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Read the three key trends The Medium will be focused on in Q4 2023. This essay focuses on "In the shift from wholesale to retail models, there are many business models that delight consumers but no single, dominant one."
Author's note: The essay originally estimated an additional $12 billion owed to Hulu. A valuation of $40 billion would create $12 billion in additional value to Hulu. But, because Comcast owns 33%, the additional cost to Disney would be only $4 billion, making the total sum paid to Comcast around $13 billion. The essay has been updated to clarify that.
The argument remains true that any valuation of Hulu above $27.5 billion increases the burden upon and risks to Disney to find ways to grow the business beyond its 48 million subscribers. My original version had lumped those two points together. I apologize for the error.
Wall Street private securities and investment research firm Sanford C. Bernstein estimates Disney will pay a final price of $40 billion for Hulu. That means it will need to pay an additional $4 billion (67% of $12B) for Hulu on top of the $9 billion it already owes for the remaining 33%. including a control premium. The problem for Disney is that Hulu is probably worth more outside the Disney ecosystem than within it.
I say “probably” because data from research firm Antenna shared with Bloomberg’s Screentime showed “about 6% of all U.S. streaming subscribers canceled their service in September, the highest rate since the firm started measuring the stat in 2018.” The rate of cancellations “spiked” at Disney+, Apple TV+, Hulu, Max and Starz. In Antenna’s June 2023 report, both Disney+ and Hulu had been ticking up to 5%. This new data suggests that they are now closer to 6%, or near where Paramount+ was then (yesterday Deadline reported Paramount’s Chief Product Officer is leaving along with some junior staffers).
Antenna reports churn for Netflix is down and “way below every other service”, despite a recently launched campaign to crack down on password sharing. The sense is that we may be at a moment where IAC Chairman Barry Diller’s refrain may be finally proven true: Netflix “has already won the ‘streaming wars’”.
So what will become of Hulu? Its churn rate no longer seems to benefit from a bundle with Disney+ and ESPN+. After being the only Disney streaming property to show continued growth in recent quarters, it now seems it will share the downward trends of legacy media streaming services. Any valuation for Hulu that is higher than the fair market price of Hulu—a floor of $27.5 billion which Disney and Comcast agreed to in 2019—seems wrong by all objective measures. The question is whether that valuation reflects Hulu’s future outside of the Disney ecosystem.
Key Takeaway
It is becoming increasingly clear that Hulu needs a different home than Disney to maximize its value. The open question is what it means for Hulu to have its value maximized in this marketplace.
Total words: 1,700
Total time reading: 7 minutes
The Comcast Case for $40 Billion
In September’s “Is It Charter's or Comcast's Wicked Game Against Disney?”, I wrote about how Comcast CEO Brian Roberts used the opportunity of the Goldman Sachs Communacopia + Technology Conference to praise Hulu as “a pure-play, fabulous, scaled streaming service” and push for a higher valuation:
The value of the bundle, we've seen Hulu packaged with Disney and with ESPN+, you'd be able to stay in that bundle. That reduces churn like half for Disney and others. So that value goes with it. And we've seen analyst reports that a buyer depending on who they were, if it was to scale them up, they could have a couple of billion dollars or who knows what of synergy. Just that piece of the synergy and the churn benefit could be worth $30 billion. And that's before you ascribe any value to the actual Hulu.
Roberts is making two points here. The obvious takeaway is that Hulu reduces churn and therefore is valuable inside or outside of Disney. As per the above, that may no longer be true (which favors Disney’s argument for a lower fair market value). Second, given Netflix has an estimated 68 million subscribers, he suggests a buyer not named Disney will be able to scale Hulu upwards beyond 48.3 million subscribers in the U.S. He does not seem to be ruling out international growth, either, which Disney is reported to have opted against to keep Hulu’s fair market value down. He effectively has laid out the argument for a valuation of $40 billion or more.
Is Hulu worth $40 billion?
Hulu's revenue for the trailing twelve months is $11.1 billion. Netflix’s operating margins are 26% at $14.5 billion in U.S. revenue over the past twelve months, so let’s conservatively assume Hulu’s operating margins are 15% or $1.7 billion per year. The $28.5 billion fair market value floor is almost 17X Hulu’s estimated operating income. At $40 billion it is 23.5X. Assuming Hulu’s operating income is not much different from its earnings before income, taxes, depreciation and amortization (EBITDA), both are aggressive valuations relative to the standard ranges of 5X to 10X EBITDA. They are especially aggressive given Hulu's spike in churn rate.
To get to 5X operating income, Hulu would need to quadruple its revenues to $72 billion—225% Netflix's $32 billion in revenue for the trailing twelve months—while holding operating margins steady. That is no easy task: Hulu’s revenues are domestic, only, whereas Netflix’s $14.5 billion is generated annually over 200 countries and territories. Disney+ is in fewer territories—150 and it describes its reach in “markets” and not “countries and territories”—and is generating around $1 billion per quarter in international markets ex-India, or $4 billion per year. That is 25% of Hulu’s annual revenues in the U.S., alone. Disney has opted for Star instead of Hulu overseas. A substitution of brands or platforms would do little to move Hulu's growth needle.
