Disney: Culture Wars Overshadowed by Profit Potential (NYSE: DIS)


Yuji Chen

(This article was in the October 31, 2022 newsletter.)

Disney (NYSE: DIS) long ago made a statement about inclusion and diversity that earned the ire of the state of Florida. This anger meant that a a law was passed that meant for Florida to dissolve the standalone unit that Disney has for its business unit, the theme park. But the law never specified how to unwind decades of trade deals, or how bondholders would be paid. Reimbursing the bondholders is part of the covenants.

Since then, things have calmed down and probably nothing would happen because the state of Florida would immediately owe the affected bondholders money the minute it took over.

But then the CEO made a statement about the “wake-up call” that news quickly spread and could well start all over again if management isn’t careful. As long as a cool head prevails, a reasonable solution will likely be found, or the status quo will remain.

Still, the statement itself deserves careful consideration. The CEO’s comments emphasized neutrality. The company itself is neither woke nor unwoke. However, any film or entertainment released at any of the companies is vetted to ensure it maximizes sales while minimizing friction or backlash. Movies are there, for example, to maximize profits. If these profits do not occur due to an explosive film, for example, the management will quickly correct the situation.

Disney is not spending the money it spends in its various business units to promote the policy. It’s there to make money. Therefore, everything that constitutes a business is geared towards maximizing business prospects. For company prospects, minimizing backlash in the process is also a long-term goal.

But management comments and statements are another matter. Nevertheless, it will be interesting to see how the latest comments are received by the market and the business community. Next year is expected to be a year in which the company’s recovery from fiscal 2020 continues. Let’s hope management’s statements won’t derail the continued recovery.

The upshot of all of this is that Disney’s release schedule as well as existing sales based on previously released films and franchises have been criticized for not being mainstream enough. The test of this statement should come from the market, not from politicians or the media. Investors will know if future versions will do better or worse than expected. Anything that does not meet expectations will be adjusted as it has been for many years.

Recent posts

Hocus Pocus 2 is a movie released on Disney+ that seemed to be a commercial success. In fact, the film became a streaming record for the streaming service. So there are apparently enough people who aren’t bothered by the recent comments. Business as usual continues so far. But more importantly, if a record is set, there is no material backlash to fear.

The wakanda forever The film is expected to open soon with high expectations.

Meanwhile, the horror movie Barbaric became an unexpected minor hit.

In short, the company seems to be living this experience rather well.

Streaming Challenges

Probably the biggest remaining challenge is making streaming profitable.

Disney Summary of progress in the streaming sector in the third quarter of 2022

Disney Summary Of Progress Made In The Streaming Business Third Quarter 2022 (Disney Third Quarter 2022, Earnings Summary Press Release)

The subscriber business shown above has grown rapidly. It also produced a big loss for the company, which other divisions more than compensated for, so the company made a profit. Now there is going to be a move towards profit depending on the direction, and some things have already started that process. When the fourth quarter is released, an update on this whole situation will be critical.

Despite all the talk about suitable characters for families and kids, the company seems to have had no problem attracting streaming customers. This business, however, must now turn from display loss to profit. This may or may not be possible, given that the streaming “wars” have only just begun.

Disney has an advantage in that other parts of the integrated company can derive enough benefit from the streaming segment that the company does not have to report a profit. Not all competitors seem to be in the same position. The other consideration is that the streaming business could “disappear” tomorrow and the business still has plenty of profit opportunities as the streaming business is not of a material size for the losses generated. Now, of course, the future could be different. But Disney is established enough to pick up a decent streaming business should it become necessary.

Amazon (AMZN) has purchased MGM Studios to bolster its entry into the streaming business. It’s at least confirmation that the integration Disney has is an advantage Amazon sees as it enters the streaming war itself. Whether that will be enough to compete successfully in the long run remains to be seen.

Cash flow

The cash flow statement reflects the ramp-up of post-pandemic activity.

Disney Summary of cash flows from operating activities

Disney Summary of Cash Flow from Operating Activities (Disney Third Quarter 2022 Earnings Press Release)

Note that the change in operating assets and liabilities shows that current assets needed funding of approximately $2 billion. It didn’t take as much working capital and short-term assets during the pandemic. But that’s clearly not the case with open parks and movies being made. Such expansion of current accounts should be expected by investors.

But this same funding will not be required to the extent noted above in the next fiscal year. The parks are now open and generating cash. Films have started to be released and are also generating cash which offsets the costs of future releases being made. As a result, cash flow is most likely expected to increase by approximately $2 billion in the next fiscal year.

Calculation of Disney's free cash flow in the third quarter of 2022

Disney Third Quarter 2022 Free Cash Flow Calculation (Disney Third Quarter 2022 Earnings Press Release)

Likewise, Disney is showing increased investment in calculating the free cash flow needed to open parks in the post-pandemic period. Therefore, in the coming fiscal year, the investment line is expected to decrease to something similar to the past years of ongoing activity. Free cash flow will also benefit from the previously mentioned increase in cash flow from operating activities.

When this is combined with a normal film release schedule as well as the film’s expected earnings, one can easily see free cash flow with the potential to approach five billion before any additional contributions from the recent acquisition of 21st Century Fox. just before the pandemic. This acquisition should also benefit Disney in the future.

The future

Disney found itself caught in an unfortunate situation regarding diversity. At present, this discussion seems to be largely out of favor in Florida. Despite the passage of the law, there is unlikely to be a material change in the situation because bondholders have a change of control under the covenant. This and any solid planning for a change of control is likely to prevent that change of control for the time being. There are currently a lot of details that would need to be ironed out before any changes happen.

In the meantime, it is clear that cash flow should take a big step forward in the current year. This includes free cash flow.

The acquisition of 21st Century Fox is not yet fully exploited. This will likely happen in the post-pandemic period. But it could take a year or two for investors to see results.

Clearly, the current stock price anticipates some of the potential improvements noted. But there will likely be many more improvements in the post-pandemic period. The potential for recovery far exceeds any adverse possibilities in Florida, if they even occur.


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