Disney vs. Netflix – Don’t Cross the Streams?

On Thursday, April 11, 2019, Disney (DIS) announced its new streaming service – Disney Plus – with a monthly subscription price of $6.99 launching in November 2019. The service features Disney’s entire back catalog of movies and television shows as well as a large number of new programming the company plans to develop exclusively for the service.

Netflix (NFLX), the long-term #1 player in the streaming space and a household brand, dropped nearly 4.5% in stock price on the Friday following the announcement, but does Disney’s new service really flick Netflix to the side?

“Disney isn’t Netflix.”

Many analysts argue that Netflix deserves a higher valuation than Disney because Disney doesn’t have the growth prospects of Netflix. This is the argument for Netflix’s sky-high Price to Earnings Ratio (PE Ratio) of 131.02 versus Disney’s PE of 17.82.

While it’s true that Netflix has been growing dramatically over recent years, what if the analysts have it backward? 

Instead of valuing Disney at Netflix’s valuation, what if Netflix only deserves Disney’s valuation?

Netflix’s stock price would be $47.76 per share!

(Netflix’s $2.68 Earnings Per Share (EPS) x Disney’s Price-to-Earnings (PE) of 17.82 = $47.76)

What’s our argument? Why should Netflix get Disney’s PE Ratio? Not to answer these questions with another question, but…

What is Netflix’s business model endgame?

Netflix started its life as a DVD-rental company, pivoting to streaming when DVD rentals started to taper off (read: disappear entirely). Now, Netflix is a streaming powerhouse producing its own award-winning content.

Great! What else does Netflix have going for it?

In addition to content, Netflix has… um… name recognition? A nice red logo? Incredible hubris? 

What’s Netflix’s “next big thing?”

Will Netflix add more users? Will it add more countries?

That’s all well and good, but is that it? How does adding more subscribers make Netflix’s business plan any different from Disney’s?

Disney is already home to the best content in the business, except it also has an incredibly lucrative diversified portfolio of assets including theme parks, television networks,  and a vertically-integrated business model capable of fully capitalizing its intellectual property. 

All Disney has left to do to compete with Netflix is to add a streaming service, and Netflix has already shown all the pitfalls Disney needs to avoid.

Streaming isn’t new and the technology has simplified to the point where almost anyone can start a service. This ease-to-start-up will eliminate Netflix’s Pricing Power – the strength many analysts claim it has – where it continues to hike prices without losing subscribers. Will subscribers really stay if there are cheaper options with better content?

Netflix may have a head-start on Disney, but Disney’s a juggernaut with huge financial reserves and a back catalog that could slaughter Netflix’s few meager hits.

Additionally, Disney has financial capacity (it’s been profitable for decades unlike Netflix which still hasn’t turned a profit in even one quarter). Disney could pick up Electronic Arts (EA), Take Two Interactive (TTWO), or Activision-Blizzard (ATVI) and throw a real video game studio into its mix.

So, how does all this qualify Netflix to have a higher valuation than Disney? 

Disney isn’t trying to become Netflix, Netflix is trying to become Disney. 

“Streaming isn’t Zero-Sum.”

An argument made by analysts to defend Netflix is that “streaming isn’t a zero-sum game.” The theory is customers will subscribe to more than one streaming service.

In other words, one company’s success doesn’t necessarily mean the other’s failure: Disney’s streaming service can succeed without detracting from Netflix’s success.

This argument is valid – customers may subscribe to multiple streaming services.

However, these same analysts argue that Netflix is the best in the streaming space and although it probably is… for the moment… what if Netflix stops being the best in the space?

What if users get Subscription Fatigue and start cutting streams just like they’ve been cutting the cord for years? 

Assume you’re a customer who enjoys each service’s content equally, which subscription would you cut first – the most expensive one (Netflix) or the cheapest one (Disney)? 

Although strictly anecdotal, many Get Irked contributors canceled their Netflix subscriptions years ago, opting to use Amazon Prime’s included Video service which offers a bevy of quality programs including The Grand Tour, The Man in the High Castle, The Marvelous Mrs. Maisel, Fleabag, Catastrophe, The Tick, and many, many others. Our primary reason to have Amazon Prime membership is for the other benefits – fast shipping, deals, discounts, music, audiobooks, and more – the Video service is basically free. Why pay extra for Netflix, too?

We don’t think we’re alone in doing this. The modern consumer is looking for the best value and for ways to reduce costs, not increase them with additional services.

Subscription Fatigue is only going to become more pervasive. 

To make matters worse, instead of evolving as something new, the streaming space is rapidly starting to follow the same development cycle as a different industry we’ve known for decades – cable television.

For years, the cable companies were actually good investments, at least, until customers got tired of paying for so many channels they weren’t watching.

Although some customers may have switched to streaming services for the convenience of watching content on-demand, the majority switched to save money.

How is the streaming sector going to be different than cable? Instead of paying for too many channels, subscribers will be paying for too many streaming services. The end result will be the same – customers don’t like paying for content they’re not watching.

With Disney Plus at $6.99/mo. (about half of Netflix’s monthly subscription) and Amazon (AMZN) throwing their high-quality streaming service in with their Prime membership at $9.92/mo. (annual membership) or $8.99/mo. for just Prime Video, why will customers stay with Netflix at $12.99/mo. (or more)?

