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Morningstar | Disney Posts Weak 3Q; Management Focused on Fox Assets and Direct-To-Consumer Efforts

Disney missed expectations for its fiscal 2018 third quarter as revenue and operating income fell just short of Street expectations, but revenue came in line with our lower projection. The studio segment continues to outperform even with the Solo movie disappointment as Avengers: Infinity War exceeded $2.0 billion in global box office and Incredibles 2 will likely soon become the highest grossing Pixar film. CEO Bob Iger appears focused on the Fox media assets and the firm's direct-to-consumer efforts as he used his prepared remarks to address these two potential avenues of growth for Disney. We are maintaining our wide moat rating and our fair value estimate of $130.

Revenue for the quarter increased 7% year on year to $15.2 billion. Media networks revenue was up 5% due to growth at both cable networks and broadcasting segment. Affiliate fee revenue was up 5% in the quarter as higher rates continue to offset the 2% decline in subscribers. Disney has a number of distribution renewals over the next two years which will be a good test of the strength of ESPN. The subscriber decline has decreased from the 3% quarterly subscriber loss level of the last several quarters. The ad revenue at broadcast networks was up 3% as higher pricing offset lower impressions due to ratings. Management noted that scatter pricing is 23% above the upfront rates as we believe the ABS stations are benefiting from competitive primary races. Parks and resorts remains an area of strength with 6% growth despite only one week of Easter occurring in the quarter versus two last year. While domestic attendance was only up 1%, per capita spending growth of 5% was impressive as was the per room spending growth of 8%. Revenue at the studio segment improved 20% due to a strong theatrical quarter along with growth in television distribution. EBITDA margin  for the firm fell by 90 basis points to 30.3% as the revenue growth was more than offset by increased marketing and programming costs.

As we noted above, management is trying to shift investor focus to the potential growth from both the Fox media assets and the DTC efforts. With respect to the Fox media assets, Iger provided some of the first plans for specific properties such as FX and Fox Searchlight. Disney plans to invest in the FX brand and to increase the content spend to help the DTC offerings. We expect the new FX shows to be earmarked for the more adult-orientated DTC offering, Hulu, which has had some success with original content but lags its larger competitors like Netflix and Amazon Prime Video, both of which are investing heavily in original content. It also appears that Disney will use FX in a similar manner to Fox, keeping the cable network as its primary prestige platform for scripted shows. We note that while FX has been surpassed by Netflix in terms of Emmy nominations, the platform still garnered the fourth-most nominations in 2018 and the third-most in 2017. While some observers thought that Disney would shut down Searchlight as the firm has largely abandoned the prestige film market, Iger looks set to continue to invest in the studio's theatrical business. We expect Searchlight to also support the Hulu original content push as Netflix has continued to invest in prestige films.