A strong opening weekend for Black Widow highlighted Disney’s competitiveness

In a rare move, The Walt Disney Company disclosed some details around revenue and profit made from streaming. Per Variety:

Disney and Marvel’s superhero adventure “Black Widow” captured a massive $80 million in its first weekend, crushing the benchmark for the biggest box office debut since the pandemic. The film, starring Scarlett Johansson, is the first from the Marvel Cinematic Universe to open simultaneously in movie theaters and on Disney Plus, where subscribers can rent “Black Widow” for an extra $30. Disney reported that “Black Widow” generated more than $60 million “in Disney Plus Premier Access consumer spend globally,” marking the rare occasion in which a studio disclosed the profits made from streaming.

Directed by Cate Shortland, “Black Widow” collected an additional $78 million from 46 international territories, boosting its global box office haul to an impressive $158 million. Combined with Disney Plus numbers, the final weekend figure sits at $215 million. Curbing overall ticket sales, however, is the fact that “Black Widow” still doesn’t have a release date in China, which is an all-important moviegoing market for the Marvel franchise.

A few things that jumped out to me with this report. First, Disney continues to show the ability to tell appealing stories to a wide audience. Granted, not everybody will enjoy their stories, but the revenue numbers don’t like. They have crushed revenue expectations in the past when the majority of movies that crossed $1 billion in revenue came from the studio and Endgame is still the top two successful movie of all time. Netting $215 million in the first weekend without China when many markets are still dealing with Covid-19, especially the Delta variant, is a great sign in my book.

Second, Disney has a unique ability to be flexible with how they introduce their movies. All the series such as Loki, Wanda Vision or The Falcon & Winter Soldier are exclusive on Disney+ and that makes sense. For the movies, they can reach the audience in different ways. Movies can be exclusive on Disney+ for free to all subscribers or to Premier Access buyers first and to all subscribers after a few weeks. Disney can choose to release movies in theaters first and then on Disney+. Or they can release it in theaters and on Disney+ with Premier Access; which is exactly what they did with Black Widow. The flexibility allows the company to react to the changing environment caused by Covid. Plus, it’s a great tool to maximize revenue and profit. Movie theaters will bring in nice revenue, but whatever money Disney generates from Premier Access is pure profit.

This unique flexibility is a competitive advantage that none of Disney’s competitors can copy. To convince people to shell out another $30 after already paying a membership, a streamer needs a strong brand and IP. Disney has that. Does Netflix have any movie that could do the same? I don’t think so. Even if a streamer has the necessary IP, does it have all the other ingredients needed t o pull the feat off? Like, if the streamer has a big enough subscriber base to even move the needle? Or does it have the relationship with theaters to negotiate a deal like Disney did? I think other streamers will look at today’s announcement from Disney with interest and try to explore the possibility of copying the model. So I will look forward to see how they can pull it off.

In the last earnings call, Disney reported that they had about 104 million Disney+ subscribers with a third coming from Hotstar in India. Hotstar subscribers pay much less for a Disney+ plan, hence it drags the whole streamer ARPU down. What’s interesting in this case is that Disney+ Premier Access is not available in India. News outlets such as Yahoo reported that the feature was not available in India. My friend from India confirmed it too. Given that Premier Access costs more or less $30 in every available market, $60 million in revenue from the feature means that around 2 million subscribers or around 1-2% of Disney+ subscriber base paid for early access to Black Widow.

Netflix bulls will keep pounding on the big lead that Netflix has over other streamers and, as a result, the cost advantage. That’s true. But what Disney shows is that there is an alternative way to succeed. Disney doesn’t have yet the subscriber base like Netflix has. But it has other unique assets: 1/ A dedicated fanbase to its IPs; 2/ The flexibility to make money from other channels, not just its streaming service; 3/ Its theme park complements nicely its Direct-To-Consumer segment. When you generate more money per movie than your competitors, does it matter whether it comes from your subscribers? That’s not to say Disney can neglect the task of increasing its customer base. It’s important that Disney can catch up to Netflix on this front and please investors in the short term. But it’s even better to introduce Disney+ at a low price in many markets to attract audience while making money from theaters and Premier Access. So far, I haven’t seen another company with this model.

Disclosure: I have a position on Disney and Netflix.

Take-aways from the latest interview of Disney CEO

Bob Chapek, the CEO of Walt Disney, attended Credit Suisse 23rd Annual Communications Conference and had some interesting comments on the business. If you are interested in the company or its competitors, it’s really worth a read. Here are a few highlights.

In response to the interviewer’s question on the investments on the experience side in the next 5 years, Bob’s answer was, as follows:

Sure. Sure. Well, we’ve got ambitious plans to expand our business. I had just mentioned Avengers Campus a second ago, and we’re encouraged by the great response we have there, but we’re not stopping there because, as you know, we’ve been undergoing a massive transformation of our Epcot park at Walt Disney World in Orlando. And we’ve got a Ratatouille attraction that we’re bringing in that first premiered in France. We’ve got a new nighttime show Harmonious that will be on the water there at Epcot, and it will be a huge guest pleaser. And then we’ve got our Guardians of the Galaxy: Cosmic Rewind attraction or coaster that will give us our ability to bring that whole Marvel franchise into the park. Internationally, we’re thrilled to bring Zootopia into Shanghai Disney Resort. You mentioned Shanghai.

That’s obviously a property that did extraordinarily well in the box office when Zootopia came out. So that will be a big hit in Shanghai. We’ve got Frozen installations coming into Hong Kong Disneyland. At Disneyland Paris, we’ve got the [indiscernible] of its own Avengers Campus taking off from where Anaheim has. It just recently launched Avengers Campus, and we’ve also got the Art of Marvel Hotel that we’re putting in. We’re installing Tokyo Disney Resort. We’ve got the 8-themed port over at Tokyo DisneySea.

