The Walt Disney Company (DIS): Part 2
Parks, ESPN, Culture, and Valuation
This report was written by Luke Emerson and edited by Value Punks. Luke is a brilliant analyst. We believe he has written THE deep-dive on Disney. If you or someone you know is looking for an analyst please reach out to Luke at Luke.Emerson.CFA@gmail.com
We hope you enjoyed the first part. Following its release, Disney's stock surged by approximately 15% (a correlation that's hard to ignore!), though it has since seen a slight pullback. We attribute this rise partly to the double-digit profitability guidance for its streaming operations provided in the quarter, along with the blockbuster announcement of a sports streaming joint venture between Disney, Fox, and Warner Bros. Discovery. Despite the recent uptick, we remain confident in Disney's potential for long-term outperformance.
A quick recap of our conclusions from Part 1:
The Disney Entertainment division is showing signs of stabilization, with management acknowledging past errors and actively implementing corrective measures.
The decline in the linear segment is concerning, yet the Charter agreement and re-bundling of Disney's services (with other streamers following suit) create a synergy between streaming and linear platforms, expanding the reach of the former while slowing the decline of the latter.
Disney's streaming hand is underappreciated with the (largely) untapped potential of its bundled offerings, ongoing platform integration, and advanced advertising technology.
Disney has yet to fully leverage its unparalleled portfolio of broadcasting rights for live sports in streaming, which could significantly enhance subscriber growth, engagement, and profitability.
The income statement highlights notable inefficiencies. As Disney continues to scale and streamline its operations, the division's profitability is expected to significantly improve. The anticipated crackdown on password sharing in 2024 is also expected to bolster overall profitability.
This report, Part 2, will cover:
The unique value of Disney Parks and Resorts, and why the market is likely underappreciating the potential of the $40 billion earmarked for incremental capacity over the next decade.
The issue of whether Disney has a "parks problem," including concerns about its pricing strategies.
The future of ESPN and the potential for technology or league partnerships.
The impact of Big Tech's entry into sports media and the upcoming renewal of NBA broadcast agreements.
The cultural implications of the "Bob swapping"—Bob Iger's return—and an analysis of the ongoing activist investor situation.
A sum-of-the-parts DCF analysis, outlining key drivers, risks, and mitigants to the investment thesis.
And more.
Parks, Experiences, and Products (37% of FY2023 Revenue)
“Disneyland is an experience involving many moving parts in harmony, like an orchestra. Everything has to be tuned, what you hear, what you smell, what you see, how you see it, the speed at which you assimilate all of that, just like a film, is choreographed.”
– Marty Sklar, the late creative executive, from “The Imagineering Story” (2019)
While watching his daughters enjoy a merry-go-round at Griffith Park, Walt Disney conceived of a place where adults and children could have fun together. While the company excelled at storytelling, venturing into the design and operation of a theme park was unchartered territory. Nonetheless, the project broke ground in 1954, with a hefty investment of $17 million (equivalent to about $155 million today) — a gamble that would have led the company to bankruptcy had it failed.
Disneyland's opening day on July 17, 1955, was broadcast by none other than ABC, which deployed 29 cameras to document the historic occasion — far surpassing the previous record of seven cameras for a live event. The broadcast drew an audience of 90 million across the U.S., setting yet another record.
More than 28,000 people attended the event, nearly triple the park’s official capacity, due to ticket counterfeiting and fence-jumpers. This, coupled with many operational mishaps, prompted the media to crown the event “Black Sunday.” Yet, the public could see that Disneyland was unlike any other place on earth.
"Average working-class people were able to experience a cruise through the exotic jungles of the world, take a romantic journey aboard an authentic stern-wheeled stream riverboat, fly over London as Peter Pan, or even hear the sharp cry of a steam whistle as an 1800s locomotive hauled happy visitors around the magic kingdom."
– The Imagineering Story
Within 90 days, the park’s one millionth passed through the turnstiles, and after a few years, was attracting five million guests annually. Walt, reflecting on the park's conception, said:
“A picture is a thing that once you wrap it up and turn it over to Technicolor — you’re through. Snow White is a dead issue with me. I wanted something live, something that could grow. The park is that. Not only can I add things, but even the trees will keep growing. The thing will get more beautiful every year. That’s why I wanted that park.”
