Recently, Third Point’s Dan Loeb wrote a letter to Disney management after taking a position in the company, and Liberty Media’s John Malone gave an abbreviated interview to Ben Mullin of The New York Times.
From the PARQOR perspective, I think both Malone and Loeb are getting a core element of the emerging streaming marketplace wrong. But what does “wrong” mean in the context of critiquing (1) one of the most successful cable and media executives, ever, and (2) one of the more successful activist investors in the market?
There is an inherent danger of calling something “wrong” at a time when Netflix - the streaming market leader pioneer - is reorienting itself towards bets on gaming and advertising, and actively redefining what was the “right” path forward. Beyond Netflix, there never really has been a market paradigm for “right”.
A core objective of PARQOR is to suss out the signals for what “right” may look like if and when it emerges during or after the “streaming wars": Whether a business has the “right” business model to (PARQOR Hypothesis framework) or the “right” executives helming the ship (Fiduciary vs. Visionary framework) or the “right” priorities for shareholders (Curse of the Mogul framework).
As I wrote last week, "right" is increasingly defined as "profitability and customer retention—and in particular how much value these companies can extract from said customers along the way." Loeb's proposed strategy is closer to being "right" than Malone's in this point, but even he gets operational and technological details wrong.
What Malone Gets Wrong
I think the most important questions about what’s “right” in an increasingly DTC world point to whether a media company with a streaming service is investing in understanding what its consumer needs, and whether it is doing enough to invest in its ability to execute on that understanding.
Malone’s argument - or what we know of it - nakedly disagrees with this premise. It argues that scale and “great films and great TV shows” are Warner Bros. Discovery’s answers to “right”. I think those reflect a fundamental lack of concern about whether great content may actually reach the consumer in a DTC world.
It may seem funny to make this point after the record-breaking debut of "Games of Thrones" spin-off "House of the Dragon" in both the U.S. (10MM watched the premiere, the largest ever for an HBO original series) and Europe, where it debuted to 21 countries where HBO Max was recently laid out. it, 2.2MM watched it on HBO in the U.S., implying 7.8MM watched on HBO Max. That said, both in Europe and the U.S., a new “great TV show” succeeded because of, and not in spite of, WarnerMedia management’s fan-obsessed focus on laying the foundation for a closer and broader DTC consumer relationship both within and beyond streaming.
Moreover, if scale is the objective, it’s not yet clear how the combined scale from the merger helped to drive marginally more consumption of "The House of Dragon" than HBO Max would have seen on its own.
An Alternative Solution
I asked two weeks ago in "Batgirl", "Multiversus" & Consumer Data”:
“How else will Warner Bros. Discovery compete in streaming if it does not value the information and business potential gained from converting valuable demographics to HBO Max subscribers? How will it keep those subscribers from churning out if it does not offer complementary services like gaming that brings their understanding of consumers?”
The answer to this question lies in focusing on building deep consumer relationships through data and across mediums, and not scale and “great films and great TV shows”. DTC is simply not just another plug-and-play distribution channel: it requires an intimate understanding of the consumer.
Also, $1.7B in operating income and $1B in cash came almost (if not) entirely from $2.3B in linear EBITA last quarter. Scale matters to operating income and cash flow, but it’s harder to imagine how “great films and great TV shows” help to drive linear revenues as cord-cutting accelerates after, as "House of Dragon" proves, the majority of consumers increasingly seek them on streaming.
What Loeb Gets Wrong
Loeb’s arguments are more DTC-savvy than Malone’s: he thinks Hulu would be better off within Disney+ because it would “provide significant cost and revenue synergies, ultimately reigniting growth in the domestic market”. Spinning out ESPN would give Disney “greater flexibility to pursue business initiatives that may be more difficult as part of Disney, such as sports betting”.
The ESPN Proposal
I wrote the challenges of sports betting to Disney in Chapek's "Three Pillars" for Disney's Future Faces Tough Trade-Offs In Sports Betting. That analysis concluded:
Effectively, solving for sports betting in DTC terms is Disney solving for both the conversion and retention stages of a conversion funnel but without owning the consumer within the Disney BEADS ecosystem. It also means having a lower quality understanding of the sports betting consumer at a time when Disney's CEO demands a "relentless" focus on the consumer.
That means, unlike the ESPN+ subscriber, the sports betting consumer has both one foot in and one foot out of Disney's ecosystem, which is an un-Disney-like outcome. This is a riskier outcome to ESPN and Disney than the risks posed by "edgy" content.
So I think Loeb's argument for ESPN is more compelling than his argument for Hulu, primarily because it inherently reflects the Fiduciary vs. Visionary framework’s point about operational and cultural constraints: it proposes an outcome where executives can pursue the type of technological and business model experimentation that legacy media executives, and especially Disney executives, are culturally incentivized to avoid.
