Dan Loeb's Disney Activist Stance Gets Mixed Reviews

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Some on Wall Street say that the studio should increase Disney+ original content, as the activist investor suggests, while others disagree. Says one: "Quality underlies their value proposition to consumers, not quantity."

Wall Street experts are giving mixed reviews to activist investor Dan Loeb's letter to the Walt Disney Co., in which he pushed for dividend payments to be instead used to boost streaming content.

The mid-week news that Loeb, the founder of hedge fund Third Point, suggested the Hollywood giant spend $3 billion that has traditionally gone into its dividend per year on more content for its streaming service Disney+, earned praise from those who want Disney to become more like Netflix. But others argue the Mouse House can keep growing its streaming subscribers, while also bringing back its dividend, which it suspended in May amid the coronavirus pandemic.

Disney at an investor day last year said it had earmarked about $1 billion for original content for Disney+ in 2020, which would more than double over time.

"By reallocating a dividend of a few dollars per share, Disney could more than double its Disney+ original content budget," Loeb argued in his letter to Disney CEO Bob Chapek. "Beyond bringing additional subscribers onto the platform, increased velocity of dedicated content production will deliver several knock-on benefits spread across your existing base including elevated engagement, lower churn, and increased pricing power."

LightShed Partners analyst Rich Greenfield highlighted in a Thursday note to investors that "we have been advocating for Disney to move far faster into SVOD over the past year, including spending far more on content, the creation of one service, pivoting away from theaters and putting all their TV content onto streaming first versus broadcast/cable TV."

He argued that "while structurally challenging and financially painful in the short-term, especially with higher than normal [debt] leverage today, the opportunity appears obvious when you see the scale of Netflix versus Disney's studio financials."

Concluded Greenfield: "Disney's decision to push all of their major films beyond Soul into mid- to late 2021 was one of the catalysts for us to get more bullish on Netflix, as it become clear they are not ready or willing to replicate the Netflix model. ...  Ultimately, we suspect new management is needed at Disney to make the difficult decisions needed to reposition the company for the future."

Sanford Bernstein analyst Todd Juenger in a Friday report shared a similar view that the firm needs more original content investment for the streamer. His response to investors' question if Disney should boost its spending on streaming content: "Since the revelation of the Disney+ plan, we have consistently maintained a view that Disney should, or would be forced to, increase their content investment."

But Juenger also explained: "Our theory has been that Disney+, as it was laid out in the plan/guidance, is primarily a library product, with a smattering of new originals. Especially in the early days of the service, the plan was to have only about a dozen originals in year 1. COVID has of course made that even less."

The analyst noted that Disney's plan calls for 50 originals in year 5, "or about one per week. But that is spread across 5 brands (Marvel, Lucasfilm, Pixar, Disney Animation, National Geographic), so for any given brands, it's only about 10 per year, less than once a month that consumers will get something new. And it won't always be The Mandalorian. It will also be Behind the Scenes Making of The Mandalorian."

How does that shape up with Netflix? "For reference, in the marketplace, rightly or wrongly (we strongly believe "rightly"), Netflix will be offering essentially one new original per day, across the full conceivable spectrum of genres," Juenger said. "Our concern is whether Disney's product plan will be enough to attract and retain anything but the most core, hardcore fans of those brands, and also how much pricing power Disney will have with that content mix. We believe a more ambitious new original content strategy, while still limited to the brands that define Disney+, will provide a good return on investment mostly by increasing the usage of the product among its core customer base, which should decrease churn and improve ability to raise price."

Juenger and Greenfield have also both been in favor of Disney consolidating its three streaming services – Disney+, Hulu and ESPN+ – into one, which Loeb also advocated in his letter. They argue that would provide a broadened offering for consumers. "The winning SVOD services will be those that take advantage of global scale to drive the most value to the consumer (quantified by billions of dollars of content spend, on the highest value forms of content), at the lowest unit price to the consumer," Juenger explained. "Netflix can deliver $20 billion of content to a consumer for $12 per month and have the financial model work brilliantly, because we expect they can attract 300 million, 400 million, 500 million or more global subs over time. With Disney's [streaming services] split over multiple brands, the same scale doesn't work, so the consumer value proposition will struggle to compete."

