Will Walt Disney's Star Wars Prove To Be White Knight In 2016?

  • Walt Disney continues to face weaknesses in its cable segment due to subscriber loss.
  • The company's other revenue segments, particularly the Studio Entertainment and Consumer Products are doing well.
  • Specifically Disney's upcoming Star Wars is slated to not only break box office records, but also bring in record revenue from related Consumer Products in 2016.

Walt Disney shares have plunged 4% ever since the company revealed in its latest 10-K that ESPN, the biggest channel in its cable segment bringing in 33% of Walt Disney’s revenue, had lost 3 million subscribers to end fiscal 2015 with 92 million subscribers, a 3.2% Y/Y decline. The last time Disney had that few ESPN subscribers was a decade ago.
I discussed the problem of loss of subscribers for ESPN in an earlier article. In the article, I pointed out that Disney had so far been successful at offsetting loss of revenue associated with subscriber loss primarily with higher affiliate revenue. Affiliate fees refers to the fee that Disney charges cable providers for the privilege to broadcast its channels. ESPN affiliate fees are the highest in the industry by a mile, which at $6.55 is more than triple what second-placed TNT charges cable companies. But of course, there is a limit to how far Disney can keep hiking its affiliate fees to keep offsetting subscriber loss. Even though the company is projected to hike its ESPN affiliate fees another 10% in 2017 to $7.20, it cannot continue doing this indefinitely and must find other ways to continue growing.

Luckily for Disney, the company is not bereft of other growth runways.

Disney Hikes Royalties on Star Wars Products

Walt Disney has five major revenue segments:

  • Media Networks-this is the segment ESPN is part of: 43.1% of revenue during the last quarter
  • Parks and Resorts: 32.3% during the last quarter.
  • Studio Entertainment: 13.2% during the last quarter.
  • Consumer Products: 8.8% during the last quarter.
  • Interactive: 2.6% of revenue during the last quarter.

Our focus is on Studio Entertainment as well as Consumer Products. Studio Entertainment is basically the movie division while Consumer Products refers to the products that Disney licenses through its intellectual rights to third-parties to publish, develop and sell. Walt Disney’s Consumer Products include things like toys, home décor and furnishing, apparel, footwear, health and beauty products, and consumer electronics.

Although this revenue segment is Disney’s second smallest, contributing 9% of revenue and 12% of operating income, it’s the fastest-growing both in terms of revenue and operating income. During the last quarter, Consumer Products finished the quarter with revenue of $1,195 million, good for 13% growth, while operating income of $416 million was good for 29% Y/Y growth.

Walt Disney’s Studio Entertainment and Consumer Products segments are closely related since the themes used in Consumer Products originate from the movies released by the Studio division. Very often, if Walt Disney produces a blockbuster movie, retailers clamor to build products based on the theme of that movie. It therefore follows that the success of Disney’s movies tends to have a trickle-down effect on the products that are sold based on the themes of these movies.

Disney enjoyed a blockbuster year in 2014 as far as its movies go, and it was widely expected that this would provide difficult comps for 2015. And this is exactly what has played out. The Studio division reported revenue growth of just 1% during the last quarter, despite the fact that Disney released several blockbuster movies that set industry records in 2015.

The good news though is that strong growth in the Consumer Products segment is set to become even stronger if current indications are anything to go by. Walt Disney is set to release Star Wars: The Force Awakens, a movie that many industry analysts have already slated to become a blockbuster (some have predicted that it will become the world’s first 3-billion dollar movie), in December this year. Disney partners who are looking to cash in on the popularity of Star Wars by building products based on the theme will have to cough up a lot more than they usually do as license fees. Disney has turned the screws on its product licensing partners, and will now demand a 20% royalty cut on products built based on Disney's Star Wars. That’s double the normal rate that Disney charges its product partners. Hasbro (NASDAQ:HAS) is the largest licensee for Star War toys, along with others such as Electronic Arts, Lego, CoverGirl, Rubie’s Costume Company and Kay Jewelers among others.

Analysts project that Disney's Star Wars consumer products will reach $5 billion during the first year of the release of the latest Star Wars movie, easily topping the $2.8 billion record set by Cars 2. The Consumer Product division finished the year with revenue of $4.5 billion, which implies Star Wars consumer products could accelerate growth in the division by as much as 50% if those predictions turn out to be true. That should be more than enough to offset the weakness in Walt Disney’s cable division.

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