Are we all really jonesing for the next season of Orange is the New Who Cares, House of Cards Falling Down or Stranger Things Getting Less Strange and More Cliche? Netflix may have 5,500 titles, but with 5,400 of them appealing only to really niche and obscure audiences (i.e. the majority of us aren’t watching this stuff…), who cares?

Plus, do Netflix users just enjoy Reed Hastings’ hefty price increases coming at a rate of nearly twice a year?

We’re not so sure Netflix has the pricing power or “stickiness” analysts think it has.

“Disney’s just for families with kids…”

Many analysts make the following argument: “Disney Plus is just for kids.”

Um… what?

Disney owns Marvel. Disney owns Star Wars.

Disney just picked up Fox’s content division including powerhouse adult entertainment series like The Simpsons, Family Guy, and untapped movie properties like X-Men and Fantastic Four.

Much of Disney’s content isn’t just aimed at older audiences, it’s actually fairly inappropriate for young children. In fact, a large part of Disney’s content is aimed at the Holy Grail of Audiences: the 18-35 year-old demographic.

And, as for the “just for kids” argument, for customers who do have kids, Disney Plus isn’t going to be optional. Every parent needs a break and no content company provides a better break for parents than Disney’s child-safe, family-friendly content which also just happens to be incredibly addictive.

Plus… wait for it… Disney owns ESPN.

What’s the most-watched type of content for adults? It’s not serialized dramas or 80’s-inspired sci-fi series – it’s sports.

True, ESPN has been a drag on Disney’s stock for nearly half a decade as subscribers have been canceling their cable subscriptions in droves, but this trend has started to change: subscribers are returning to ESPN mobile because sports sells.

And this change started before Disney announced Disney Plus.

If ESPN has been a drag on Disney’s stock, what happens when ESPN flips from being a headwind against Disney’s profits to becoming a tailwind?

Once Disney cracks the streaming code (a matter of when not if) – perhaps with a bundled Disney Plus/ESPN subscription or maybe just rolling them together in a single service called “Disney Takes Over The World Plus” – maybe just stay with “Disney Plus,” actually – Disney will dominate the content aspect of the streaming space with content for all ages targeting the entire family, not just one segment of it.

Add into this that Disney has yet to embrace legalized gambling on sports. Although it hasn’t, yet, this doesn’t mean Disney’s not going to engage adult audiences with the ability to gamble directly from the ESPN app.

If subscribers return to ESPN and Disney turns on the sports gambling faucet, what kind of price multiple will Disney deserve?

What if Disney earned Netflix’s PE Ratio?

Disney’s stock price would be $956.45 per share!

(Disney’s $7.30 Earnings Per Share (EPS) x Netflix’s Price-to-Earnings (PE) of 131.02 = $956.45)

Give Disney the same Price-to-Earnings Ratio (PE Ratio) as Netflix and you’re looking at a nearly $1,000 stock!

When we calculate Disney’s stock with Netflix’s PE Ratio, investors have to ask themselves: Which company is truly over-valued right now? 

To be clear, our argument isn’t that Disney should be worth Netflix’s valuation, Netflix should be worth Disney’s valuation.

Disney is the winner of this episode of Versus

If you’ve made it this far, it should be clear that Get Irked believes Disney (DIS) to be the long-term investment winner over Netflix (NFLX).

Without question, Netflix has provided crazy returns for its investors up to this point, but with no long-term strategy bringing true innovation, does Netflix really deserve the valuation it currently receives?

Will Netflix be able to continue delivering mouthwatering returns in the future?

By no means do we believe Netflix is going to zero. However, with so many new competitors entering the streaming space and no real technological or business model advantage truly differentiating Netflix from other content producers, we think Netflix’s P/E Ratio will erode over time, dramatically lowering its stock price, at least to a realistic valuation more in-line with its competitors.

The best case scenario for Netflix (and Disney, too, actually) will be for the Price-to-Earnings Ratio of the two companies to converge: Disney’s P/E Ratio will increase to meet Netflix and Netflix’s P/E will decrease to meet Disney in the middle.

If the two companies’ P/E Ratio averaged (a pretty simple and unrealistic forecast, we agree), both companies would receive a P/E of 74.42.

Disney stock would be $543.27, Netflix would be $199.45.

Although such an outcome would certainly be incredibly lucrative for Disney shareholders, we believe the actual P/E Ratio both companies will earn to be much lower than 74.42, likely closer to 25-30, a typical P/E for a company with growth prospects.

Netflix shareholders may want to take heed of this possibility, however, as without a substantial improvement to its Earnings-Per-Share, Netflix stock would be valued at $67-$80, a decrease of 75-80% from its current $350 share price.

In the meantime, Disney is adding new income streams, capitalizing on existing streams, dominates the content development space with hit-after-hit, and sports a 1.35% dividend. A 25-30 P/E Ratio would value Disney’s stock at $182.50-$219, an increase of 40-70% from its current $130 share price.

Given these prospects, we have to say make ours the Mouse House with its existing revenue streams and potential for future growth.

“Big Red” Netflix with its lack of innovation and no path to profitability may actually be beaten already, Netflix just doesn’t know it, yet.