Judgment day: Quarterly earnings for Disney largely disappoint as predicted and result in a drop in Disney stock prices in after hours trading

We predicted it; now it's happened
Updated 8/12/16:

It's almost exactly a year to this day that the website Disneyleaks made its bold prediction a week ahead of Disney's August quarterly earnings call in 2015.

They said Disney's stocks would tank due to the revelations of major problems of cable subscriber losses at Disney's biggest profit-generating subsidiary ESPN, the 24-hour, all-sports cable network.

Since then Disney stock had tanked and has remained stagnant for over a year.

Now a year later, we made similarly bold predictions that Disney stocks will once again fall—when no one else would—on news that Disney's fundamentals were beginning to erode in all their divisions, except for their movie studios division.

Today, Disney announced their quarterly earnings ending on July 2, 2016 have largely fallen short of Wall Street projections across most of its divisions, except for its movie studios, during their busiest time of the year. It does appear that there are problems and issues in all of Disney's lines of businesses.


Disney reported quarterly earnings of $1.62 per share on $14.28 billion in revenues, which barely eked out Wall Street projections of $1.61 per share by a penny and $14.17 billion in revenues; however, the overall marginal gains were again exclusively attributable to a lopsided 39.6% increase in profits from the movie studios division, which is only Disney's third biggest revenue-generating and most volatile line of business.

The markets reacted badly to Disney's 3Q earnings call, announced after the closing
bell of trading on Tuesday. The sell-off began shortly after the announcement in 
after-hours trading on the announcement.
The movie business has been highly volatile and unstable for all media companies of late, and Disney's gains in the third quarter have largely come from a few blockbusters, such as Captain America: Civil War and The Jungle Book, released before the official opening of the summer movie season on Memorial Day, at the start of the fiscal third quarter, and from home video sales of Star Wars: The Force Awakens and Zootopia.

Since Memorial Day, Disney has missed on two of three summer tent-pole releases, including bombing on Alice Through the Looking Glass and The BFG.

So far, only Finding Dory has been a bright spot this summer for Disney, which puts Disney's last summer tent-pole entry, Pete's Dragon, under immense pressure to deliver box office gold next week against continuing Olympics TV coverage.


Given that most of the movie studios' successes were made prior to Memorial Day, before the official kick-off of the summer movie season, many investors question if Disney's movie studios are beginning to slump much in line with other movie studios, due to radical changing viewing habits of movie goers and the specter of losing business to online offshore video piracy and illegal video streaming sites.

Revenue numbers without corresponding sales volumes, attendance
numbers, and subscriber numbers muddy the rosy picture above.
Disney relied heavily on its volatile movies studios unit to barely
eke out meeting Wall Street projections this quarter, but it may
again miss analysts' expectations on the next fiscal quarter.
Without the unexpected and unpredictable 40% increase in profits from the movie studios division this quarter, Disney most assuredly would have fallen well short of Wall Street analysts' forecasts. (See revenue figures on the left.)

As a result, Disney stock prices dropped by 1.80% in after hours trading as markets reacted badly to the mixed results from Disney. The rest of the U.S. stock markets closed up today.

The quarterly earnings call announcement was made after the closing bell of the trading day, so the bigger drop might come during the remainder of the week when trading resumes.

This is the second straight fiscal quarter that most of Disney's divisions reported less than stellar growth numbers in revenues, but no one else reported that Disney would falter this badly except for us.

Just looking at the numbers, we knew this bad news was coming since last month.

At earnings projections of $1.61 per share and $14.17 billion in revenue for this quarter—that would be an 11% and 8% increase from the same period last year—these benchmarks were just too lofty to meet for any company, and also puts immense pressure on Disney to perform for the next fiscal quarter.

Disney's primary cash cow ESPN again reported a significant decline in subscriber numbers, which now only reaches 88.8 million households, due to cord-cutting and cord-shaving continuing to erode ESPN's cable bundle subscriber base.

ESPN has lost 4 million subscribers so far just this year, according to A.C. Nielson, and that number is continuing to increase year after year. Cord-cutting is accelerating with no signs of slowing down.



Wunderlich Securities estimates more than 60% of ESPN's revenues come from affiliate fees, which in turn, come from cable bundle subscribers who pay $7.21 per month in ESPN affiliate fees, whether or not the subscriber watches the channel and before adding all the other fees from all the other ESPN channels, according to SNL Kagan.