Walt Disney passed away before the opening of his ultimate project, Walt Disney World Resort in Orlando, in 1971. In the years after his death, the Imagineers continued to add new attractions, refresh old ones, and spread the magic around the world with new resorts in Tokyo (1983), Paris (1992), Hong Kong (2005), and Shanghai (2016).
Overview
Disney's Parks, Experiences, and Products (DPEP) division stands as a cornerstone in the company’s asset portfolio. The division encompasses theme parks, resort hotels, a cruise line, guided tours, merchandise, gaming, and publishing.
These assets both augment the returns and lower the break-even on content investments. Their record financial performance is particularly noteworthy against the backdrop of a challenged studio arm and unprofitable streaming operations.
The crown jewel of the division is, of course, the theme parks. Needless to say, the value of these properties transcends their financial contribution: how does one assign a value to a child's awe upon encountering their favorite Avenger, or the thrill of piloting the Millennium Falcon? For adults, they offer a retreat from the mundane, reigniting a sense of youth and wonder — a rare occurrence under any circumstances, let alone at such scale.
Disney’s Magic
“What we love as storytellers is not showing you everything at once. We prefer to give you just a taste — a moment where you’re like, 'Oh my god, look at this building — this is the droid shop, it’s incredible!' Then, as you turn the corner, we present this amazing view — almost like a cinematic reveal. We’re excited because this isn’t the only one. Every time you turn a corner, we paint another reveal for you. We’re always leading you through the scene towards a destination you haven’t seen yet.”
- Chris Beatty, Imagineer
What sets Disney's theme parks apart is their exceptional level of immersion, a result of three key elements: storytelling, meticulous attention to detail, and innovative technology. While the storytelling is universally appreciated, the investment community can often overlook the importance of the latter two.
Attention to Detail
Disney's Imagineers obsess over every detail, considering every component down to the smallest bolt or screw. “If you wouldn’t see something in a film, it shouldn’t be in this land,” one Imagineer stated. However, achieving full immersion goes beyond visual fidelity. While lands like Galaxy’s Edge and Avatar - The World of Pandora are visually striking, the experience also extends to sensory authenticity.
For instance, guests expect the alien flora in Pandora to feel artificial, like plastic. Accordingly, it comes as a great surprise when they feel realistic — and strikingly unfamiliar. Similarly, the unique scents in places like Pandora or Galaxy’s Edge add another layer of immersion.
“They will be able to smell the fragrances that we are going to create. They are going to be able to touch the materials and fabrics. They are going to be able to live this place as if it is real — because it is real,”
-Doug Chiang, creative executive at Lucasfilm.
The believability of these imagined worlds is further enhanced by the interactions with Disney’s cast members. Renowned for their dedication to staying in character, they play a vital role in maintaining the integrity of these fantastical realms.
Technology
At the heart of Disney's strategy lies a commitment to technological innovation. This often involves developing new technologies or combining existing ones in innovative ways. Scott Trowbridge, an Imagineer, illustrates this with the development of the immensely popular Millennium Falcon ride:
“We knew we needed this to be near cinematic quality imagery, rendered at a high frame rate in real-time. That technology didn't exist then. We started down that path, expecting that by the time we were ready to open, it would all work — we didn't know for sure. Months before opening, it didn’t work; it almost worked. It almost worked for a very long time as we fixed bugs, connected one piece of technology with another, and figured out why there was an impediment... But that's what life is like on the cutting edge of technology: you're treading in territory where no one's been before. Yet, we're counting on everything working flawlessly on opening day. That can keep you up at night.”
Moreover, it's crucial that the technology behind the magic remains invisible to guests. As one Imagineer put it, "You have to build the best technology you’ve ever built, and then make it invisible." A standout example is the animatronic Spider-Man at Avengers Campus, performing acrobatic stunts 65 feet in the air, unbeknownst to guests that it's a robot.
Disney's Imagineers have mastered the art of infusing robots with emotion, as seen in the droids that now wander the parks, designed to move and express like a small child. The technology is impressive, but the artistry is so excellent that people don't even notice it.
Operations
Disney's flagship resorts, Walt Disney World in Florida and Disneyland in California, boast the equally distinguished titles of the world's "most visited" and "most Instagrammed" destinations. The company's international operations includes Disneyland Paris (Europe’s leading vacation destination), as well as Hong Kong Disneyland and Shanghai Disney Resort, with Disney holding 48% and 43% ownership stakes in these locations, respectively. Furthermore, Disney licenses its intellectual property to a third-party operator for Tokyo Disney Resort. Disney also operates a beachside resort hotel in Hawaii, “Aulani,” with hundreds of hotel rooms and time-share villas.