We’ve got 2 new hotels and attractions going in for Frozen, Tangled and Peter Pan. And then we’ve got 3 new ships and a second island destination. So we certainly have a plethora of new things coming, and that’s really mining all the work that we had done prior to the pandemic and kept working on during the pandemic so that we would not have any sort of glitch in our supply chain of new attractions and experiences for our guests, so we can keep that growth engine of parks going.

Source: Credit Suisse 23rd Annual Communications Conference

That’s an impressive pipeline of investments both in depth and breadth. The company has different types of physical attractions under different brands and themes ranging from hotels, resorts to cruise lines and theme parks, from Frozen, Peter Pan to Disney & Marvel. Despite being badly hit by the pandemic, Disney’s traditional cash cow, their Parks business, is likely going to make up for lost time & money, now that folks are increasingly vaccinated and restrictions are lifted. These assets are difficult to replicate. First of all, they are expensive. Any company that wants to emulate Disney needs to ready their check books for a huge sum of money for initial constructions and yearly maintenance. Second of all, Disney competitors need to also build up a library of themes & characters that relate to consumers and entice them to visit the physical attractions. Disney has spent decades of creating, marketing and distributing content. Their brand name is known and loved by generations of consumers. Even if a competitor has the required resources to invest in content, those resources cannot buy the timeless reputation and name that Disney has.

Netflix is trying to take a page from Disney’s book. It’s building Netflix Shop where merchandise related to their originals is sold. This is the first piece of the puzzle. Netflix is popular among viewers around the world and it has some great originals. Hence, it makes sense for the streaming service to start making inroads into the retail side. However, having an online shop is very different from building giant physical attractions that represent huge fixed costs. It will take a lot more from Netflix to build an empire like Disney’s, but everything has to start somewhere.

Second, when asked about how much IP is there to mine, Bob Chapek had this to say:

Well, I’ve always learned not to underestimate our creative teams, particularly our Marvel creative teams. We’ve got 8,000 characters that we have to mine. And you say, well, 8,000 characters, who knows what these 8,000 characters are. But remember that all of our Avengers, for example, our Avengers characters, when we made the acquisition, weren’t exactly household names. Take Loki, for example. Loki was the most watched season premier ever on Disney+ during its opening week. And no one knew who Loki was even when we got started on this journey on Marvel. No one knew who Iron Man was or Wanda or Vision or Falcon or the Winter Soldier. Black Widow, Shang-Chi, nobody knew who these characters were.

Source: Credit Suisse 23rd Annual Communications Conference

I didn’t grow up reading Marvel comics. Years ago, when characters like The Hulk, Iron Man, Thor or Captain America debuted, I barely knew them, yet they are now some of my favorite. I suspect that many casual viewers will first get to know the likes of Shang Chi and others among 8,000 characters from movies or series by Disney. The ability to build characters and tell engaging stories, especially interconnected ones, over a long period of time is a creative competitive advantage that is hard to match. The last 12 years from the first Iron Man movie to End Game is evidence of such an enduring output of creativity. Does it guarantee future success and repeat of the past? No. But it’s much more assuring than records of many competitors.

Next, when the interviewer asked whether Disney would add an ads-supported plan to Disney+, Bob ruled that possibility out at least in the near future.

Yes. We’re always reevaluating how we go to market across the world, but we’ve got no such plans now to do that. We’re happy with the models that we’ve got. But again, we won’t limit ourselves and say no to anything. But right now, we have no such plans for that.

I support this position by Disney. The flagship streamer, Disney+, is already on the cheap end among streamers with the latest reporting ARPU standing at $3.99. The addition of an ads-supported plan would like drive down ARPU even more. Plus, nobody likes to have their streaming experience tainted with ads. Netflix goes to great lengths and invests a lot of resources to make sure that their viewers have the best streaming experience possible on their platform. Disney is wise to do the same if it hopes to compete with its rival. If the company wants to make money from ads, it has its own media channels to do so.

On what “new content on Disney+ every week” means:

Yes. Our plan is to do — hit that cadence this year in terms of a new product every week. And what we mean by that is a new movie or a series, meaning, a new production or library add every week. And that’s not counting new episodes, if you will, but does count new seasons. So we count new seasons. We don’t count new episodes in that. And something new can be a new movie or a new piece of content or something new added to the library. So that’s how we’re defining that. And that’s the plan right now.

Because Disney+ subscriber base is sufficiently big now, it enables the company to spread the fixed content investments across more than 103 million viewers, giving Disney a cost advantage over other streamers, except Netflix. Additionally, new content helps the company acquire more subscribers who will, in turn, add to the economics advantage mentioned above. What I am unclear about is whether a new weekly content is purely originals or whether it includes licensed IP. If it’s the former, it will be great news for Disney stock bulls, a gift to subscribers and ominous signal to competitors.

Last but not least, Bob Chapek touched upon the impact of price increases on churn:

Yes. In terms of, I guess, an objective way to look at the price value relationship, the growth rate that we’ve experienced on Disney+ sort of stands out as the headline there. But you’re right, we did launch at a very attractive price value opening point. And the first price point — or our first price increase that you mentioned in the first 16 months happened recently, and we’ve seen no significantly higher churn as a result of that. In Europe, as a matter of fact, we took a price increase twice as high as we took domestically more or less. And we — that was with — commensurate with the integration of the Star brand as the sixth brand tile. But our churn actually improved, right? So we took an even higher price increase and our churn improved because we added more content. And I think that investment in the content at attractive price point gets you strong retention, and strong retention, obviously, is one of the key factors towards overall platform growth. And — but that doesn’t mean that in the future as we continue to add more and more great content that we wouldn’t necessarily reflect that in the value that we add and then price it accordingly.

