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Company-wide cost restructurings and streaming profitability were two big themes in Disney’s and Warner Bros. Discovery’s earnings calls yesterday. Warner Bros. Discovery reported $111 million of adjusted EBITDA and a path to “at least break even or even profitable across the D2C segment”. Disney confidently projected a path to profitability by Q4 2024, despite reporting losses of $420 million in the segment. It also reported it is on track to achieve around $7.5 billion in cost reductions within the company, approximately $2 billion more than it had targeted earlier in FY 2023.
But there is still an uncertainty lurking within these stories to investors, best captured in a question from Bank of America’s Jessica Reif Ehrlich on Warner Bros. Discovery’s earnings call: Is the growth in streaming “enough to offset these linear challenges” given that linear is Warner Bros. Discovery’s “biggest business?”
By “challenges” she is referring to Warner Bros. Discovery’s pro forma linear advertising revenue fell nearly $1 billion in the first nine months of 2023. Her framing of the question is wickedly clever and deceptive in its simplicity. Because on a basic level, it effectively asks, “As linear disappears, what’s left to be excited about?”
Key Takeaway
Despite a lot of selling, neither Disney nor Warner Bros. Discovery offered investors a roadmap through “a generational disruption”. If there is growth in streaming and games to be found, management's answers on earnings calls suggested new management is necessary.
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Total time reading: 5 minutes
This question provoked a robust and fascinating response from Zaslav and his CFO Gunnar Wiedenfels. Zaslav started off by conceding there is longer-term uncertainty in the advertising marketplace. Wiedenfels followed by changing tone, pushing an aggressive sales pitch that pushed back on Ehrlich’s bearishness for linear. He also included a compliment for the precedent set by Charter’s deal with Disney. Zaslav then closed out the response by acknowledging “This is a generational disruption we're going through” and explaining how Warner Bros. Discovery was maneuvering through that change.
She did not ask the same question to Iger on Disney’s call (instead, she asked him about his “holistic view” on advertising and its business in India). That is probably because he has spent the past six months teasing investors with scenarios of Disney’s future without linear or broadcast channels, including ABC and ESPN. Also, the recent carriage deal with Charter dropped eight Disney networks from its customer bundles, whereas Warner Bros. Discovery has yet to cross that Rubicon.
Long-Term Vision
In their growth sales pitch, Zaslav and Wiedenfels ended up in a place no different than Iger ended up in Disney’s sales call. None of them offered a long-term vision or solution for the “generational disruption” in the media business. None have offered any clue whether they will be able to offset the challenges of the decline of the linear business. But, they are obviously willing to sell investors and analysts that they are the management teams to solve them.
A big part of the reason neither Iger nor Zaslav has an answer for “generational disruption” is because, generally speaking, Wall Street investors think only two fiscal quarters ahead. There is some but not much incentive for management to tell the story of a broader vision. They can outline the future, hit investors’ short term concerns and then skimp on the details. Iger is a master of this. He has returned in large part to boost Disney’s stock price and it has jumped 7% this morning since the earnings call (as of today’s mailing). The reason for the jump is primarily the good story on cost-cutting and spending restraint.
Warner Bros. Discovery is down 17% since the earnings call in large because of the shortfall in advertising revenue and the long-term uncertainty for the advertising marketplace. Wiedenfels also mentioned “geopolitical and economic uncertainty and strike related constraints” as additional obstacles.
The stock market reactions, though divergent, still capture the challenge presented within Ehrlich’s question to Zaslav and Wiedenfels: What businesses do they have to replace the linear business? Iger seemed to anticipate this question better than Warner Bros. Discovery, outlining “four key building opportunities”:
Achieving significant and sustained profitability in streaming;
Building ESPN into “the pre-eminent digital sports platform”;
Improving the output and economics of Disney’s film studios; and
“Turbocharging growth” in its Experiences business.
But, Ehrlich’s point was whether the growth or even profitability in streaming is “enough to offset these linear challenges?” Notably, only the first two building blocks relate to that question and neither offers any answers. Back-of-the-napkin math—and based on the numbers above—suggests that if streaming’s operating margins mirror those of linear in the long run (31% in FY Q4 2023), Disney’s direct-to-consumer business could produce 2x the quarterly operating income that linear does now.
That would be a great accomplishment, one that would match the promise of the mythical “streaming multiple” and only Netflix seems to be on the path to actually achieving. But, to Erlich’s point, there is no roadmap to get from here to there. Iger warned investors that core Disney+ subscribers in fiscal Q1 will “decline slightly versus Q4 due to the expected temporary uptick in churn from the recent US price increases, as well as from the end of the summer promotion.” He then said “we expect to see sub growth rebound later in the fiscal year”, but without a rationale or roadmap as to why.
Instead, Iger could only offer salesmanship and promises made with a bias toward the short-term thinking of investors. In reality, streaming may not ever be a growth business, or achieve the types of operating margins to replace those lost from linear.
Iger’s TikTok Misread
On this point, I believe Iger erred in his salesmanship of building ESPN into "the pre-eminent digital sports platform”. When asked about how Disney will grow ESPN, he responded:
“ESPN is the number one brand on TikTok. Not the number one sports brand, not the number one media brand, the number one brand with about 44 million followers, which is an incredible statistic. ESPN is a very popular, high demand -- high in demand product in the United States, and unique, we believe, and we feel leaning into it is the smart thing to do because of its unique quality, how popular it is and how profitable it has been.
On its face it is a compelling sales pitch: ESPN the brand is both surviving and dominating in the most popular short-form video platform out there. But, as I wrote in Monday’s “Chasing TikTok”, the sales pitch misunderstands both the TikTok platform and the business model for short form video. As Samir Chaudry of Colin and Samir explained in a recent interview:
“When I'm watching TikTok you are watching TikTok. TikTok I'm scrolling the ‘For you’ page so TikTok is the creator. You take the top 10 creators off of Tik Tok, TikTok is still TikTok.”
That statement implies that if ESPN was removed from TikTok, it would matter little to the TikTok ecosystem. The TikTok platform as the creator will figure out a similar or better alternative. It could disintermediate Disney with content from sports leagues. Iger's pitch implies Disney could monetize ESPN content on TikTok as it does online or on linear. But, there is no way that can be true. TikTok still struggles to attract advertisers and Disney does not receive affiliate fees from TikTok. Also, as Disney global ad sales chief Rita Ferro told a conference recently, Disney sees short form content platforms like TikTok and Snapchat as “an extension” to its linear programming, but not necessarily advertising businesses.
Ultimately, this mistake points to another implication of the question Ehrlich was asking: If there is growth in streaming and games to be found, are these the management teams that will find that growth? As the decline in the linear business accelerates, the challenges the business will face will be less and less related to linear. Growth will need to come from retail first, consumer first media business models like streaming and gaming.
Despite a lot of selling, neither Disney nor Warner Bros. Discovery has a roadmap through “a generational disruption”. The answer to Ehrlich’s question in both earnings calls is that neither management team demonstrates an understanding of the new competitive landscape emerging before them.