In 2023, international operations represented 19% of Parks and Resorts revenue (excluding Consumer Products). There was a 6% year-over-year increase in theme park attendance, with around 126 million visitors globally, though this figure was still below the peak of 142 million in 2019. Hotel occupancy showed a gradual recovery trend: domestically, occupancy rose to 85%, and internationally to 74%, improvements from 82% and 56% in 2022, respectively, yet still trailing behind the pre-pandemic averages of 89% and 82% from 2018-19.
In response to the pandemic, Disney introduced a variety of measures to regulate park capacity, notably an online reservation system. While many competitors have since removed these restrictions, Disney has chosen to maintain operations at approximately 80% of its pre-COVID attendance levels. This decision stems from addressing guest feedback regarding overcrowding before the pandemic and recognizing a decreased post-pandemic tolerance for such conditions.
“It’s tempting to let more and more people in, but if the guest satisfaction levels are going down because of crowding then that doesn’t work. We have to figure out how we reduce crowding but maintain our profitability. And we did that well.”
-Bob Iger
Recent changes, effective from January, include the elimination of reservation requirements on less crowded days and the removal of “park-hopping” restrictions for guests with access to multiple parks. However, the reservation system remains in place to regulate the daily attendance of annual pass holders, who tend to spend less.
Disney Cruise Line
Disney operates an expanding fleet, currently comprising five cruise ships with plans for three more. The line stands out by appealing to a demographic beyond the typical cruise-goer. Josh D’Amaro, Chairman of Disney Parks, Experiences, and Products, highlights that about 40% of Disney Cruise Line passengers wouldn't consider cruising if not for Disney's unique offering. Despite its premium pricing and infrequent promotions, the line achieved an impressive 98% occupancy rate in the fourth quarter. As a result, even though it represents less than 2% of the global number of cruise ships, its share of industry profits is disproportionately larger.
Consumer Products
Disney's Consumer Products division stands as a global leader, holding the title of the world's top licensor and dominating the children's publishing industry. While typically contributing less than 20% to the division's revenue, Consumer Products stands out for its exceptional profitability and economic resilience. This segment encompasses all products sold outside of Parks and Resorts.
Economics
Despite attendance and hotel occupancy rates not reaching pre-pandemic levels, DPEP reported record financial performance in 2023. The division achieved over $9 billion in operating income from $32.5 billion in revenue, yielding a margin exceeding 28%, excluding unusual items.
While admissions are the main revenue stream for Disney Parks, they are unparalleled in their ability to generate microtransactions. Each themed area is replete with a diverse range of merchandise and themed food and beverages, all seamlessly woven into the experience. For instance, Galaxy’s Edge offers guests numerous spending opportunities, from crafting custom lightsabers at Savi’s Workshop to assembling unique droid units at the Droid Depot, as well as themed souvenir drinks like the iconic blue milk from “Star Wars: A New Hope.”
Despite the discretionary nature of theme park visits and significant fixed costs, Disney Parks and Resorts exhibit impressive economic resilience. The only instance of faltering occurred during the pandemic when almost everything was affected. For instance, during and immediately after the Global Financial Crisis, the division maintained an average margin of around 13%, excluding Consumer Products. From 2018 to 2023, excluding the pandemic years (2020-21), domestic Parks and Resorts had an average operating margin of 25.7%, while international operations had an average of 14.4%, climbing to 20.2% in 2023.
Highlighting Disney's robust economic moat, per capita guest spending has surged by 103% domestically and 98% internationally over the last decade, more than doubling the respective Consumer Price Index increases. In 2023, international guest spending increased by 21%, following a 23% rise in 2022 (constant currency), compared to the 3% and 13% growth seen domestically.
Competition
Comcast's Universal Studios stands as Disney's principal competitor in the theme park industry. Similar to Disney, Universal operates parks in Florida, California, Japan (Osaka), and China (Beijing), with an additional park in Singapore. Unlike Disney, however, Universal has not ventured into the cruise line business. Predictably, there is a constant rivalry between the two, with each striving to surpass the other’s latest attraction.
