To The Moon

One of the things I’ve learned in 30+ years of investing is how important history is in analyzing companies. Understanding what has happened in the past, why it happened, and what the results were can inform what’s likely to work in the future.

Sometimes, I learn from what companies got right.

Sometimes, I learn from what companies got wrong.

And that brings me to $Walt Disney(DIS)$ , a company whose history I covered in-depth in the Disney Spotlight. But I may have focused my history lesson on the wrong area. I focused on Disney’s entertainment history and the ebbs and flows of content creation, which come and go every decade or so.

What I didn’t focus on was the history of Disney’s parks and how it was the parks that have always been the driver of Disney’s economic value.

This realization hit me while listening to Acquired’s The Walt Disney Company episode.

The Walt Disney Company | Acquired

Walt Disney pioneered synchronized-sound cartoons, invented the IP flywheel, and built the modern theme park — turning a twice-failed Kansas City animator into the most powerful brand in entertainment.

www.acquired.fm/episodes/the-walt-disney-company

The episode details how early in Disneyland’s history it was that the park, not movies, generated most of the company’s profits as early as the late 1950s.

And the Disney flywheel of movies → merch → parks was an accidental development. But once it was put in motion, it was this flywheel that drove the business.

Disney had cracked the secret of Hollywood.

The movie business kind of stinks!

A hit can make a lot of money, but everyone has to get paid before the studio does. Actors, distributors, and theaters all get paid first.

A $200 million movie doesn’t need to make $200 million at the box office to make its money back. (The numbers below are roughly accurate and depend on the movie)

Theaters get about half of the box office.

Distributors usually keep 100% of the revenue that’s left over until their promotion costs are paid back.

After the distributor is made whole, the distributor and studio split what’s left.

A movie with a $200 million production budget and a $100 million promotion budget needs to make about $1 billion at the box office to break even.

See…the movie business kind of stinks!!

You can see why the parks business was so attractive for Disney.

But that reality was obfuscated by a booming cable business that was led by the acquisition of Capital Cities/ABC in 1996, which brought ESPN and Bob Iger to the company. The steady growth of cable and ESPN’s value to the cable bundle helped Disney’s financials, no doubt. But it wasn’t core to Disney.

As the content distribution world changes, I think Disney needs to get back to its core and spin out some of the assets that distract from what’s most important…driving the parks!

They’re the company’s past, present, and future.

Disney Of Today

Before I get to my remedies, it’s worth going into what Disney is right now. I think of Disney’s business today in three buckets:

1. Studios

Disney Animation, Pixar, Marvel, 20th Century, and Searchlight are Disney’s content engine.

They make films and TV shows that end up going out to various distribution mediums. Some content also makes its way to the parks.

2. Distribution

Disney is known for its movies, and Disney owns its distribution arm in film, Buena Vista.

But the bigger value add in distribution has long been television.

Disney owns ABC, most of ESPN, and a plethora of other channels that end up on everyone’s cable bill.

For years, this has been a reliably profitable business and a great way to distribute Disney content.

They’ve also added streaming with Disney+, Hulu, and now the ESPN streaming app.

What’s worth pointing out here is what’s owned and what’s rented. Disney's cable business relies heavily on ESPN, which rents its (most valuable) content from sports leagues.

It owns studio content and ABC’s live content, but the live content doesn’t add to the flywheel. And neither do sports.

That will become important later on.

3. Experiences

Experiences are Disney’s theme parks, cruise ships, plays, and merchandise. As you can see from the chart above, they now drive a vast majority of Disney’s operating profit at over $10 billion per year.

They’re also Disney’s biggest moat. The company has spent 70 years building and perfecting the parks business, which I marveled at in Disney’s Real Moat.

And it’s these experiences that have to be central to how we should think about the company today.

Originally, my thesis for Disney stock was partly centered around the company bundling Disney content, general entertainment, and sports to create a streaming bundle that would be a must-have the world over.

I don’t think that bundle proposition is working.

I think I got this wrong for a few reasons:

1. No streaming service has everything, so the bundle is less valuable when there are multiple a la carte options.

   1. Ex. Even Netflix is losing share of TV time.

2. The economics of sports are antithetical to the rest of Disney’s business because it’s rented and fleeting, so ESPN’s revenue needs to be maximized immediately. The rest of Disney wants to get as many people as possible watching Disney content to create a wider funnel to the parks. It’s a long game.

   1. Especially in streaming, Disney can do either a big funnel OR maximize revenue per user. It can’t do both.

3. I’ve come to realize that the parks/experiences are what’s most important to Disney. Anything that doesn’t feed into a park or an experience of some sort is a distraction.

With this lens, I think Disney needs to make some big moves to rationalize the business.

The Cable TV Distraction

Disney didn’t intentionally get into broadcast and cable TV.

Originally, Walt’s show on ABC was a long advertisement for Disneyland that also happened to generate revenue, not to mention ABC helped fund Disneyland.

What a great business model!

Buying Capital Cities/ABC in 1996 and pairing the booming TV and cable business with a leading studio made a lot of sense in a world of vertically integrated players.

ESPN and ABC gave Disney bargaining power against cable companies it wouldn’t have had if it were just selling The Disney Channel.

In a world of cable at the center of content, owning ESPN makes a lot of sense.

But the cable bundle is dying, and streaming is playing by different rules.

Streaming is an aggregation business, and you’re either YouTube and Netflix — user-generated content and all types of content, respectively — or you’re falling behind.

Bundles haven’t worked in streaming because there are too many options, and no one is forcing scarcity. Disney doesn’t force you to buy ESPN, and HBO doesn’t force you to subscribe to Paramount. And YouTube is the behemoth that doesn’t play by traditional distribution rules.