While it’s encouraging to see the current price inelasticity of Disney+, it’s equally important to understand that we don’t have a lot of context here. Disney+ had a low price at launch and even a 3-year bundle at one point. Because the starting point was low and the increase here is not significant in absolute ($1 in the US.), even though customer reception towards the latest price increase was positive, it doesn’t guarantee the same outcome for the next raise. They could plow millions of dollars into content, raise prices yet get spurned by consumers. Furthermore, since we don’t have information on the previous churn, it’s tough to conclude whether the current churn is good. Yes, there was an improvement, but for all I know, it could be upgraded from “disastrous” to “concerning”.

In short, Disney has a lot of great assets and great things going on for them. As the world is gradually opening up with an increasing vaccination rate, it will turbocharge the recovery of a business whose cash cow was terribly affected. On the streaming side, the pandemic was a boost in what I consider largely a two-horse race between Disney and Netflix. Each company has its won advantages and strengths. It’ll be super interesting to see how the market will be in the near future.

Review of Walt Disney’s Q2 FY2021 results

There are two main stories regarding Disney: Disney+ as well as other streaming services and their non-streaming segment.

As more and more folks in the US are vaccinated and the CDC relaxed its guidelines, Disney reopened its theme parks and resorts in the last quarter. Traditionally, this segment is the key source of Disney’s profit, but was severely hit by Covid-19. Compared to the prior year quarter, Q2 FY2021 saw revenue from Parks, Resorts, Cruise and Merchandise drop by more than 50%.

Figure 1 – Breakdown of Disney’s Q2 FY2021 Revenue – Source: Disney

Hence, having their physical attractions open is definitely good news to investors. It’s also a testament to the resiliency and health of the business. Its cash cow was hit very hard by the catastrophe that is Covid-19, yet it pivoted successfully to Direct-to-Consumer while waiting for better days to come. In addition, Disney is going to launch an all-new Avengers campus in California on June 4 and allow bookings for its new cruise ship Disney Wish starting May 27th. The Avengers campus, I suspect, will be a big hit to consumers. Thousands, if not millions, love the 10 year story arc with about 23 Marvel movies. As the original cast such as Chris Evans or Robert Downey Jr is more or less out of the picture and the new generation of superheroes are slowly making their way to the scene, fans will cherish a chance to connect physically with their old and new heroes. That’s the power of Disney. They invest a lot of money in creating content and then luring consumers to visit their parks, resorts, cruise lines and buy merchandise. While other streamers can compete with this company on the content front, few, if not none, have the capability and resources to replicate what Disney has on the other part of the equation.

Disney’s Streaming Services

Because Disney+ is touted as the company’s single most important priority, all attention is fixated on the health of the service. At the end of Q2 FY2021, Disney+ has almost 104 million paid subscribers, up from 95 million in the previous quarter. The net add of 8.7 million paid subscribers is much lower than what Disney added in the previous three quarters during Covid. The executives blamed the following for the smaller add:

  • Covid pulled forward subscribers
  • A price increase in two main markets: EMEA and North America
  • No new market launch. The launch of STAR+ in Latin America is postponed to the end of August to leverage major sports events such as the new season of Premier League, La Liga & Copa Libertadores
  • A disrupted schedule of Indian Premier League, India’s national cricket league

On the earnings call, the company reaffirmed its target of 240-260 million paid subscribers on Disney+ at the end of fiscal year 2024. To meet the lower end of that target, by my calculation, Disney needs to have a net add of about 12.5 million subscribers every quarter between now and Q4 FY2024. As you can see above, there are quite a lot of factors that can affect the number of subscribers, but if I have to make a bet, I’ll say that they can do it. There are two reasons. The first one is that Disney+ right now is only available in 31 countries. It’s not even live yet in Asian or LATAM countries where there are a lot of folks. My country alone has 96 million people and 50% of those are between 18 and 54 years of age. There are a lot of spots on the world map where Disney+ can expand its presence. The second reason is that the company lowballed their subscriber target before. It’s likely that they may be doing it again with the current one.

The main criticism of Disney’s current growth strategy is that it relies too much on the low ARPU market in India. Hotstar makes up 1/3 of Disney+ total subscriber base, up from 25% two quarters ago. The low price in India suppressed ARPU of Disney+ from $5.61, excluding Hotstar, to just $3.99, including Hotstar. While ARPU is obviously an important part of a streaming business, it’s equally important to take into account where Disney+ is at the moment. Fans of Netflix usually cite its scale as the main competitive advantage. In other words, Netflix has a cost advantage because it can spread content expenses over many more subscribers (around 200+ million). To negate that advantage of Netflix, Disney+ has to grow its base, but it would need a magic wand to acquire more users and grow ARPU because that’d be virtually impossible.

Disney subscribers, net adds and ARPU
Figure 2 – Disney’s Subscribers, Net Adds and ARPU

Any comparison between Netflix and Disney+ at this stage is very challenging. First of all, Netflix is available in 190+ countries whereas Disney+ is only in 31. When Netflix started, the category didn’t exist and it had to be a trailblazer. But it also means that Netflix didn’t have a fierce competitor like its current version nowadays. Any price it set was essentially the best price at the moment. On the other hand, while Disney+ doesn’t have to create a whole new market like Netflix did, it has to compete against an established and experienced rival that has a major cost advantage. There is a vicious cycle at play here. Netflix’s competitors have a cost disadvantage because they have a smaller scale. The longer that disadvantage persists, the hard it is to plow billions of dollars a year into content. Without content, there wouldn’t be any subscribers, hence, Netflix’s advantage is reaffirmed. As a result, the likes of Disney+ have to prioritize scale over ARPU for the time being, to avoid being sucked into that vicious cycle. Another difficulty lies in the different operating models. Netflix’s content is rarely available in theaters. Its content library is available to all subscribers without restrictions. Meanwhile, Disney+ releases its content in different fashion:

  • Exclusively available to all subscribers without additional charge
  • Exclusively available to subscribers with Premier Access (about $30 per title) for a few weeks before being widely available to all
  • Available first in theaters for a period of time (45 to 90 days) before going to Disney+

The variety in the release strategy may affect the user acquisition to Disney+, compared to Netflix, but who is to say that it doesn’t help Disney generate more money or profit from taking a different path? Disney+ tried the Premier Access with Wulan and a couple of movies afterwards. I reckon that it must have yielded some success so that they decide to keep it moving forward. With an exclusive theater period, Disney is trying to see if the high margin revenue from theater owners are worth suppressing the subscriber base on its flagship streamer. Whether the flexible model employed by the iconic brand or the dedicated philosophy of Netflix will prevail remains to be seen.