To quadruple Hulu’s $11 billion in annual revenues, Disney would need to figure out international strategies to grow $4 billion into $33 billion and drive growth while holding operating margins constant. Growth is expensive as marketing platforms mature and their ability to charge higher fees increases. So, growth is unlikely and seems especially unlikely within Disney. As I wrote in July’s “It’s Complicated”, this in large part of the operational culture: “the complexity of [Disney’s] ecosystem can overwhelm and undermine even the best-executed corporate objectives.”
Hulu’s Value Ex-Disney
Since its acquisition of Hulu in 2019, Disney has built its entire streaming platform off of BAMTech while keeping Hulu in a holding pattern. The expectation has been that Disney would put all of its streaming apps on one platform to make its back end more efficient and to make consumption easier for consumers. Although CEO Robert Iger announced that Hulu would be both integrated as a tile into Disney+ and kept as a separate streaming app, the Wall Street Journal recently reported the initiative has been “slowed by delays”. Also, “some features designed to attract customers to a planned new Disney+ and Hulu bundle won’t be available when the Hulu tile within Disney+ debuts later this year.”
To date, Disney appears to value Hulu more as the programmatic advertising back-end for Disney’s streaming services. The business rationale for making a single advertising back-end is increasing revenue and operational efficiency. If one believes streaming is Disney’s growth engine, as Iger told investors in the FY Q3 earnings call, then Disney management is assuming streaming ad revenues will be able to replace some of the $7 billion in lost cable and broadcasting revenues. However, if churn rates continue to trend higher across all three of its streaming services domestically, that assumption becomes increasingly questionable and so does a valuation of $28.5 billion or higher.
So, we must question whether the practicalities of Disney owning Hulu are too costly and therefore too risky. For someone to value Hulu at $28.5 billion, must have a bolder business plan for the Hulu platform than Disney’s and be in a position to execute it. Outside of YouTube and Netflix, there may be plenty of buyers who would value Hulu’s profitability, but it is not clear whether there a company or management team exists that knows how to grow a streaming service in 2023.
Who Gets Stuck With The Tab?
In Monday’s mailing, I wrote about the “uncertainty around technology’s ability to not only redefine traditional TV broadcasting, but match its creativity”. The narrow example I used was Amazon’s upcoming Black Friday NFL Broadcast on November 24th which will leverage interactive ads and more consumer packaged goods advertisers to help drive sales. It is keen to prove that “its massive pile of shopping data can be used to enhance TV advertising”, as Next in Media’s Mike Shields recently wrote. But, as Shields also asked, “If the most powerful commerce company on the planet - not to mention the one with the greatest pool of first-party data that can be used for ads- can’t use those strengths to its advantage in TV advertising - then what are we doing here?”
Shields’ point is an important one: If Amazon fails, neither YouTube, Netflix or Disney has a better solution. There may be an inherent limit to the value of video advertising to both distributors and consumers in streaming. Netflix’s push into gaming certainly implies there is a limit. If this limit truly exists—and Disney is currently the weakest positioned of the bunch in terms of first-party data and technological sophistication—there are no growth prospects for Hulu. $28.5 billion will be an expensive price tag, and both Brian Roberts and Robert Iger will both have overestimated the long-term value of the streaming business model.
Activist Nelson Peltz and his team at Trian Fund Management—now one of Disney’s largest investors with a stake valued at upward of $2.5 billion—recently were reported to be losing confidence in Disney’s management. In last year’s activist campaign, they had pushed Disney management to buy Hulu or get out of streaming altogether. Iger has since waffled on Hulu’s future, suggesting last year Disney might sell it off but this year saying Hulu is a part of its streaming future. Given the uncertainty Amazon faces with its monetization model, it is hard to imagine Peltz will be on board for any large price tag for Hulu and especially with Disney’s current management team in place.
It is becoming increasingly clear that Hulu may need a different home than Disney to maximize its value. The open question is what will justify a valuation of $28.5 billion for Hulu in this marketplace. Should Amazon prove that video advertising is not as promising as many have assumed it to be, that will weaken Hulu’s advertising growth prospects. Should Netflix prove that gaming is the growth engine of the future, then that will weaken Hulu’s overall streaming growth prospects. Should YouTube prove that content demand has evolved past traditional linear content to a broader mix of creator economy content, podcasts and clips, that will weaken the value of Hulu’s library.
Comcast and Disney both value the company in a way that may overestimate the platform’s long-term value in the marketplace. There are few alternative rationales. To justify a $40 billion valuation, much less a $28.5 billion valuation Hulu will require a management team who understand that Amazon and Netflix are hitting the limits of the streaming model. It is not clear who those people are, but it is clear that neither Comcast nor Disney management are not them.
Additional Reading
Last August, I wrote about Peltz's previous activist campaign with Disney in "Media Conglomerates, Unrelated Assets & Change".
In July's "It's Complicated" I argued media ecosystems — both within companies and more broadly — have become too complex to navigate disruption.
In September's "Is It Charter's or Comcast's Wicked Game Against Disney?", I asked whether the Charter-Disney negotiations were part of Brian Roberts' strategy to drive up the price of Hulu.