Walt Disney Co. (DIS) CEO Bob Iger was emphatic with investors this week: "This isn't just a defensive move, it's an offensive move."
But the announcement on Tuesday, Aug. 8, that Disney will launch a new subscription-based ESPN digital service early next year followed by a souped-up Disney-branded TV/movie streaming service in 2019 is a reaction to two overarching realities: ESPN is losing subscribers at a faster and faster pace, and Netflix Inc. (NFLX) is sucking away more and more total audience viewer time, cutting into Disney profit both via pay-TV and at the local movie theater.
Disney had to do something on both fronts.
"Disney's decision to shift its distribution strategy towards a direct-to-consumer model leans into the accelerating shifts in video consumption," Credit Suisse media analyst Omar Sheikh said in an investor note on Wednesday. "Ahead of us we now have a period when ... growth will be diluted by investment, but we believe the company is laying the groundwork for a stronger future."
Investors with short-term concerns weighed on Disney shares Wednesday. Shares were down 4.9% to $101.77 in the morning after the company's most recent earnings fell short of expectations, and analysts warned that profits may slip due to increased investment in the new platforms.
Unquestionably, Disney's announcement that it will launch a a direct-to-consumer service for ESPN (largely expected) and a general TV/film service (a bombshell of sorts) marks a momentous shift in the business model for the company's largest division, television media.
By incorporating a direct-to-consumer model alongside its existing pay-TV distribution channel, Iger is creating an internal tension that he generously described as "optionality." Exactly what these two new services will look like and whether either will cannibalize Disney's existing businesses remains unclear.
The subscription-based standalone ESPN app will likely serve as an "add-on" for subscribers to the flagship cable network. Depending on what content is included, it could attract millennial consumers loath to take out a full-blown cable subscription. We just don't know yet.
Either way, Disney is signaling that cord-cutting has finally reached a tipping point. While still quite profitable, ESPN is simply not as profitable as the company had projected this far into fat TV-rights contracts for the National Basketball Association and Major League Baseball. It's likely that Disney sees the future and is expecting more subscriber declines at its sports channel.
Though Disney doesn't reveal its subscriber numbers, declines have increased to somewhere near 3%, according to Bernstein Research media analyst Todd Juenger. If that's the case, "the rate of decline is accelerating," he said in an investor note.
As for going direct-to-consumer, Disney is arguably playing catch-up. Time Warner Inc. (TWX) moved HBO to a standalone service three years ago, and CBS Corp. (CBS) followed with its CBS All Access service in late 2014. Nine months later, it launched a digital version of Showtime. Earlier this week, CBS said that the two services combined to amass more than 4 million subscribers. Those aren't Netflix numbers, but then again, they're not CBS's core business either.
To be sure, Disney is unlike any other U.S. media company. No single company has the collection of studios along with a film and TV library to come anywhere near Disney. With control of streaming technology company BAMTech, Disney can begin to build a multichannel subscription-based platform to rival Netflix. It also gives Disney the option to go around pay-TV providers with its content, including ESPN.
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"This is a good strategy for them in the long run, because they have niche content with super followings," said Shahid Khan, founder of Mediamorph Inc., a digital content supply-chain software company backed by Liberty Global plc (LBTYA) and Advance/Newhouse Partnership. "Disney has global appeal. Disney is one of the few companies that actually has the brand to pull together its own direct-to-consumer play. In the long run, the [return on investment] on this is going to be huge."
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