Media Networks is Disney's largest revenue-generating division, accounting for 53% of Disney's operating income in 2015.


To offset this predictable bad news, Disney announced it had acquired a 33% stake in BAMTech, a video streaming service focused on streaming Major League Baseball games, for $1 billion, to pivot away from investors' growing concerns about ESPN.


However, this new online acquisition seems to counter the business model established for ESPN and may quicken the cord-cutting phenomena against ESPN's business interests if consumers are given the choice of picking one or the other.


Whether or not online consumers, who are used to seeing broadcast sporting events for free, will pay a premium for this expensive mobile streaming online video sports service remains to be seen, and it also remains to be seen whether revenues generated by this untested online service can make up the difference in huge losses from cord-cutters for ESPN.


However, what is known is that ESPN will not offer access to its its full line of premium professional and college sports broadcasts on its proposed standalone, on-demand, digital, live-streaming online service, which it plans to unveil later this year. This has many shareholders grumbling because it leaves no solution to the bleeding caused by cord-cutters for ESPN's cable bundle subscription-based business model.

Is Disney down and out? We'll find out when the full market
reacts this week after the news of the Q3 earnings call settle in
In Disney's other lines of businesses, we have noticed that, even during Disney's peak season for their various business operations in the summer, all of their divisions have been slumping off of their normal sales volumes from the usual traffic numbers we have been used to seeing in the past.

Unfortunately, Disney doesn't disclose any of its hard volume numbers for investors—whether that is cable subscriber numbers or theme park attendance numbers—which they seem not to do for a reason.

It's pretty obvious why Disney isn't completely transparent in its disclosures with its shareholders about key sales numbers since those kinds of metrics generally are the best indicators of how good or bad business is doing, and nobody hides how bad business is doing from investors and security analysts better than Disney.

For instance, everyone knows that Hong Kong Disneyland is still precipitously dropping in park attendance; however, to make it seem like Hong Kong Disney has turned its fortunes around, when it really hasn't, Disney had massive layoffs at the resort, despite continuing declines in their attendance numbers.

Thus, the deceptive revenue turnaround appears to be a red herring for Hong Kong's slumping attendance numbers.


Disney unfortunately let it leak that Shanghai Disney's July attendance numbers were under a million visitors in the month of July, and Disney CEO Bob Iger even let it slip that attendance numbers at both Disney's U.S. parks were down more than 4%.

Bob Iger did his best Pinocchio impersonation on Tuesday when he claimed the
larger 'Florida problem' of the Zika viral outbreak, Brexit, higher ticket prices, and 
slumping Latin American tourism numbers was not affecting attendance numbers 
at Walt Disney World or bookings to Disney Cruise Line, but we've seen this exact
same lack of honesty from him before last year during the disastrous measles 
outbreak at Disneyland. (See videos above and below.)
Iger admitted this revelation of slower traffic to Disney World despite the fact that he denied that worries over the Zika virus, drop in tourism number from a number of Latin American countries due to political instability, poor currency exchange rates with the U.K. as a result of the Brexit vote, and competition from the Rio Olympics had any effect on lower visitor numbers to U.S. Disney theme parks.

Iger's implausible denials also come on the heels of Disney World announcing hotel room discounts during what is supposed to be Disney's busy Christmas holiday from Nov. 6 to Dec. 23, after resort management noticed a dramatic slow down in hotel bookings for the last four months in the entire Central Florida region.

His less than honest response was no different than when Iger said park attendance at Disneyland was not affected by the measles outbreak from early last year, despite the fact that numerous media outlets reported that attendance at Disneyland was down in the first and second quarters of last year in the fallout of the measles outbreak that began at Disneyland and spread to several and states and three countries.

This this appears to be a contradiction with what he reported with falling attendance numbers in the theme parks this quarter from the so-called "Florida problem" and suggests a full disclosure of the park attendance numbers would have settled the issue, once and for all.


But given the fact that Disney World laid off many workers and significantly decreased new hires and working hours for existing cast members, it suggests Disney World has already been significantly affected by the larger "Florida problem" of losing tourism dollars.


Revenues at Disneyland Paris were also significantly worse, down 10% from 360 million to 327 million euros due to continuing fears from terrorist attacks by ISIS all over the EU.