Besides Disney+, I am excited about ESPN+. The service has been growing very nicely in terms of subscriber count and ARPU. At 13.8 million subscribers, there is still a lot of upside within the US to go. For sports fans, its content library is very appealing with Serie A, Bundesliga, UFC, Australian Open, US Open, Wimbledon, MLS & College Basketball. The new deals with Major League Baseball to stream 30 games per season till 2028 and with La Liga in an 8-year deal to stream 300+ matches per year in both English and Spanish will absolutely make it more attractive. Since streaming rights need to be negotiated for every geography, it remains to be seen how or if Disney is able to grow ESPN+ out of the US.

Adobe’s impressive performance and Disney flexing its streaming muscles

Disney’s enormous potential in the streaming area

On its 2020 Investor Day, Disney showed everybody that it was going to be a force to be seriously reckoned with in the streaming business in the years to come. The four hour presentation was packed with announcements on upcoming titles, business updates and impressive revised projections. Netflix fans always point to the fact that the streamer won the streaming war by having a much bigger subscriber base than any other competitors. The big subscriber base allows Netflix to operate at a much lower cost advantage. For the same investment of $1 billion in content, a base of 100 million subscribers will lead to a cost of $10 per subscriber while a base of 10 million will result in a cost of $100/user. As each user brings in monthly revenue, a lower cost structure enables a higher profitability which, in turn, enables more money in content creation which, in turn, leads to more appeal to consumers.

Netflix, with 195 million subscribers, enjoys a cost advantage to other competitors. It already got over the peak operating losses and has seen positive free cash flow for the past three quarters, despite spending a massive amount of money on content. I believe none of the other streamers achieved that feat yet. In short, Netflix has an invaluable head start.

Enter Disney Plus. Last year, Disney forecast to have around 60 to 90 million subscribers by the end of FY 2024. They just announced that the number of Disney+ subscribers was 86.8 million as of December 2, 2020. Critics say that Disney reached this number due to a huge subsidy in the Indian market which constitutes 30% of the base now. Well, that’s true, but it’s hard to reach the mass market in a short period of time and keep the price high. You have to take a multi-step approach. Expand the base first, add more value and increase the price.

That’s what Disney is doing now. With more than 86 million subscribers in the pocket, the company is planning 100+ titles per year for the next few years, coming from established brands such as Marvel, Disney, Pixar, Star Wars and National Geographic. At the same time, Disney is addressing the Average Revenue Per User (ARPU) issue with a price hike of $1/subscriber/month in the US and €2/subscriber/month in EU starting March 2021 and with a Premier Access model. The Premier Access model lets subscribers gain first access to select titles before everyone else for an additional fee. A few months ago, Mulan cost Disney+ subscribers an additional fee of $30 in exchange for first exclusive access.

As a result, Disney expects to have around 230-260 million Disney+ subscribers by the end of FY2024. Within one year, they revised the forecast from 60-90 to 230-260 million subscribers for the same time frame. There must have been some sandbagging, but I believe that even the folks at Disney didn’t expect to have such a big leap. The new figure should put Disney+ in the same conversation as Netflix by the end of FY2024 and well ahead of the other streamers. The profitability expectation remains at the end of FY2024, unchanged from the Investor Day last year, even though the legendary company expects to at least double its content cost by FY2024. The same upgrade in expectation is similar for ESPN+ and Hulu

Investor Day 2019Investor Day 2020
Disney Plus
Subscriber60-90 million by FY 2024230-260 million by FY 2024
ProfitabilityFY 2024FY 2024
Hulu
Subscriber40-60 million by FY 202450-60 million by FY 2024
ProfitabilityFY 2023 or 2024FY 2023
ESPN+
Subscriber8-12 million by FY 202420-30 by FY 2024
ProfitabilityFY 2023FY 2023
Source: Disney

Those are impressive revisions, particularly given Disney’s distinct advantages. First, streaming services aren’t the only way they generate revenue and profits. Their Media and Parks segments generate considerable revenue and profit as well, especially Parks. Parks has been hit particularly hard by the pandemic, but once we go back to normal and vaccine is delivered to the public, Disney should have no problem attracting guests back to their hotels, parks and resorts. Even though the other segments don’t directly subsidize the streaming services, having them around definitely helps the company as a whole in terms of profits, revenue and cash flow. Netflix, rightfully worth every accolade for their laser focus, has only one line of business. As long as that line of business thrives, they will enjoy the full benefits of not having to spread resources like Disney. However, on the other hand, a crisis would hit them harder than Disney without any cushion.

