Pebble 2023 Theme: Disney Finds Itself Trapped Between Declining Cable & More Costly Streaming
Someone finally called Disney out.
Even more incredibly, the challenger may have got away with it. Both these facts raised eyebrows and reset expectations around the country.
In the end it was probably not too surprising that that someone was "the Cable Cowboy" himself, John Malone.
John Malone is a long time critic of Disney and is currently on the board of Charter which is a cable and broadband provider. In early September Disney was forced to pull their content from Charter's 15 million cable subscribers in an escalation of a long running dispute over the fees Charter pays (or in this case was refusing to pay) to run Disney's content.
In short, Charter said "no mas" to Disney's new contract demands. In response Disney had no choice but to remove their shows from nearly 13% of America's cable subscribers. It is not unimportant that these subscribers are concentrated in New York, Los Angeles and the Dallas area. These are huge media markets and also full of the rich and powerful audience that Disney will not want to anger for long.
This was an unprecedented move by a cable company and though the dispute has now been resolved and the channels are back on, this isn't over. More importantly than the next salvo, is the fact that it is a very revealing episode about some of the seismic shifts going on under the surface in the business of delivering media and entertainment into people's homes.
This wasn't just a business negotiation that got a little out of hand. It was also a perfectly timed corporate sneak attack coming at the very start of the College and NFL football season and right as Disney's ESPN was hosting the very end of the US Open tennis tournament.
Outrage comes nowhere close to the reaction from the red blooded sports fans who were all keyed up for the return of the American gridiron after 7 long months without.
The most accurate parallel might be young children discovering Christmas was canceled but only on Christmas morning itself. "Total meltdown" doesn't even come close to describing it.
Now, these types of "carriage disputes" actually occur pretty frequently but this was both more serious and, more significantly still, had an unusual outcome.
The reason?
Disney caved.
Disney received the higher fees they were looking for their content but also made a key concession that Charter had long demanded:
The House of Mouse agreed to package their streaming service, ESPN+, for any Charter customers with their cable bundle for free. This was something they were very reluctant to do.
Why did Disney cave then?
In short, the television cable business has radically changed and not for the better.
The longer version is that, ironically, Disney has lost a lot of leverage as online streaming has grown and companies like Charter have come to value the internet side of their business far more than the cable portion. In the irony of ironies, the deterioration of cable as a business has meant that cable companies can better dictate terms to the content providers.
In other words, this was a reversal of the normal way of doing business. The price taker became the price maker.
Additionally and very crucially, in John Malone and Charter they finally met an opponent that brave enough (or crazy enough) about the consequences of infuriating their customer base, at least temporarily.
Typically, cable companies have moaned and gnashed their teeth about the prices they pay to content providers like Disney. In the end though, the house that Walt built had a tough choice: either pay the going rate for live sports or suffer without.
But that has all changed as Charter's AND Disney's business has been revolutionized by the advent of high speed internet.
For Charter, what matters these days is their broadband internet business not their cable subscriptions. They know that, over time, cable customers will keep either dying or migrating to online only via the "cord cutting" phenomenon.
For Disney, they are also get that betting on the decline traditional cable and are, of course, building up their own competing streaming service in Disney+.
BUT the key difference is that Disney has been double dipping. They have been charging Charter and other cable companies for their content and also charging the same customers to subscribe for their online content.
Nice work if you can get it!
There are a few reasons this has occurred:
For years as "cord cutting" has gathered momentum Disney discovered they could nonetheless charge Charter and other cable companies full freight.
In fact, Disney made $2 billion from their cable content business and directed those profits explicitly to building out their streaming platform, Disney+.
Lastly and even more insultingly, Disney had the gall to move some of their best content off of the cable channels and onto their separate streaming service.
i.e.: if you want to watch your usual show X, you now need to sign up for ESPN+ or Disney+ in addition to your cable package.
Come again?
Essentially, Disney (and other content providers) have been hitting Charter and other cable providers with high (and rising) prices for their shows and movies while at the time setting up a competing online service and stuffing it with the best stuff.
It isn't just Disney to be fair. Time Warner does the same with HBO+, NBC Universal does the same with Peacock and CBS does the same with Paramount+. The difference might only be one of degree: Disney is bigger and has better content and a more sophisticated online operation.
The content companies obviously loved this. Who doesn't love extra normal profits and double dipping? It is the stuff that capitalists dream about.
The cable companies however, have been furious for years. They have watched their subscribers ebb away via cord cutting and, even worse, sign up for the cheaper and heavily promoted streaming services from the same content providers that then start removing their best content from cable to online only.
It is no surprise why John Malone has been so strident in his criticisms.
For context, as recently as 2018, Charter had nearly 17 million cable customers. That number has now shrunk to well under 15 million. The company still generates several billion dollars of free cash flow annually but the overall trend is clear: the business is dying.
Why does this matter?
There a few implications:
The biggest one is the age of super-profits for entertainment content companies is over.
This is what makes the current Hollywood strike so interesting. No doubt the talent - and especially the people behind the talent - should make more and get paid fairly for making content in an age of streaming.
But the profits of many studios have been severely flattered by years of double dipping with Disney as the most accomplished and egregious example.
The next implication is that Disney is caught in a tough spot as a business.
The House that Mickey built is trapped between the rock of cable providers with sudden leverage and the demands of actors, screenwriters and "the talent" for a bigger slice of the streaming pie.
That doesn't mean that Disney will go bankrupt, of course, just that their businesses are going to be far less profitable. That makes it a less attractive stock to own until, that is, they suddenly become an attractive company to takeover. Could all of this end with Disney selling itself?
This brings us to the last and all important question of:
Who will benefit from all this? Who might either buy Disney or simply act as a better gateway for their excellent content?
Almost certainly, big US tech companies.
That is who is waiting in the wings. No doubt they are enjoying this thoroughly. The cash rich giants in Cupertino and Redmond and Seattle don't just plan on outcompeting Disney for online streaming customers but also will likely soon outbid the likes of Disney or TimeWarner or NBC Universal for very valuable legacy sports content.
i.e.: Thursday Night Football is just the start of sports being streamed online. the NBA, tennis, baseball, F1 races, UFC Mixed Martial Arts, you name it.
The big technology firms like Apple and Amazon have plenty of excess profits to pay and it won't be long until some iconic sports competition is mostly streamed on an online app controlled by a big tech firm. It won't yet be the Super Bowl but it may not be long till either the weekly NBA contest or Monday Night Football or perhaps both are streaming only.
That is what happens when you are greedy and short sighted as the like of Disney have. You get fat and lazy and eventually someone bigger and meaner comes along and eats your lunch. It is a tale as old as America.
To conclude, last week we provocatively argued that it would be better to just buy Nvidia rather than try and partake in the Arm IPO as a retail investor. This week we would like to commit another seeming heresy by concluding that it might be time to exclude Disney from your portfolio at least for a time.
Minnie, Mickey, Woody, Buzz Lightyear and especially Sebastien and all 101 Dalmatians (a personal favorite) are still great but Disney's profit won't be and that will quickly flow through to a multi year challenge for the stock.
That isn't our only outlandish opinion this week either....
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