Disney’s stock has treaded water for three years now at $100 a share or a $150 billion market capitalization. That’s mainly because Wall Street views it as a media stock in secular decline with its highly profitable cable networks disappearing without a clear path to an equally profitable over-the-top (OTT) future.
Disney — like all traditional media companies — is viewed by Wall Street as being worth nine to 14 times its enterprise value (EV) to EBITDA. But that’s the wrong way to view it. Disney should correctly position itself as a “Disney as a Service” company. If it did, it would get valued — like other services companies — on a price-to-sales (P/S) basis.
Other subscription-based businesses — like software as a service (SaaS) companies — get valued at a much richer valuation than traditional media. Salesforce.com has a trailing price-earnings (P/E) ratio of 732 times. Its P/S ratio is 8.7 times. Many smaller, faster-growing SaaS companies — like Workday, for example — get P/S ratios of 12.5 times. Disney’s, by contrast, has a trailing P/E of 14 times and a P/S of 2.7 times.
Yet, unlike most media companies, Disney has the opportunity to quickly reshape its perception on Wall Street and be seen as a powerful subscription-based service offering access to unique online and offline experiences on a repeatable timeline.
It wouldn’t be the first public company in recent years to embark on such a shift. Several have recently converted Wall Street’s perception of them from a traditional P/E-based valuation to a subscription-based one using a P/S one. This shift has greatly benefited their shareholders.
Adobe used to sell a one-off, license-based software package to creative and corporate professionals. Prior to its public announcement of a move to a subscription-based business model in May 2013, Adobe’s P/S ratio was around four times. It’s now 14.5 times.
Before Satya Nadella took over as Microsoft’s CEO in February 2014, Microsoft was seen as a take-all-the-money-upfront software company. Its P/S ratio low the year before Nadella’s hiring was 3.3 times. After he took over, he put a much greater emphasis on the cloud (which he had previously been responsible for) and turned Microsoft’s popular core software apps like Office into subscription-based services (Office 365). Today, Microsoft’s P/S ratio is 6.9 times and its share priced has tripled after being flat for a decade.
The latest big product-based (and P/E-anchored) company to put an emphasis on subscriptions is Apple. Starting in early 2016, Apple began mentioning its “services” revenues during its earnings calls. At that time, Apple’s P/S ratio was 2.2 times. In the most recent earnings call earlier this week, Apple pointed out that it now has 270 million subscribers to its services (compared with 100 million Amazon Prime subscribers and 125 million Netflix subscribers). It’s not just a narrative. Analysts noted that its services revenues were now 15 percent of Apple’s total or $9 billion in the recent quarter.
In fact, that 15 percent number is understated. A lot of Apple’s hardware revenues are for the iPhone. But iPhones get upgraded every two to four years by most — if not all — of those 270 million Apple “subscribers.” CNBC’s Jim Cramer correctly pointed out this week that this is a razor and razor blade model. That’s a subscription.
So, what is Apple’s P/S ratio today since the shift to a services model? It’s 3.7 times — nearly double what it was two years ago.
The reason why investors are willing to pay more for subscription- or services-based revenues is simple: These revenues tend to be (1) sticky and (2) higher margin.
Which brings us to Disney.
Disney’s biggest problem isn’t a substantive one. It’s a narrative one — much like Apple two years ago.
Wall Street thinks Disney sells stuff on a one-off basis. Sure, they have a big hit with “Avengers” this week, the thinking goes, but will that last? High-margin cable service subscribers are cutting the service and investors don’t understand what’s going to replace that in equal amounts of profits.
In my view, Disney needs to think of itself as “Disney as a service” — much like Apple now discusses services. It needs to reorient itself into knowing exactly how many global subscribers it has and how much stuff it’s selling on a regular basis to those subs.
Netflix isn’t getting judged by Wall Street on its profits. It’s getting judged by its global subscriber count and the prospect that it can keep upping the price for its streaming service. Why shouldn’t Disney be judged by its potential for amassing a huge number of global subscribers and charging them a lot over time?
If Disney understood how to reorient itself as a Disney as a service company and it projected that to Wall Street, it could have a much higher stock price. (Matthew Ball wrote an article titled “Disney as a Service” in REDEF two years ago but it was only about launching a streaming service and not the broader concept I discuss across Disney’s portfolio of assets.)
Here’s how it would work.