Moreover, Disney has so many ways to appeal to consumers. First, they have an extraordinary library of content and brands, ranging from series, films, documentaries and sports. Second, they can always create value out of a bundle such as what they are doing now with a bundle of Disney+, Hulu (ads and no ads) and ESPN+. Another model that can be deployed is Premier Access as I describe above or a theatrical release in which a movie will be available first in theaters and then on Disney+. An example is Black Widow. This takes me to another strength that Disney has. A portfolio of household brands that need no introduction. When somebody mentions Avengers characters or Star Wars, there is little introduction needed. That kind of brand power helps draw viewers regardless of the medium. When Disney releases Black Widow in theaters first, they likely won’t need to persuade Marvel fans to pay to watch. What they may need to persuade them on is whether it’s worth getting into theaters when the pandemic may still be around. This brand power isn’t just limited to consumers with kids. On the 2020 Investor Day, Disney CFO revealed that more families without kids are subscribers than families with kids; which is a very interesting revelation since it was assumed that Disney would appeal parents through content for kids.

In short, I believe the future is bright for Disney’s streamers and the company as a whole. That doesn’t mean that I think Netflix is doomed. The sizeof the market and the consumer behavior should allow these two behemoths to co-exist. As long as other streamers have the financial ammunition to compete, they should have a seat at the table, but this should be a two-race non-zero-sum market. The winners should be consumers who will get more choices and talents, including actors, directors, creators, storytellers and so on, who will be sought after as streamers strive to create quality content.

Adobe’s extraordinary story continues

Adobe may not be as popular as some of its products. It’s the creator of Photoshop, Illustrator, InDesign and PDF. It also owns Behance, the LinkedIn of creative folks. Its less known products include Marketing Solutions, such as Email Marketing, eCommerce and Customer Analytics, and Document Solutions such as eSignatures or Document Intelligence Services. Besides its famous products, Adobe is also known for being the trailblazer in transitioning to a Software-as-a-Service model. The transformation started in about 2011 or 2012, and it has been the case study as well as the envy of established software makers all over. Adobe’s revenue grew at a CAGR of 18% from 2013 to 2020, reaching almost $13 billion in 2020. More impressively, its FY 2020 Operating Income was even higher than its revenue in FY 2014. Additionally, its Operating Margin in FY 2020 was 32%, the highest in the last 6 years.

The transformation was best reflected in Adobe’s subscription. In 2013, only 28% of the company’s top line came from subscriptions which have higher margin and stickiness. In FY 2020, the figure stood at 90%. In terms of CAGR of subscriptions’ absolute dollars, it is an extraordinary 39%.

Among the main business segments, Digital Media is the biggest and certainly the driver of growth at Adobe. Since 2013, Digital Media’s revenue grew by almost 300%. Within Digital Media, Creative and Document Cloud Annual Recurring Revenue more or less doubled in the last 4 years.

While Digital Experience, which includes B2B solutions, faces stiff competition from the likes of Salesforce, Adobe is clearly the market leader with their Digital Media offerings. How many designers or creators in the world don’t have an Adobe product? Which document format can replace the de factor PDF when it comes to official documents? Their Digital Media products, whether it’s Creative Cloud or Document Cloud, are popular among subscribers. According to Adobe’s 2020 Investor Day

  • 75% individual subscribers in 2020 were completely new to Creative Cloud
  • Individual subscribers made up more than half of the Creative Cloud’s revenue
  • 2 billion mobile + desktop devices were installed with Acrobat Reader
  • 75%+ individual subscribers in 2020 were new to Acrobat
  • Mobile IDs were more than 300 million in total as of Q4 FY 2020, with more than 175 million created
  • More than 60% of Creative Cloud ARR is based on All Apps subscribers. An All-App subscription costs $53/month, much more expensive than individual app subscriptions.
Source: Adobe

All these data points show how much customers love Adobe products. As more and more people use Adobe products, it helps the company establish an invaluable network effect. If you are a designer collaborating with other designers and businesses that are used to working with Illustrator and Photoshop, it’s difficult not to use those applications. That’s perhaps the strongest moat Adobe has. There may be better alternatives than their products on the market, but those products don’t have the brand names, the popularity, the established sales channel and the network effect that Adobe has. Once a company can establish this kind of relationship and network effect, its priority should be to continue add values to subscriptions to keep the churn low. In other words, as long as the existing subscriber base doesn’t shrink, Adobe’s revenue will only grow. Any new subscribers acquired will only add to their fortune.

Disclaimer: I own both Disney and Adobe in my personal portfolio.

How did Disney do last quarter and why was Mulan picked for the one-off strategy?

In Q3 2020, Disney reported a drop in revenue of more than 8$ billion, down 42% YoY due to the negative impacts from the Coronavirus. Most of the revenue loss came from Parks, which is historically a reliable source of revenue and profit for Disney. In the most recent quarter, Parks brought in a little less than $1 billion in revenue, compared to $6.6 billion in the same quarter last year. As a consequence, Parks recorded a loss of approximately $2 billion, compared to $1.8 billion in profit in Q3 2019. Despite the challenges that Covid-19 brought onto Disney’s operations, the company actually had a small profit from its operations, if you exclude the $5 billion in impairments.

Figure 1 – Operationally Disney had a surprising small profit before the $5 billion restructuring and impairment charges. Source: Disney

Figure 2 – Parks is very important to Disney in terms of revenue and profitability. Source: Disney

Disney reported that as of 27th June 2020, there were more than 100 million paid subscribers on their platforms, including 8.5 million for ESPN+ (up from 2.4 million from a year ago), 35.5 million for Hulu (up from 27.9 million from a year ago) and 57.5 million for Disney+. On the earnings call on 4th August 2020, Disney’s CEO revealed that the subscriber base for Disney+ rose from 57.5 million 5 weeks ago to 60.5 million. The updated figure means that Disney already surpassed its lower target for 2024, a full four years ahead of schedule. While it’s definitely a good sign, it can be argued that Disney is usually conservative in its forecast and that Covid-19 has been an unexpected boost to its streaming service. It’s also worth pointing out that Disney+ Hotstar, launched in India only up to Q3 2020, made up 25% of Disney+ subscriber base at the end of the quarter.

