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Disney+ subscriber surge leads to surprise profit in Q1

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Yahoo Finance’s Myles Udland, Julie Hyman, and Brian Sozzi break down Disney’s latest earnings report with Markus Hansen, Vontobel Quality Growth Portfolio Manager.

Video Transcript

MYLES UDLAND: But let's stay on Disney for right now and talk a bit more about how investors are seeing this move. Markus Hansen joins us now. He's portfolio manager at Vontobel Quality Growth. Markus, you just heard our conversation about Disney, and I'd be curious how you guys are thinking about the future of the business and the future of their earnings power, given the shift that we're seeing towards the Disney+ service. The parks, we expect will come back in time, but just the way that they're monetizing their content itself. How are you thinking about that?

MARKUS HANSEN: Yeah, look, it was an impressive update. Prior to this, in December, they held a big investor day talking about the future content slate, all about their streaming product. And so expectations were fairly high going into this. I think what they reinforced were two things. Firstly, as your commentator mentioned, although they haven't changed their guidance, certainly getting to profitability and profit growth from the subscriber business, on the DTC side, looks like it's going to come earlier.

And this is impressive on the subscriber numbers, because remember, going into this, the amount of new content they've added has been limited because of the COVID impact. So going forward, I think there's a lot of excitement about the new slate they have coming, and that's very positive. Coming back to the park side of things, what's really impressive is with just about 30%, 35% capacity in only half the number of parks they have, they've almost, basically those parks which are open are at profitability or break even.

And more importantly, I think the one comment on the call, which was made maybe a couple of times, was the pent up demand they're seeing for the reopen. So as we roll into 2021, and obviously this depends on the scale of the vaccines coming out, but more importantly, going into '22, we have the two powerful engines kicking in for this company.

One, this global streaming platform. And just to mention again, this is a global platform, so the total addressable market for Disney+, the new Star platform, which is basically Hulu international, and eventually down the road, ESPN, as you commented, that could become the platform for streaming of sports events going forward, can be big, very big.

And then behind this, you have the core operating business, which is the traditional moat, the real jewel in the crown, which is their parks business. And on top of that, their movies business, which they will continue to roll out. I mean, the whole experience to go see a big movie like "Avengers Endgame," you're going to go see that on an IMAX and pay for that. This gives you significant earnings power, which is above anything we're forecasting right now going into '23, '24.

Now the second part of that story is what kind of multiple do you ascribe to this. Subscriber-base businesses, high barriers to entry business like parks traditionally should carry a high multiple. I think investors are excited by the volume upside and now the pricing upside of the business. And kudos to Bob Chapek. This has been a big pivot, a big transformation of the group at a handover of CEO-ship time, and they're executing, despite everything that's going on with COVID.

JULIE HYMAN: Markus, just to take a bit of a step back, I'm always curious when a company beats by this kind of margin. I guess this is sort of an analyst process question, but also a Disney-specific question. Analysts on average were looking for a pretty steep loss from Disney, and they delivered a profit. How does that happen, first of all, in terms of that gap between expectations and reality? And in the case of Disney specifically, what sort of levers did it pull to get there?

MARKUS HANSEN: Right. A very good question. So firstly, on the direct to consumer, the DTC streaming stuff, there, the subscriber numbers have accelerated faster than people expected. So coupled with the fact that the bulk of this is their own IP content, they're able to manage costs and remember, the bulk of this DTC platform has been done with very little new production coming in. So they've taken the existing IP library, a couple of new things in, but nothing like to the likes of some of their peers. Going forward, that should improve. So the cost side of DTC should pick up, but now off a much higher volume base.

Parks was the real big surprise. Most people, a theme park is a big fixed asset, right, you put it there. A lot of people expect these things anywhere below 50%, 60% capacity are going to have a hard time just breaking even profitability and cash flow-wise. What they've shown with, let's take the case of Florida, which is the single biggest, most important park, at a 35% capacity level, they're breaking even, making some money.

Now there's two things that go into that. One is the actual traffic volume that goes in. And the thing is, what are people spending when they go into the park. And what has surprised on the upside is their ability to contain costs at that level of open, of the park. And this thing, there are certain things which aren't happening, certain exhibitions and shows, so that reduced the cost.

But more importantly, the customers who are going, and demand is very strong to the extent that they mentioned, they have several days during the week when they're at full capacity at that level already, these people are spending more money. So if you've ever been to Disney, by the time you walk through the main gate and walk down that bit of Main Street, you're already spending a fair bit of money on trinkets, drinks, food and so forth.

The customer base that is going obviously is a dedicated customer base, to be fair. They're enjoying this and they're spending more money. So put it all together, a combination of good cost control, better income coming from the park side of things, and then on the DTC side, I think a good control of the cost elements going into that. And that's where the pivots come. And I think the excitement is really showing that operating leverage through this kind of environment has been impressive.

Part of that is, they did gain some early experience of what happened in Shanghai with COVID. They were able to transfer that to their businesses in the US. And we've seen that with some other companies that had earlier exposure to the COVID issues in China. And again, kudos to Bob Chapek. This is the parks guy, so I think he gets that. But more importantly, he's been able to follow on this execution of the pivot to the DTC side.

BRIAN SOZZI: Markus, I have 15 seconds left. Are you buying the stock this morning?

MARKUS HANSEN: So we've been shareholders for a while, we've owned it for a while, we have been adding recently. We continue to see the significant, certainly over the next two years, significant earnings power upside, and we don't think that's fully reflected in the current share price.

MYLES UDLAND: All right, Markus Hansen, Portfolio Manager at Vontobel Quality Growth. Markus, great to get your thoughts this morning. Thanks so much for joining the program to chat a little Disney.