Disney has all but given up on Disneyland Shanghai in convincing investors that
its newest theme park will be the major growth catalyst for its stock, so now they've
pivoted their strategy by testing the uncharted waters of the online video streaming 
service BAMTech as its means for future growth. The problem is it still doesn't solve 
Disney's problems with ESPN with cable bundle subscriber losses from cord-cutters,
and Disney is merely dipping its feet into this particular online business before it
decides to take the plunge. At this point, it's all just a wait-and-see fishing expedition.
However, there is no way we can make heads or tails about just how good or bad the financial numbers are doing because the attendance numbers at all their theme parks are hidden from the public's view.

To distract away from some of these concerning attendance losses at the theme parks, Disney laid off all the imagineers who designed the Shanghai theme park, cancelled all the expensive Diamond Anniversary nighttime shows at Disneyland, and laid off many workers at their U.S. theme parks, just so that investors would overlook any news of slumping attendance numbers with news of artificially increased revenues at those parks; however, the problems with decreasing attendance numbers still remain an issue.


There's no doubt that Disney theme park managers have been given orders to slash their budgets to the bone to make Disney Theme Parks & Resort number look as good as possible to offsets losses in other divisions.


In other units, however, Disney simply wasn't fast enough to cover-up the damage done from their slumping businesses. Income for Consumer Products & Digitial Interactive unit was down 7% year over year while income for Disney's Media Networks unit was again flat on slumping ABC ratings numbers and flat cable TV revenues.

Cable Networks income only grew 1%, despite massive layoffs and budget cuts, and ad revenues for ABC TV fell more than 4% due to continuing double-digit ratings drop at the network.


The explanation for drooping sales at Consumer Products was attributable to sagging merchandise sales of other Disney intellectual properties (e.g., Star Wars, Marvel, Disney, and Pixar) after the losing momentum from Frozen movie merchandise last year.

Shanghai Disneyland has not take-off out of the gates in China yet, suggesting
very difficult problems with promotion and marketing in mainland China
This may be concerning because, even combined, Star Wars, Marvel, Pixar, and other Disney merchandise could not make up the losses from declining Frozen merchandise sales from one single franchise, suggesting Disney's other franchises combined aren't as hot as their box offices would indicate.

Also particularly concerning for Disney was its less than stellar attendance numbers coming out of Shanghai Disneyland after their first month of operations in July, which is traditionally one of the busiest months of the year for any of the Disney theme parks worldwide, after Disney's CEO Bob Iger had hyped its newest $5.5 billion resort in mainland China as its biggest catalyst and future driver for growth at the House of Mouse.

Given the huge potential of the mainland Chinese market of being the second richest economy and the most populous nation on Earth, in arguably the most populous city on Earth, Disney had expectations that Shanghai Disney would very quickly become the most visited theme park in the world; however, things have not materialized to justify those lofty expectations.


Disney initially estimated that Shanghai Disneyland would see at least 15 to 30 million visitors a year. In comparison, Disney World's Magic Kingdom, the most visited theme park in the world, saw a record 20.4 million visitors last year, according to third-party estimates released by Themed Entertainment Association (TEA.)



Disney reported less than a million visitors in the month of July without actually going into the specifics on their actual attendance numbers from the park; however, there is enough information there, knowing that the actual numbers are less than a million, to make some educated estimations on Shanghai's projections for the upper limits on its yearly attendance numbers.

Video piracy is becoming a big problem for the movie industry as viewers no
longer have to download pirated video content to view it; instead, they can
simply stream it on their computers without having long wait times to 
download bulky files
Given that July is likely the busiest month of the year for tourism in mainland China, attendance topping out at less than a million visitors in July would make Shanghai Disney's yearly attendance projections around 8-10 million visitors, which is about 33% to 66% below Disney's initial attendance projections.

Clearly, these are concerning numbers for Disney since there were concerns already that opening a Disneyland in mainland China would severely impact the operations of Disney's already struggling Hong Kong Disneyland, which will have to compete with Shanghai Disneyland for the same mainland Chinese tourists' Yuan.

In fact, the opening of Shanghai Disney may put in the final nail to the long-struggling Hong Kong Disney theme park.

Thus, it was paramount for Shanghai Disney to be a runaway success for Disney from the get-go to offset problems created in cannibalizing Hong Kong Disney's attendance numbers.


But the biggest problem for Shanghai Disney seems to be in publicizing what differentiates it from other emerging theme parks from other developers that are being built all over mainland China. Disney was not allowed to have any significant media presence in mainland China due to the Communist Politburo's concerns to keep a stranglehold on controlling media content in the mainland.