A major announcement regarding content for Disney+ is the upcoming rollout of Mulan. Disney will make the movie available to Disney+ subscribers at an additional price of $30, meaning that you first have to have an active subscription and pay another $30 on top of it as a one-time fee to see the movie.

This one-off strategy is an interesting move in my opinion. Due to the impacts of Covid-19, Mulan’s schedule premiere has been postponed a couple of times. As the US is still struggling to handle this pandemic, folks won’t visit cinemas any time soon. Hence, Disney either would have to keep delaying the movie’s debut or put it on its streaming service. If the latter is the better option, what is the reason for the additional charge?

Bob Chapek, the CEO of Disney, labeled this move as a test and I tend to agree with him. There are three likely reasons behind Disney’s decision:

  • The company wants to see how much a movie like Mulan can attract new subscribers or entice existing ones to pay more. Making it free on Disney+ is an easy and straightforward decision. Why not using this as a test and getting more revenue, given the situation that we’re in right now?
  • A subscription can be shared with 5-6 people and as we still stay at home most of the time, it’s likely that a movie that charges $30 will be watched by more than one person. Disney is probably testing to see how the $30 price point is accepted by consumers. I mean, if 4 people watch the movie with a new subscription, that’s roughly $10 for each person, almost a movie ticket and they can still have access to Disney’s library for a month. Another point is that consumers are likely to react more positively to a price drop than to a price hike. If $30 is too high and Disney wants to repeat this test in the future at $20, it will likely be better than increasing the test price from $20 to $30.
  • One can argue that Disney is angling for a future permanent one-off strategy as in the one-time charge will give subscribers exclusive early access to blockbusters. However, there are a couple of challenges with that. The first is that Disney has to convince subscribers to pay extra for every blockbuster. A movie such as Endgame may have the drawing appeal, but not every movie will be like that. The second challenge is how Disney would work with theaters once Covid-19 blows over. If Disney’s finest could only be found exclusively on Disney+, what would draw in moviegoers? Movie distribution brings in a significant sum of revenue for Disney. Hence, the company may likely have to deal with this question mark if it decides to pursue a one-off strategy.

In the near future, Disney will be one of the companies wishing for things to go back to normal as quickly as possible. Their streaming service should be fine. They have a lot of geographical footprint to grow into, boosted by a formidable library content, legendary marketing prowess and a household brand name. What they really want to add is feet inside theaters and the walls of their branded parks, hotels or resorts. That’s why they opened up parks in the US to some extent despite the Covid-19 warnings; which I fervently disagreed with. Given how the situation has progressed for the past few weeks, I won’t be surprised that it will take them at least a couple of quarters to regain the Parks business. Nonetheless, the business has shown resilience and I think the bull case for them is stronger than a bear case.

Disclaimer: I own Disney stocks in my portfolio.

Notes from Disney’s Q1 2020 earnings call

Today, Disney announced its Q1 2020 results. There are a lot to unpack as the business is pretty diverse. I am just covering some of the stuff I mainly care about.

Overall, revenue increased 36% year over year. The effect from investments in Disney+ is reflected on operating income which increased only by 9% compared to last year

Parks made up 35% of Disney’s revenue, but more than 58% of its operating income. Parks also provided the largest margin at 32% among Disney’s segments, followed by Media Networks.

Subscribers

  • Disney+: 28.6 million paid subscribers as of 3rd February 2020 from US, Canada, Netherlands, Australia and New Zealand
  • ESPN+ 7.6 million paid subscribers as of 3rd February 2020
  • Hulu has 30.7 million paid subscribers as of 3rd February 2020

Given that Disney publicly set a target of 60-90 million paid subscribers worldwide and of profitability in 2024, it is a promising start to reach the 28-million mark already just a few months after launch. Bob Iger wisely tried to play down any enthusiasm from the figures by citing the inability to point out the reason for the growth and uncertainty in the key international markets where Disney+ will debut soon.

Average Revenue Per User

The dip in ESPN+ and Hulu SVOD APRU was attributed to the bundle that offers Disney+, ESPN+ and Hulu Ad Supported for $12.99/month. Regarding the Hulu APRU, it’s even higher the non-ads subscription of $11.99/month. Christine McCarthy, Disney’s CFO, had the following comment:

The ad supported, the product is priced at $5.99. And but the ad-supported part of the equation makes the ARPU come out even higher than the ad-free. Most of the subscribers subscribe to the ad-supported. So that’s a good balance of the ARPUs when you stack them up next to each other.

Source: Atom Finance

Regarding the APRU of Disney+, since the service is offered at different pricing tiers including the promotion with Verizon, the 3-year plan last year, the bundle and full price, it’s difficult as to what to make out of the figure. Below are a few things from the earnings call:

  • 50% subscribers came directly from disney.com
  • Bob Iger mentioned “20% of those subscribers” came from Verizon. The comment in the earnings call wasn’t clear, but he clarified it in this interview with CNBC
  • Most subscribers came from the US
  • Conversion from free-to-pay and churn rates were better than what Disney had expected
  • No significant churn after Mandalorian Season 1 ended

Other notes

  • “It was 65% of the people who watch Mandalorian watch at least 10 other things”
  • Each Disney+ subscriber spent 6-7 hours every week on the service
  • 18-22% guests to parks were international guests
  • “Attendance at our domestic parks was up 2% in the first quarter, and per capita guest spending was up 10% on higher admissions, merchandise and food and beverage spending. Per room spending at our domestic hotels was up 4%, and occupancy was 92%. So far this quarter, domestic resort reservations are pacing up 4% compared to this time last year, and booked rates at our domestic hotels are currently pacing up 10%.”
  • The fight between McGregor and Tyrone brough “1 million pay-per-view purchases and 0.5 million new subscribers”

Disclosure: I own Disney stocks in my personal portfolio

First look at Disney Plus

Disney+, the biggest initiative and priority in the near future of the iconic company, went live today in the US and Canada. I have been using it for 2-3 hours and below is the summary of my experience so far.