Universal raised the stakes with "The Wizarding World of Harry Potter," prompting Disney to unveil attractions like "Pandora: The World of Avatar" and "Star Wars: Galaxy's Edge." Most industry observers agree that these attractions were better than anything that had come before. While Universal's parks are known for their thrilling and exciting experiences, Disney's parks are celebrated for their enchanting and magical atmosphere.
Domestic Parks and Resorts
In California, both companies’ resorts span approximately 500 acres. However, Disneyland usually attracts double the attendance of Universal's counterpart.
Disney World stands out in terms of size and attendance, covering around 25,000 acres (half of which is utilized), dwarfing Universal Orlando’s 540 acres and drawing nearly six times more visitors.
International Parks and Resorts
In China, both companies have similarly sized resorts at about 1,000 acres each. Universal's other international parks in Osaka and Singapore are considerably smaller at 130 and 50 acres, respectively.
Disney’s international resorts collectively cover approximately 6,600 acres, significantly more than Universal's international presence.
Financials
In 2023, Universal Parks and Resorts saw revenues of approximately $9 billion, an increase from $7.6 billion in 2022. In comparison, Disney Parks and Resorts reported revenues of $28.2 billion and $23.4 billion, respectively, in the same years.
Both divisions exhibit similar operating margins: Universal recorded margins of 25.1% in 2023 and 21.5% in 2022, while Disney posted margins of 24.8% and 21.7%, respectively.
It's important to note that this comparison isn't directly equivalent due to two main factors: Disney’s revenue figures include its cruise line operations, and Universal’s figures encompass consumer products sold outside its parks and resorts.
Growth
“Since the returns have been so strong, why not invest more?”
– Bob Iger, interview with CNBC on Nov 8th
In September, Disney unveiled a substantial investment plan of $60 billion for Parks and Resorts over the next decade. This represents a significant increase in funding, almost doubling the investment of the previous decade in nominal terms and climbing by approximately 45% in real terms (weighted average). Iger has specified that around $40 billion is earmarked for incremental capacity.
Over half of this investment is designated for international parks, with the majority of the expenditure anticipated in the latter half of the decade. Notable recent and upcoming developments at international locations include:
Shanghai Disneyland unveiled its second expansion and Disney's first Zootopia-themed land on December 20th. Exceeding the high expectations set by the movie's popularity in China, this addition concluded the resort's highest year of attendance, with over 13 million guests.
Hong Kong Disneyland is rebounding post-pandemic with a refurbished castle and the new "World of Frozen." While it may not match the scale of lands like Pandora or Galaxy's Edge, the positive reception is promising for future expansions themed around Frozen.
Disneyland Paris underwent a comprehensive refresh and recently opened the Avengers Campus to enthusiastic reviews. Josh D'Amaro, Chairman of Disney Parks, Experiences and Products, has emphasized the significant potential for further expansion in Paris, stating, "We are not even close to being done in Paris."
The investment plan also includes three additional cruise ships by 2025 and 2026, effectively doubling the fleet's capacity. A new port in Singapore, designated as the home port for the Disney “Adventure,” is part of this expansion. “These cruise ships have been very productive for us from an investment perspective, commanding double-digit returns,” D’Amaro revealed.
“There should always be a new reason for people to come and new things to experience,” Walt Disney emphasized. The impact of these investments is significant and often self-promoting, requiring minimal marketing due to inherent media attention.
Adding attractions increases guest capacity and enables more efficient management of visitor flow, enhancing overall visitor capacity beyond the individual capacity of new attractions. Next, we will explore the historical link between capital expenditures and earnings growth to derive a plausible forecast considering these record investments.
While refreshing old attractions and building new ones are key drivers of long-term earnings growth, they are not the only factors. Nonetheless, examining this historical relationship provides valuable insights.
From 2013 to 2022, Parks and Resorts' net capex was approximately $12.3 billion, or $14.7 billion when adjusted for inflation. During this period, normalized operating earnings rose by about $4.2 billion in real terms, yielding a ratio of roughly 3.5:1. Assuming this trend continues, the projected increase in normalized (real) operating earnings could exceed $8.5 billion, more than doubling the earnings generated in 2023.
“The same people who dreamed this up are still dreaming. And that just goes on and on. The next decade is going to be pretty amazing. I think it’s going to be truly revolutionary in what we’re able to deliver to the parks.”
– Jon Snoddy, Imagineer