The ONLY logical option for Disney is to create content that can be sold to the highest bidder (Sony’s content model) and/or have a distinct niche streaming service that commands a high price and/or builds value for the parks. The niches would be Disney+ for families and ESPN for sports fans. One belongs in Disney, the other doesn’t.

In 2026, owning cable and broadcast networks is a distraction to what’s most important, and that’s making great movies and building great experiences.

ESPN Needs to Go Solo

The first move is to spin out ESPN. I think the company could simply be distributed to existing shareholders, including Hearst (18%) and the NFL (10%). The business is on solid footing financially and would have interest from public investors.

Having a solo strategy would also make a lot of sense for ESPN.

As it stands right now, ESPN needs to be “Disney-friendly”, but does that make sense in a world where MMA is growing in popularity and gambling is helping make the economics work?

ESPN could also do what makes the most sense for itself from a content and pricing perspective. Maybe that’s bidding for a bigger NFL package and raising prices from $30 per month for streaming to $60 per month?

Maybe an NFL package is bundled with Fox and Paramount (CBS), who don’t want to bundle with Disney+?

Being owned by Disney is probably limiting ESPN’s freedom of movement, and I think going it alone would both make ESPN better and unlock value for Disney.

Sports don’t fit with the rest of Disney’s strategy anymore, and it’s time it was set free.

ABC and “Other” Sale

I think the next move after spinning out ESPN would be to sell ABC and the other cable networks. ESPN is the tentpole that holds the bundle value together and hanging on to these distribution businesses makes no sense without the largest point of value.

This could free up some cash and improve the ability of studios to operate independently.

If studios were free to sell content where it made the most sense and advertise where they see the highest ROI, it could improve the studio business.

“Disney Night” on Dancing With the Stars is fun and all, but does it really add value to Disney as a whole?

A studio like Disney should be maximizing distribution. That’s hard when you have owned distribution.

The Math

So far, I have Disney spinning off ESPN and selling ABC and the networks. So, how does this math work for investors? Today, Disney’s valuation is:

• Market Cap: $165 billion

• Debt: $47 billion

• Enterprise Value: $212 billion

The debt is what I’m most worried about because it reduces management’s ability to invest in experiences.

So, these spinoffs and sales could free up some cash.

ESPN Spin Off

ESPN could be spun off into its own public company. Disney has been preparing for this for years, splitting off the financials so investors can see how much revenue and operating income sports is generating.

Let’s peg Disney’s value in this venture at $30 billion, which would initially be stock under my spinoff scenario. That’s a hefty premium to Versant’s (CNBC, USA Network, Golf Channel) $7 billion enterprise value, but Versant’s business is in decline on both the top and bottom line.

ESPN is still the most valuable asset in the cable bundle and deserves a premium. But I also think it would be better run as an independent company.

• ESPN would be free to bundle with other streaming services.

• Rights deals would be scrutinized on their own for ESPN as a standalone and not through the lens of ABC/ESPN/streaming.

• Costs could be optimized, and ESPN would be free to lean on technology and distribution partners that make its business more valuable

The days of ESPN being the tentpole of Disney’s cable and broadcast strategy are over.

It’s time to rip the Band-Aid off!

Value: $30 billion, which could be liquidated over time in order to pay down debt.

Spinning Out ABC and Cable Assets

Without ESPN, it doesn’t make sense for Disney to own ABC or the other cable assets it owns. The bundle economics that made the strategy work just don’t exist.

But the networks have some value…to someone.

Maybe that’s Versant. Maybe it’s Netflix. Maybe Amazon would bite. Maybe private equity?

But someone would want to own the channels that still provide content to tens of millions of people each year.

Value: ~$10 billion

What About Hulu?

With these two moves, we’ve unlocked $40 billion in value, which nearly covers the $47 billion in debt.

Depending on how deals are structured, debt could either be spun out with businesses or bought down as stock is sold.

Having less net debt reduces the risk in Disney’s business and provides clarity on what Disney will become.

What I haven’t discussed — and sits in no man’s land — is Hulu. Maybe Hulu should be spun out, too? Maybe it goes with ABC?

Before being acquired by Fox, it would have made a good merger with Roku.

I have this asset stranded for now, but if it’s up for sale, Hulu could add another $10-20 billion in value for Disney, based on streaming valuations today.

Disney Becomes a Content Engine + Experiences

By getting rid of ESPN and ABC/cable assets, we’ve cut out the declining (or flat, at best) and unfocused parts of Disney’s distribution assets.

This frees Disney studios to monetize content elsewhere.

Yes, Disney+ is still a Disney asset, but shows and movies could be sold to other networks and other streaming services.

Netflix could be a friend writing checks, not a threat to the streaming bundle.

Disney+ would live on as an all-Disney-all-the-time service for families and Disney diehards. But content could follow the biggest checks and the biggest audiences.

And that’s OK because the money isn’t in the content.

The money is in the parks.

If Disney were valued at $165 billion and all it had were premium parks and other experiences, that’s a good business!

The Disney I Want to See

I want to see a more focused Disney that looks like this:

• Studios: Disney Animation, Marvel, Lucasfilm, 20th Century, and Spotlight.

• Niche Streaming: Disney+.

• Experiences: Expand parks, cruises, and other experiences.

I think that would highlight what uniquely works for Disney and unlock value that isn’t core to Disney’s business. It may also deserve a higher multiple for the stock.

Sometimes, the sum of the parks is lower than the assets on their own. I think that’s clearly the case for Disney today.