The sign-up is pretty standard and smooth. Nothing major. Even though there was some reported difficulty in finding the app on Apple Store

Fairly expectedly, the app encountered some technical issues which users widely reported here. I have had my fair share as well

That led to Disney+ Help twitter page issued the statement below

In addition to the technical mishaps, I was a bit frustrated by the User Interface. While you can download episodes from the mobile app, I couldn’t find the feature on the browser version. I am not sure if that was intended to limit the downloads, but I was under impression that it was possible.

At the end of a movie, you are presented with a suggestion like the screenshot below, but there is no way to get back to the homepage or the category page

There is an “Extras” tab under the main banner of a movie/episode. They can be never-seen-before clips that viewers will appreciate. However, they could have made the tab more visible or added it to the end, in my opinion

There are some Extras clips on the mobile app that are not available on disneyplus.com.

At the bottom of the website, there is a tab called “Interest-based ads”. On that page, you can choose to opt out of behavioral targeting by ads companies on disneyplus.com

In terms of content, I am excited about National Geographic and Marvel. But to succeed, I do think Disney Plus has quite a long way to go and much to improve if they want to augment user experience

Disclaimer: I own Disney stocks in my personal portfolio

Mixed Feelings from Netflix’s Earnings Report

Netflix released its earnings yesterday. There are causes for optimism and concern from what I have seen.

Important metrics improved YoY significantly

This quarter, Netflix added 517,000 domestic paid subscribers and more than 6.2 million international paid members, bringing the total subscriber count domestically and internationally to more than 60.6 million and 97.7 million approximately.

Contribution margin for domestic and international streaming is 41% and 20% respectively, resulting in the margin for streaming to be around 30%. Contribution margin of Domestic DVD is around 61%. Contribution margin represents what is left of revenue after all the variable costs to pay for fixed costs and to generate profit.

On a year over year basis, revenue, operating income and paid memberships saw remarkable growth for a company this size

Cause for concerns

Even though domestic paid memberships increased, Netflix missed its own expectation by almost 300,000, making it the second consecutive quarter that it did so. The company blamed the miss on the higher pricing elasticity than expected

That’s really on the back of the price increase. There is a little more sensitivity. We’re starting to see the – a little touch of that. What we have to do is just really focus on the service quality, make us must-have. I mean we’re incredibly low priced compared to cable. We’re winning more and more viewings. And we think we have a lot of room there.

But this year, that’s what’s hit us. And we’ll just stay focused on just providing amazing value to our members in the U.S. And I think that gives us a real shot at continuing to grow net — long-term net adds on an annual basis. But we’re going to be a little cautious on that guidance and feel our way through here.

CEO – Reed Hasting in Earnings Call (Per Seeking Alpha)

I saw a sentiment floating around on Twitter a while back that argued that Apple TV+ and Disney+ aren’t really competitors to Netflix. I mean, to some extent, they may differ a bit from Netflix, but if we want to talk about competing for viewers’ attention, time and disposable income, how can they not be? Sure, boats move different from trains, but if patrons can choose either to go from point A to point B, how can they not compete with each other? Now Reed Hasting admitted the challenge from other streamers, especially Disney+

From when we began in streaming, Hulu and YouTube and Amazon Prime back in 2007, 2008, we’re all in the market. All 4 of us have been competing heavily, including with linear TV for the last 12 years. So fundamentally, there’s not a big change here. It is interesting that we see both Apple and Disney launching basically in the same week after 12 years of not being in the market. And I was being a little playful with a whole new world in the sense of the drama of it coming. But fundamentally, it’s more of the same, and Disney is going to be a great competitor. Apple is just beginning, but they’ll probably have some great shows, too.

But again, all of us are competing with linear TV. We’re all relatively small to linear TV. So just like in the letter we put about the multiple cable networks over the last 30 years not really competing with each other fundamentally but competing with broadcast, I think it’s the same kind of dynamic here.

Source: Seeking Alpha

Chief Product Officer Gregory Peters made an important point below

I would say our job and then what we think our pricing for a long-term perspective is continue to take the revenue that we have that our subscribers give us every month, judiciously and smartly invest it into increasing variety and diversity of content where we really want to be best-in-class across every single genre.

And if we do that and we’re successful in making those investments smartly, we’ll be able to continue to deliver more value to our members. And that really will enable us to, from time to time, ask for more revenues so that we can continue that virtuous cycle going

Source: Seeking Alpha

Quite an important “if” condition there. In short, Netflix borrows capital to invest in content to the tune of billions of dollars every year and hopes that their subscriber base growth and revenue will keep enabling them to do so. In essence, every streamer will do that. Every single one of them needs to churn out quality content to convince viewers to choose their service. Failure to produce quality content to justify expensive investments will be costly for these streamers.

For Netflix, the stakes seem to higher. Other competitors have additional revenue streams apart from their streaming service. Netflix essentially relies on their subscription revenue. As this quarter shows, the price elasticity already has some negative effect, and it’s BEFORE other heavy-marketed competitors such as Apple TV+ and Disney+ debut in 2-4 weeks. The new challengers price their services at much lower points than Netflix. The room to increase price to recoup their investments faster is getting smaller. I do think a price hike will negatively affect Netflix.

Some may say: oh Amazon kept investing heavily in their early days as well and Netflix can be the same. They are not, as I wrote here. Their free cash flow continues to be in the red while Amazon was in the black for years.