Numerous offshore streaming video piracy sites will likely change viewing
habits of movie goers for years to come. As this technology improves over
time, expect theatre and home video revenues for the studios to drop.
Thus, Disney has not had the traditional means to publicize and market its theme parks, products, and other services in a way that it has had over its competition in other places that Disney had built its theme parks.

There are even reports from the media that Chinese visitors are fed up with Shanghai Disney's numerous glitches, inflated prices, and have already become less than enthused by what the park actually has to offer.

Thus, Disney's marketing disadvantage in mainland China seems to have leveled the playing field somewhat for other local theme park developers, such as the Dalian Wanda Group, to compete head-on with Disney with an advantage in the sheer numbers of theme parks they have or will build in China and by offering significantly cheaper ticket prices.


In addition, the lack of copyright and trademark protections in mainland China seem to have also leveled the playing field for competitors to feature the same Disney-owned characters in their theme parks and sell cheaper, pirated, knock-off Disney products to Chinese consumers.


All these factors may explain why Shanghai Disney is not the runaway success that Disney had hoped that their huge investment would materialize into, out of the gate.

Instead, it may take years, if not decades, before Disney will make back its money on its investment, much like its other struggling foreign theme park failures, such as Hong Kong Disney and EuroDisney. Thus far, Disney's all of foreign theme park operations—with the exception of Tokyo Disney which is not even owned by Disney—have been a total train wreck.


As for the rest of the reasons why Disney's business fundamentals are eroding, you can read more about them in our previous article, which predicted what would happen today in greater detail during Disney's earnings call.


So, the big question is: How will Disney stocks do in the future, especially given the fact that the rest of the stock market is doing so well? 

It looks like Disney stocks will remain stagnant, or even drop, for some time.
The movie sector, which is a distant third in the amount of revenues generated by various divisions at Disney, is too highly volatile to expect reliable double-digit growth numbers for the Empire of Mouse, quarter after quarter, especially in the face of the rapidly changing digital landscape of booming illegal video streaming services and rampant video piracy taking place online. 

Rogue One may be a misstep for Disney as many critics have said there really wasn't anything new to energize the Star Wars franchise from the mediocre-reviewed Episode VII, and how many Avengers movies will Disney release before movie audiences get tired of seeing the same thing in a tired B-list super hero team-concept comics franchise?

There are still numerous unsolved problems in the media networks sector, especially with dwindling subscribers for Disney's biggest cash cow ESPN and dipping ratings at the ABC TV network. 

Disney is merely dipping their toes in the untested online streaming video service business with their latest experiment BAMTech, as they have before with Maker Studios, Hulu, and Vice Media. Thus, this is not a significant strategic pivot in finding a major catalyst for growth for Disney as no one will interpret this move as one in which Disney embraces cord-cutters.

Disney is in danger of falling well behind their competitors (e.g., Time-Warner, Netflix, etc.) in offering digital, on-demand, stand-alone, over-the-top services for any of its content. Disney's first baby steps in its proposed digital stand-alone online service for a very limited version ESPN has, so far, been met with extreme skepticism by Wall Street.


Consumer products and digital interactive units were down significantly by 7%, suggesting the real story here that consumers have become blasé about Disney various movie franchises (e.g., Frozen, Star Wars, Marvel, Pixar, and other Disney intellectual properties) as merchandise is not flying off the shelves anymore.

Even the Force was not with Star Wars merchandise sales as consumer products
dipped by 7% as Frozen merchandise sales had been the real driver for growth
in the last few years. Now as the enthusiasm for Frozen is waning, all the other
Disney franchises combined (Star Wars, Marvel, Pixar, Disney, etc.) cannot
make up the difference.
As reported last quarter, announcement for Disney's Infinity digital interactive division was shuttered last quarter, and Maker Studios is struggling, announcing layoffs.

Theme parks attendance numbers and Disney Cruise Line bookings are continuing to drop everywhere and will continue to decline well into next quarter with fears of terrorism, fears about the Zika virus, slumping tourism from key Latin American countries, poor international currency exchange rates against a strong dollar, and competition from the Rio Summer Olympics.

And decreasing enthusiasm from the Chinese and a lack of media penetration in mainland China may stifle growth numbers in Shanghai Disney for a number of quarters before Disney makes its money back on its $5.5 billion Chinese investment.

Based on what we see so far, we expect Disney stock to remain stagnant or even drop as there are few catalysts to be excited about that will demonstrate any significant growth for Disney's stock prices. 


Sources: 

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