Analysis: DIS FOXA NFLX

Last night, Disney (DIS) reported a solid top and bottom line beat with its quarterly results which we discussed in our Alert here. Despite the outperformance in the results, shares were roughly flat Wednesday morning and appear to be stuck in this $112-$113 range as the quarter is being viewed as meaningless with respect to the company's broader direct-to-consumer picture.

Even so, the market's reaction to the quarter looks a bit underappreciated relative to the positives that are going on at the company. In our past discussions, we frequently talked about how Disney needed to right the ship at ESPN first in order to promote a company-wide narrative of growth and offense driven by DTC initiatives, instead of being forced to play defense around its results. For a few quarters in a row now, we have begun to see this turn.

ESPN's result's trended well in the quarter as subscriber growth only declined by 1%. Just as important, the growth in subscriber numbers from ESPN+ looked very encouraging. We have long held that the ESPN+ product is a must-own service for any sports fan. For a true real-world example of the terrific value proposition behind the ESPN+ product, let's look at the events that happened overnight.

Last night at 2:17 a.m. ET, ESPN Senior NBA Insider Adrian Wojnarowski broke the news of a blockbuster trade between the Los Angeles Clippers, and my beloved Philadelphia 76ers. Unfortunately, due to the late-night hour of the trade, most news outlets couldn't provide a true in-depth look on the deal. But not ESPN, the world-wide leader in sports. In addition to the general mechanics behind the trade, ESPN+ subscribers were given access to an article that graded the deal on based on the short-term and long-term risk/rewards for both teams.

But in-depth expert analysis is only one small piece of the value at ESPN+. The product is also a tremendous source of live streaming sports, including Top Rank Boxing, Major League Baseball, the NHL, MLS, Italy's Series A soccer, and plenty of college sports events. It lends itself to fans of both the traditional "major" sports as well as some niche ones, like combat sports which is expected to become a future driver of growth on the product. Evidence is clear that fans of combat sports want this type of product, and the product's recent subscription numbers support management's view of the demand. The first broadcast of UFC Fight Night on the ESPN+ platform generated 525,000 new subscribers on the day of the event.

In just a short amount of time, ESPN+ plus went from 1 million paid subscribers to 2 million. We think greater times will be ahead as the company tailors the product around the wants of the sports consumer.

We have also been proponents of what the legalization of sports gambling could mean for ESPN+ and the flagship product. A question on this was raised by Credit Suisse analyst Douglas Mitchelson during the company's conference call last night. He wanted to know if and how gambling-based content would fit with the family-friendly brand of Disney. In response, CEO Bob Iger confirmed that Disney would not be involved in the business of gambling, but he did add how there was "plenty of room" for ESPN to provide additional coverage that would be relevant to a sports gambler. We never expected Disney to take bets, but the creation of more content geared towards a legalized gambling industry? This could easily provide tailwinds to viewership and subscriptions as more and more people seek a trusted source like ESPN for their gambling related content.

Now that ESPN trends have fully stabilized, ESPN+ has gotten off to a strong start, we have seen multiple quarters of strength at U.S. Parks (and the 2019 openings of Star Wars land should drive immediate demand), and upcoming headwinds in Licensing and Studio have become better understood, we believe Disney has finally gained control of its narrative and management is ready to unleash its real driver of future growth.

This comes at an important time because it allows anticipation to build ahead of the April 11th Investor Day. As a reminder, this is when Disney will provide greater insight around its overall DTC business and management will unveil the Disney+ streaming service, a product that will be a must-own for every household because it will feature a massive amount of high-quality content from both Disney and what was acquired from the 21st Century Fox (FOXA) deal.

Although one general concern has been centered on if Disney+ could thrive in what is becoming an increasingly competitive streaming industry with Netflix (NFLX) leading the way, Disney is the King of Content and that in itself will drive customers. Additionally, the price point on Disney+ is expected to be very competitive relative to Netflix. Where the two companies differ is that Disney already enjoys of the benefit of having a huge, high quality content portfolio and a production studio with a proven track record of success. Meanwhile, Netflix relies heavily on the content of others and their expensive, in-house production studio has been viewed as hit or miss. Disney's ability to undercut Netflix pricing should not be forgotten.

Instead of being known as a victim of cord-cutting like several others in the media space, last night's results from Disney's core business confirmed that its trends remain solid. Again, this is key because it puts an overhanging concern in the rear-view mirror, allowing investors to focus on Disney's brighter outlook for growth. Now we do not want to make light of the margin headwinds in 2019, but the market should grow to appreciate the offense the company is playing by investing in itself. When there is more clarity around the DTC business (at the Investor Day), we expect the price to earnings multiple on DIS to expand because its growth potential will become much more tangible. So while this quarter is being viewed as "meaningless" by the market's eyes, it has set the company up nicely to deliver a real growth strategy at the April event and that will be the key driver of the stock.