The expensive bidding war for content may play into Netflix’s favor. Their huge subscriber base enables them to spread the cost much better than competitors, especially new ones that have to acquire subscribers from scratch. Hence, it can be argued that Netflix will be one of the only few standing after the dust settles. It does make sense to think about the streaming war’s future that way. As does it make sense to think that there is a possibility that the game Netflix is playing may not work out for them, given the intense competition, the decreased price inelasticity, the huge debt they have incurred and the continuous negative free cash flow.

I think that we will have more clues around the next earning call or two as we’ll see how Netflix will fare after the arrival of Apple TV+ and Disney+. Even then, we won’t know definitively who will win in the end. Fascinating times ahead.

Weekly readings – 19th October 2019

Amazon published their official position on a few social issues

Global electric car sales and market share, 2013-18

Source: IEA

The poor in America pay a higher tax rate than the rich. I guess the tax cut is doing what it is supposed to? (I am being sarcastic)

TurboTax’s decade-long war to prevent Americans from filing taxes online for free. I was angry when I read this article. Billions of hours and dollars are wasted every year on filing taxes and only a handful of people benefit at the expense of millions

To buy a phone in China, a face scan will be required as of 1st December 2019

Bob Iger’s massive bet on Disney’s future.

Sleep Deprivation Shuts Down Production of Essential Brain Proteins. The sleep deprivation pandemic is real in our society and there doesn’t seem to be signs of its abating.

How Amazon is redefining the expensive and wasteful process of returns

Boeing lead pilot warned about flight-control system tied to 737 Max crashes, then told regulators to delete it from manuals. Frankly, this is just disgusting. Boeing is one of the two plane manufacturers that dominate the sky and it still has this kind of behavior

Book: The Ride of a Lifetime: Lessons Learned from 15 Years as CEO of the Walt Disney Company

Admittedly, before reading this book, I already had vested interest in Disney. I am fascinated by the transformation that the company has been going through and I own its stock in my humble portfolio. Nonetheless, it is one of those books that I have read with more focus than I have others.

The book offers interesting insights into the transformation Disney had to go through to revive its Animations and fend off the disruption in the Entertainment industry. Through the words of Bob Iger, the delicacy of M&A negotiations is put on display, including prices paid for companies, the process to get the sellers to sell and the politics that come with acquisitions. To a fan of business strategies and technology, it’s fascinating to read.

One of the things I like about the book is the relationship between Bob Iger and the late great Steve Jobs. Bob repeatedly mentioned his admiration and love for Steve, even long after the late co-founder of Apple died. If you live your live so well that people fondly remember you long after you die and that you change lives while you live, it’s a life magnificently lived. Almost 10 years since his death, Steve is still an inspiration to me.

Bob’s account is an example of how patience and hard work can be rewarding in the long run. He used to be a guy grabbing coffee for Frank Sinatra. In his 50s and 60s, he ran one of the most iconic and influential companies in the world. He also gives away his leadership lessons which I will quote below.

All in all, if you are looking for an easy and good read, you won’t be disappointed with this one.

Decades after I stopped working for Roone, I watched a documentary, Jiro Dreams of Sushi, about a master sushi chef from Tokyo named Jiro Ono, whose restaurant has three Michelin stars and is one of the most sought-after reservations in the world. In the film, he is his late eighties and still trying to perfect his art. He is described by some as being the living embodiment of the Japanese word shokunin, which is “the endless pursuit of perfection for some greater good”

When Iron Man 2 came out, Steve took his son to see it and called me the next day. “I took Reed to see Iron Man 2 last night” he said “It sucked”

“Well thank you. It’s done about $75 million in business. It’s going to do a huge number this weekend. I don’t take your criticism lightly, Steve, but it’s a success and you’re not the audience” (I knew Iron Man 2 was nobody’s ida of an Oscar winner, but I just couldn’t let him feel he was right all of the time

Later, after we’d closed the deal, Ike told me that he’d still had his doubts and the call from Steve made a big difference to him. “He said you were true to your word” Ike said. I was grateful that Steve was willing to do it as a friend, really, more than as the most influential member of our board. Every one in a while, I would say to him, “I have to ask you this, you’re our largest shareholder” and he would always respond, “You can’t think of me as that. That’s insulting. I’m just a good friend”

After the funeral, Laurene came up to me and said, “I’ve never told my side of that story.” She described Steve coming home that night. “We had dinner and then the kids left the dinner table, and I said to Steve, ‘So did you tell him?’ ‘I told him’. And I said, ‘Can we trust him?’ ” we were standing there with Steve’s grave behind us, and Laurene, who’d just buried her husband, gave me a gift that I’ve thought about nearly every day since. I’ve certainly thought of Steve every day. “I asked him if we could trust you” Laurene said. “And Steve said, ‘I love that guy’ “

No matter who become or what we accomplish, we still feel that we’re essentially the kid we were at some simpler time long ago. Somehow that’s the trick of leadership, too, I think, to hold on to that awareness of yourself even as the world tells you how powerful and important you are. The moment you start to believe it all too much, the moment you look yourself in the mirror and see a title emblazoned on your forehead, you’ve lost your way. That may be the hardest but also the most necessary lesson to keep in mind, that wherever you are along the path, you’re the same person you’ve always been

Value ability more than experience, and put people in roles that require more of them than they know they have in them

“Avoid getting into the business of manufacturing trombone oil. You may become the greatest trombone-oil manufacturer in the world, but in the end, the world only consumes a few quarts of trombone oil a year!” He was telling me not to invest in small projects that would sap my and the company’s resources and not give much back.

At its essence, good leadership isn’t about being indispensable; it’s about helping others be prepared to step into your shoes – giving them access to your own decision-making, identifying the skills they need to develop and helping them improve, and sometimes being honest with them about why they’re not ready for the next step up

Technological advancements will eventually make older business models obsolete. You can either bemoan that and try with all your might to protect the status quo, or you can work hard to understand and embrace it with more enthusiasm and creativity than your competitors.