The sacrifice would be spinning out a cash-generating machine: linear networks generated $2.5B in operating income for Disney in Q3 2022, alone, of which $2B was from domestic channels (80%!). It may generate as much as $9B in FY 2022 - applying that 80% gets nearly $8B from domestic channels alone in FY 2022,.in large part by ESPN being distributed in 76MM homes (as of last November).
Notably, his argument has echoes of what former WarnerMedia CEO Jason Kilar told Recode’s Peter Kafka last year: “if you’re going to invest a lot of upfront capital in creating beloved characters in worlds, I think it’s only natural if you have the capabilities and if you have the skillset in terms of leadership and talent to be able to lean into telling those stories, both in a linear fashion with narrative storytelling but also an interactive fashion with gaming.”
Loeb’s point is that Disney’s risk-averse, operational culture prevents them from leaning into telling sports stories in across mediums (linear, streaming, sports betting). I think there’s plenty of objective evidence to support that, perhaps most evident in ESPN+’s subscriber numbers growing in lockstep with Hulu after the launch of the Disney+ bundle. In other words, but for the bundle ESPN+ would struggle to survive.
That said, Disney CEO Bob Chapek came up through Disney Theme Parks, which is also a DTC business. He also has been openly discussing CDP business logic for connecting streaming data with Theme Parks data as he outlined last year to the JP Morgan Global Technology, Media and Communications Conference.
So, given that there is both understanding of DTC at the senior-most levels of Disney, and business initiatives seeking to unlock value through consumer data (including bundle deals with National Geographic, which I wrote about in April), I do wonder whether there is more downside to Disney than upside in spinning ESPN out. Chapek and his team seem to have more understanding of DTC than Loeb is giving them credit for.
Hulu
Loeb’s Hulu proposal undervalues what Hulu may be most valuable for: its personalization algorithm, and it has algorithms for both content recommendations and targeted advertising. I think its personalization algorithm is the second best in the U.S. only to Netflix (and YouTube may be better than moth). So his proposal, ironically, undermines the more-DTC-friendly logic he is arguing for Disney to pursue.
Hulu was built on a different back-end, and as The Information reported last year, “Hulu’s engineers have resisted being absorbed into Disney's tech team” and there have been longstanding tensions between both the Hulu and BAMTech engineering teams.
Loeb's argument for Hulu to be integrated into Disney+ effectively assumes:
The technologies are compatible (they are not)
The operational teams are compatible (they are not), and therefore
46.2MM Hulu subscribers who use the app will seamlessly shift over to Disney+ (that's a big ask of them, especially if #1 is no longer true).
The Entertainment Strategy Guy recently estimated that as many as 15.3MM subscribers are duplicated across Disney+, Hulu and ESPN, leaving somewhere between 26MM and 30MM Hulu-only subscribers. eMarketer projects Hulu will drive $4.5B in ad revenues for Disney in FY 2023, reflecting an annual growth rate of around 25%.
It seems awfully risky to reduce Hulu to a tile at the expense of so many operational risks, and ultimately a risk of churn. On this note I liked this argument from screenwriter Van Robichaux: “I think as Hulu’s sweetheart deals they secured when they were founded all start to expire they will become a major licensor. People expect Hulu to have lots of shows.”
Meaning, the Hulu algorithm will have value for surfacing shows that get lost on other streaming services with large libraries and weaker algorithms. That's a tremendous value proposition for media companies like Warner Bros. Discovery and Paramount Global who still embrace the arms dealer model. Why reduce that to a tile in an app?
New territory for *everybody*
Ultimately, what Malone and Loeb get "wrong" is that no one, not even Netflix, has a clear signal on what the consumers need from media companies. The growing predominance of the DTC paradigm amplifies the need to serve those needs, once identified, in multiple ways.
Malone's answer reads lazy in this respect: how does growth emerge with great TV series and great movies when there is no ecosystem for engaging consumers? As I wrote last week, "Warner Bros. Discovery inherited a road map for understanding its customers and keeping them happy. Throwing that out now seems suicidal."
Loeb is right in the sense that Disney needs to be more agile and dynamic in evolving its DTC relationships and businesses.
Last, it's worth noting both pitches seem to be honing in on DTC as a trade-off for operating income. The simplicity of Malone's pitch seems to be "operating income is best delivered from great TV and great movies served at scale". Whereas Loeb seems to be saying, "operating income is best delivered via spinouts and cost efficiencies".
As shareholders, I think they're right (and its their right) to focus on operating income as an issue. And even if Loeb is more right than Malone about the solutions, both misunderstand that the real challenge for media companies is that profitability and customer retention require as robust an understanding on consumers as possible.
That's new territory for *everybody*, and the solutions are, at best, hypotheses that require experimentation. The certainty in Loeb's and Malone's perspectives is ultimately what makes them "wrong".