CFRA Research analyst Tuna Amobi, meanwhile, suggested there is one misconception in Loeb's letter that Juenger also touched on. Amobi tells THR that Loeb implies that "the choices for Disney are mutually exclusive at this time, much like walking and chewing gum, which isn't necessarily reflective of the company's present financial condition."

He adds: "Despite some near-term liquidity pressures for Disney – theme parks, consumer and some ads, content businesses – due to the pandemic, we continue to view this situation as very manageable at the corporate level, even if the dividend suspension is sustained a bit longer."

Amobi also feels that the Hollywood powerhouse has an advantage when it comes to figuring out how much to pour into additional streaming content. "While it's clear Disney needs to significantly increase its investments in original content to keep pace with its streaming competitors, its huge cache of library content – film and television – should provide the company with a major head start," he argues.

Meanwhile, Cowen analyst Doug Creutz believes Loeb takes the wrong approach to analyzing streaming success. "Since Disney+ was announced, we have consistently believed it has a good chance of becoming a substantial, profitable business for Disney because of the strength of the Disney brand and its attractiveness for families, Disney's valuable library of evergreen content and Disney's demonstrated ability to produce high-quality marquee content using its highly valuable intellectual property," he wrote in a report. "Very impressive first-year subscriber growth at Disney+, despite relatively little new proprietary content, in part due to COVID-19 related production shutdowns, appears to bear out our thesis."

One of the key reasons has have been bullish on Disney+ is that "we believe that the service can reach significant scale without overwhelmingly high content spend, due to the quality of Disney's evergreen library." Explains Creutz: "This suggests the service could operate at significantly higher margins than competing services that rely on heavy ongoing investment in average quality content to combat churn."

Creutz's basic "experience," as he called it, leading him to that thought is this: "The vast majority of value creation in any media business – whether TV, movies, music, video games, or OTT video – comes from evergreen properties that continue to generate significant value long after the costs of production are amortized off."

In comparison, Netflix is "approaching 200 million subscribers and still generates negative free cash flow," the analyst said. Even though it has not had "a lot of opportunity to create evergreen franchises," Creutz said "their strategy of canceling shows after just a few seasons would tend to suggest that harvesting high-quality evergreen intellectual property over decades-long time horizons is not their strategy."

Creutz's conclusion is that much more than the amount of produced content for streaming, the game is about "quality of content, and the price/value proposition."

Hal Vogel, CEO of Vogel Capital Management and a former Wall Street entertainment analyst, tells THR he also isn't on board with Loeb's thesis, even though some on Wall Street lauded it for being presented in a more conciliatory tone than typical approaches by activist shareholders, including Loeb's past proposals for the likes of Sony, where he renewed his call for a spin-off of its media and entertainment businesses early this year, arguing that they can "stand alone."

"I very much agreed with Loeb when he went after Sony," Vogel said. "Too bad it didn't work out. On Disney, though, I believe this proposal won't work either. They've already cut the dividend [temporarily]. So what? The stock is still up a lot since March and even through a rough earnings report. And just because the value per sub for Netflix is so large doesn't tell you anything except that if Netflix stock falls, so does its value per sub. It doesn't mean that Disney or HBO Max values per sub will rise to the Netflix level, as Loeb apparently assumes."

Vogel even warns: "Pouring more money into streaming is, in my opinion, a loser's game for all concerned. There are several reasons for this point of view. First, if Netflix and Peacock and Warner and others are pouring so much money into this, that raw material – writers, directors, actors etc – creative cost rises sharply. Next, the competition for new unknown content is always great old content, of which there are many thousands of hours and titles. To get recognition for new content, everyone has to spend lots of money on marketing."

So how will the Loeb appeal to Disney end? Some expect Disney management was planning to increase its Disney+ original programming spending anyway.

Creutz said that a planned, but still undated investor day will likely see Disney "announce increased spending at Disney+, which will effectively push out profitability at a given subscriber level relative to what they originally proposed last April. ... However, we think they will stop significantly short of what Loeb is suggesting, in part because quality content takes more than just money to produce, and because we believe Disney understands quality underlies their value proposition to consumers, not quantity."

What if management went along with Loeb's proposals? Said Creutz: "We do recognize that Disney announcing a plan similar to what Loeb is suggesting might help the stock price in the near term, as it would push the company closer towards a pure-play [streaming] entity, which in the current market environment might result in a bigger premium."