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8 August 2019

Disney streaming costs approach $7bn, price hikes before long

With just three months until the curtains are drawn on Disney+, the ship looks unsteady as costs associated with the streaming launch bogged down Disney’s second quarter results. Qualms were relieved somewhat through the revealing of an enticingly priced three-course platter costing just $12.99 a month – but Disney cannot sustain this cutthroat price for long.

An operating loss of $553 million plagued Disney’s direct-to-consumer division during Q2, directly linked to the upcoming OTT video service. But why is everyone so surprised? Even CEO Bob Iger described the results as “difficult to explain”. Leave it to us.

Our Disney streaming coverage has consistently highlighted how there is so much riding on the launch of Disney+ that any technical flaws will be feasted on by the media and already outlets have expressed doubts about Disney’s credibility as an OTT video platform, from a technology standpoint at least (Faultline Online Reporter included). Such monumental pressure on a global stage means Disney isn’t willing to take any chances.

“Nothing is more important to us than getting this right,” said Iger this week, rather aptly. Iger again mentioned discussions with the likes of Amazon, Apple and Google as distribution partners, saying that Disney+ is certain to conclude deals with these companies to achieve scale and achieve it fast.

If we take the $2.5 billion Disney spent acquiring the video streaming technology business BAMTech back in 2017, around which its streaming strategy has been constructed, and accumulate this initial cost with recurring losses, the situation does not look pretty.

Full year 2018 results showed losses of over $1 billion associated with ownership of Hulu and BAMTech, while Q1 2019 operating loss for the D2C segment more than doubled to $393 million. On top of Q2’s operating loss hole to the tune of $553 million, losses for the first half of 2019 associated with the D2C division already total $946 million – making it nearly $2 billion in losses over 18 months. Disney forecasts D2C losses to inflate further to $900 million in the next quarter, again doubling from quarter to quarter. At this run rate, fourth quarter 2019 losses associated with video streaming will hit $1.8 billion.

Throw the BAMTech purchase price into the mix and D2C operating losses are set to exceed $7 billion by year end, without factoring in other costs incurred before 2018 on top of ballooning production and licensing costs. The House of Mouse is creating a financial mountain that looks increasingly insurmountable.

It’s worth noting that Disney rebranded BAMTech to Disney Streaming Services (DSS) in October 2018. DSS is responsible for all backend technical components for the company’s streaming businesses – the brains behind ESPN+, Hulu and now Disney+.

And that’s just the technical side. We are yet to factor in the costly content pieces of the puzzle. Disney’s content strategy is heavily US-centric, resulting in very high content production costs, in stark contrast with Netflix which has laid down international roots and struck up collaborations on the ground, including foreign language material. Netflix is several years ahead of Disney on that front and, as the latter catches up, content costs will escalate in those territories, partly because of the growing competition.

So, Disney’s aggressive pricing combined with loss of revenue associated with pulling its content from Netflix will itself constrain investment. The company faces operational losses even though planned expenditure on original content specific to Disney+ is quite modest compared to Netflix; $1 billion for 2020 rising to the mid-$2 billion range. Disney is targeting 300 movies from its own studio on launch day and over 400 in year one.

Away from the finances now. Disney used its Q2 results to provide details on its bundling and pricing strategy. We have long known that packaging together its three streaming assets of distinct flavors – Disney+, ESPN+ and Hulu – was on the agenda. A standalone subscription to Disney+ will cost $6.99 a month, yet we did not expect the triple package to be priced as low as $12.99 a month. This is an aggressive initial stance from Disney which will certainly help it cherry-pick subscribers from rival streaming outfits. However, with costs spiraling, our guess is that Disney will hike streaming prices across the board after a year.

Total revenues for the quarter climbed 33% to $20.2 billion, while net income disappointed with a 51% decline to $1.4 billion. It was a quarter of box office records for Disney with the likes of Avengers and Toy Story 4, helping the studio sector grow sales to $3.9 billion in the quarter. Yet Disney’s other studio assets, acquired from 21st Century Fox for $71 billion, were well under target, which it blamed on slow decision making as an inevitable side effect of any recent acquisition.

Circling back to technology now for an exitlude from Iger. “We continue to look very carefully at the tech platform. We’re most focused on not how robust it is because we believe we have that already, but we’re most focused on the onboarding experience and making sure that people who sign up as subscribers for the service do so with incredible ease. We know how important it is to create a frictionless experience, and there’s a lot of time being spent on that.”