, is that above-the-line costs have to come down. You can sell Hulu, but you can’t drain the corporate treasury just because agents want higher commissions off higher backend commitments.

And theatrical films will play a large role here, as well. Although I didn’t stress this particular element in this article – I might tackle that in a future one – Iger would be wise to increase theatrical output to help populate D+ (and Hulu, if he keeps it) because that will simultaneously help promote the services and offset overall costs by bringing in some added revenue. While Marvel’s output is pretty well set and precision-designed (i.e., the storytelling arcs film-by-film form one big, integrated IP collection), Lucasfilm could add to its future slate (let’s see more Indiana Jones films, for instance – forget that ban on recasting the famous fictional archaeologist!), Pixar could increase its output, and Disney might look for more franchises from its parks. Be careful about the dealmaking with the stars, and you can increase volume on D+ more efficiently as well as effectively. In conclusion, this should be the primary goal for the CEO.

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Disclosure: I/we have a beneficial long position in the shares of CMCSA, DIS, NFLX, PARA, WBD either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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