Streaming wars – Starting gun.

Disney is out of the blocks in first position. 

• Disney has handsomely beaten expectations for its Disney+ service but at the same, the costs of fighting this war immediately become clear when one looks at the bottom line.
• At its Q4 19 results, Disney announced that it had 26.5m subscribers at the end of the quarter which has already grown to 28.6m as of February 3^rd.
• This means that Disney is adding around 62,000 per day or around 2m per month.
• It is important to note that this is USA only as the service is not yet available in other countries meaning that the right number to compare this to is the 67.7m subscribers that Netflix had in the USA and Canada at the end of Q4 19.
• While it’s direct to consumer business saw revenue increase from $0.9bn in Q4 18 to $4.0bn in Q4 19, losses also ballooned going from a loss of $193m in Q4 18 to a loss of $693m in Q4 19.
• This appears to be a huge contrast to Netflix which earned 8.3% EBIT margins in Q4 19, but this only tells half the story.
• The rest of Netflix’s story is to be found in the cash flow statement where it lost $1.46bn of cash from operations due to spending on new content which totalled $3.9bn while amortisation of existing content was only $2.6bn.
• This is typical of any company that is investing for growth but the issue is that to ensure growth the content has to be top-notch and that is very hit and miss in this industry.
• This $1.46bn of cash outflow was paid for by issuing $2.2bn of long-term debt bringing the total to $14.8bn at the end of Q4 19.
• This represents 5.7x EBITDA and 0.7x revenues which is not yet extreme but is getting close to the point where it could become a problem.
• It is here where the real streaming war will be fought because users are not going to be able to keep adding content subscriptions to their monthly packages and soon will be forced to choose one over another.
• This is why the content battle is so important and while Netflix has sourced some well-received original content, it is miles behind Disney when it comes to the huge content franchises that it owns.
• Furthermore, Disney’s financial position is somewhat better than Netflix in that it generates cash although, it too, has a sizeable debt position.
• Hence, the stage is set for the streaming wars which will also see Apple, Amazon, Google, Sony, AT&T, HBO & AMC make a pitch for consumers’ wallets
• This also means that content will become very fragmented meaning that the user experience will suffer as most users want to have all their content in one place.
• Looking at the financial performance of all these players, it is clear that the amount of money being spent on content is just not sustainable and so I suspect sooner or later there will be a big round of consolidation.
• I see Disney being one of the consolidators but whether Netflix can withstand the cash demands that this environment will place upon it is another question.
• However, given how the shares have recovered, Netflix could probably come to the market with a large rights issue and raise the capital that it needs.
• Either way, this going to be a bloody battle and the only one that I can say with some certainty will be one of the winners is Disney.
• Hence, I would prefer to back Disney over any of the others.