Today, most families spend a lot of money on Disney stuff every year. Disney content and experiences appeal to all ages. The parents and older kids like to see “Avengers” and “Black Panther.” The parents and younger kids like to see “Toy Story.” The sports fans want to see live sports. The mature adults want to watch “The Handmaid’s Tale.” The kids want to watch “Tangled.” The tweens and teens want the equivalent of “High School Musical.” Little kids want to dress in Elsa and Anna outfits. The whole family enjoys going to Walt Disney World or on a cruise or to a Broadway show.
If I assume the typical family (with two kids) goes to a Disney Park once every three years and sees two Disney movies a year in theaters, and buys some Disney merchandise, and subscribes to the big Disney cable channels today, that household is spending about $2,000 a year or $116 a month on Disney stuff. That’s a lot. And the biggest part of it is the trip to a Disney Park — something that no other streamer or traditional media company has (unless you count Comcast’s Universal Studios).
Just how important are the parks to Disney? We know that the parks division is going to surpass media networks in a couple of years as generating the most profits for the company. We also know that about 140 million people attend all eight Disney parks annually. These parks also charge top dollar for a unique and high-quality experience. Go to the parks’ website and type in that you want to buy three days of passes for a family of four. You’re going to spend around $2,500 just on tickets — before the Disney hotel while you’re there, the food, and the Disney gear you’ll buy for the family.
If you go once every five years to a Disney park, what if Disney offered you a Disney as a service monthly subscription for say $20 a month that gave you access to significant discounts to its parks/cruises/merchandise? Would that make you consider going once every three years instead? Think of the extra hotel and concession revenues that Disney would generate from those extra family trips.
What if Disney as a service allowed you free access to ESPN+ (including the flagship sports content when it eventually transitions over), free access to the Disney entertainment streaming video on demand (SVOD) service launching next year (which will include some exclusive Disney movies, TV series and kids content), as well access to Hulu for the adult stuff?
And now imagine a world — three years from now — where the only place you’ll be able to watch “Avengers 6” is on your Disney SVOD service? Is your family willing to pay $20 a month for that? That seems like a no-brainer if “The Handmaid’s Tale” is what finally pushed you over the edge just to subscribe to Hulu.
If Netflix has 125 million global households today subscribing to its service, how many could Disney get in five years from now? I think it’s reasonable — especially as China continues to see its middle class grow exponentially — that Disney could attract 300 million subscribers to pay $20 a month for Disney as a service. That’s $72 billion in subscription revenue a year.
Today, Disney has $55 billion a year in revenues. And for that, it gets a piddly 2.7 times P/S ratio.
Apple is currently at a four times P/S ratio, and probably on its way to a six times ratio in the future — which would put it in line with Google. If Disney got a six times multiple of its Disney as a service $72 billion annual revenue stream — plus a 2.7 times multiple on the legacy cable subscribers, plus extra merchandise and parks revenue it retains (let’s assume it’s 75 percent of today’s $55 billion in annual revenue) — you get to a potential 2023 market capitalization for Disney of $543 billion, compared with $149 billion today.
A 3.7 times increase in Disney’s stock price over five years is a vision which all of Wall Street would rally around. That’s preferable to a $100 a share stock price for three years running. And, by the way, if Disney management was focused on expanding its P/S ratio instead of its EV/EBITDA ratio, it would no longer care about doing stock buybacks. Instead, it would likely spend that extra money — as Netflix does — on getting the next 50 million of global subscribers.
A Disney as a services perspective would finally get Disney management off the treadmill of answering to whatever the linear cable subscriber loss was last month. Who cares about linear subs (although they remain highly profitable) when you’re growing global subs to 300 million by 2023?
And Disney has the content to pull this vision off with its studio, sports rights and now Fox assets coming into the fold.
And the best part of this strategy is that — despite the idea of “Netflix becoming Disney faster than Disney can become Netflix” — Netflix will never be able to borrow enough in the debt markets to replicate Disney parks. Disney would be playing on its home turf instead of trying to win on Netflix’s ground.
Disney as a service: An offline and online subscription package to appeal to all families around the world, whether it’s a family on the Upper East Side of Manhattan or a “Tier Four” city in China. It’s a winning vision for Disney customers, management and investors.
Disclosure: Affiliates controlled by Eric Jackson hold long positions in Disney, Apple, and Netflix. Comcast is the owner of NBCUniversal, parent company of CNBC and CNBC.com, and is a co-owner of Hulu.