On Wednesday, The Walt Disney Co. (DIS, Financial) announced a surprise restructuring plan alongside its first quarterly earnings report with CEO Bob Iger back at the helm. The company is apparently scrambling to cut costs, despite a solid performance on both its top and bottom lines for its first quarter of fiscal 2023.
Activist investor Nelson Peltz (Trades, Portfolio) welcomed the news by backing down from his proxy fight against the company. Some investors seemed to agree by bidding the stock up initially, though shares have fallen slightly in the days following the announcement.
At first glance, Iger’s restructuring plan may seem like a move that’s focused on rewarding shareholders. It follows what has become the standard Wall Street-placating formula of mass layoffs and other reductions in business investments. It even includes a promise to reinstate the dividend.
However, there are also some material downsides to this plan that investors need to take note of. These cost-cutting measures come at a critical time when Disney is facing intense competition in streaming, which was once supposed to become its main growth engine. It may be the case that such moves are needed to maintain the company’s financial strength, but is the stock priced appropriately when we consider a potential reduction the long-term growth outlook?
Iger’s restructuring plan
The restructuring plan that Disney is pursing mainly revolves around cutting costs related to content, technology and staff. Iger also re-iterated a statement he made when he returned to the CEO position – namely, that he would put “decision-making back in the hands of our creative teams and rationalize costs.”
The company says it has identified $3 billion in content-related cuts and $2.5 billion in cuts to non-content expenses. About half of the non-content cost cuts would come through marketing reductions, while 20% will come from technology, procurement and other expense reductions and 30% will come from cutting 7,000 jobs.
To put this into context, Disney’s operating expenses totaled $21.6 billion for full fiscal 2022, up from $18.6 billion in fiscal 2021.
A potential sale of Hulu is on the table as well. Disney currently owns 66% of Hulu (Comcast (CMCSA, Financial) holds the rest), and it even offers streaming bundles that include the service. Selling Hulu would slim down Disney’s streaming offerings, but it could get a decent chunk of cash from Comcast, which believes the streaming services could supercharge its streaming business beyond Peacock.
Disney will also be re-organizing its businesses into three segments for reporting purposes, with the new segments being Entertainment, ESPN and Parks and Experiences. Iger confirmed the separation of ESPN into its own separate unit does not mean the company is planning on spinning it off, though he also noted that with the upcoming negotiations for NBA rights, it would be more selective of what it is willing to spend.
The more nebulous and hard to define part of the restructuring is the part that involves giving more leeway to the creative minds behind the storytelling. Over the past decade or so, it’s become an increasingly common complaint among audience members that a lot of big-budget media (not just Disney’s) is no longer creative but is instead a stream of regurgitations of what’s been the most profitable in the past. Either that, or it’s contrived to some ideal of what corporate thinks will be more profitable.
“Our company is fueled by storytelling and creativity, and virtually every dollar we earn, every transaction, every interaction with our consumers, emanates from something creative,” said Iger on Wednesday. “I have always believed that the best way to spur great creativity is to make sure the people who are managing the creative processes feel empowered.”
Peltz’s proxy fight
Making headlines alongside Disney’s restructuring move was activist investor Nelson Peltz (Trades, Portfolio)’s decision to end his proxy fight against the company.
Peltz’s firm, Trian Fund Management, previously reported it had taken a 9.4 million-share stake in Disney’s common stock, though this holding has not yet been confirmed via 13F or other publicly available SEC filings. The firm then launched a proxy fight against Disney in January, pushing to get Peltz a seat on the company’s board.
Peltz laid out a case that centered on the destruction of shareholder value since Disney’s 2019 acquisition of Fox. He also criticized what he saw as poor corporate governance, which is no surprise given the debacle of the failed CEO succession in which Iger reportedly undermined and eventually ousted his hand-picked successor Bob Chapek. The company still has no clue who’s going to replace Iger.
With some of his main concerns addressed via the cost-cutting measures and other restructuring moves, it seems that Peltz no longer feels the need to pursue a board seat. “Now Disney plans to do everything we wanted them to do,” Peltz told CNBC’s Jim Cramer, suggesting that the other parts of the restructuring plan may have helped resolve his concerns over Iger and the rest of the management team.
Valuation and outlook
Reducing content costs and paying a dividend could help create shareholder value again in the short-term, but what about the long-term outlook?
I think the answer to that question depends on more than just Disney itself. For example, if streaming competitors also cut their content budgets, Disney won’t have as much risk of losing subscribers. If the other players vying for sports streaming rights also don’t want to pay as much, Disney may avoid losing out there as well. If we assume Disney+ and the other streaming services in the Disney family have already reached near the ceiling of its market saturation for now, then investing less on advertising for them could be a wise move.
Shifting the focus away from streaming and potentially even selling Hulu puts even more responsibility on the shoulders of Disney’s shows and movies as well as its parks, experiences and merchandise to help grow revenue and earnings going forward. Given how the stock’s valuation multiples have exploded ever since it entered the streaming wars, I think a further compression of valuation multiples could be in the cards. It may not go back to the days of mid-teens price-earnings ratios, but the current trailing 12-month price-earnings ratio seems too high at 59.35.
But what if every single cent of those cost-saving measures goes straight through to earnings? That’s not going to happen because scaling back spending on things like staff, technology, content and advertising tends to result in lower earnings. We won’t know how much of the cost cutting will translate to earnings until future earnings reports are released, but let’s go with a very optimistic estimate of 50%. That would mean earnings could increase by as much as twofold, bringing the price-earnings ratio closer to 30, which is still twice what it averaged pre-streaming but tracks with Netflix’s valuation as of this writing.
Overall, I think the most promising part of the restructuring is Iger’s pledge to turn more control over to Disney’s creative teams. This could help strengthen the company’s world-class intellectual property library, which has been and remains its main source of growth.
The cost-cutting measures are just the standard story of trying to reduce expenses and boost shareholder value amid a difficult economic environment when growth is harder to come by. I see this as more of a market-following adjustment rather than a material change in strategy. Disney was sticking to growth mode too long amid an economic slowdown.
