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Analysts expect widening segment loss as Disney launches new streaming service

Although Walt Disney Co. will provide more detail about the content and business aspects of its upcoming direct-to-consumer streaming service at its investor day in April, some financials about Disney+ surfaced during the company's earnings call with analysts.

In particular, media analysts were surprised when Walt Disney said it would see only a $150 million decrease in operating income year-over-year due to "foregone licensing" revenue in fiscal 2019. Looking ahead to the next two years, analysts expect these losses to widen as investments mount in the Disney+ offering.

Disney CFO Christine McCarthy told analysts on the Feb. 5 call discussing its fiscal first-quarter results, that with continued investment in ESPN+ and Disney+, which is slated to bow in the fourth quarter of 2019, the company would sustain a $200 million hit against operating income in its second fiscal quarter, with two-thirds of that tied to the sports streaming product.

McCarthy also noted "Captain Marvel," slated to debut March 8, will be the first theatrical that to be withheld from Disney's output deals. She said that "foregone licensing," impacting media networks and studio segments, would amount to a $150 million decrease in operating income year-over-year, weighted toward the second half of fiscal 2019.

That was considerably less than media analysts anticipated. Michael Nathanson, an analyst at MoffettNathanson, wrote in a note that he had expected that level to reach $500 million in fiscal 2019. "In fiscal year 2020, the slate of fiscal year 2019 movies that come after 'Captain Marvel' should be a bigger drag. Logically, as more film licensing agreements are not renewed, the impact should grow," he said.

RBC Capital Markets analyst Steven Cahall believes Disney will have foregone licensing revenue of $500 million in fiscal 2020 and its direct-to-consumer and international segment will suffer a peak operating loss of $1.85 billion.

Nathanson anticipates operating losses will ramp up and "the combination" of forgone revenue and direct-to-consumer losses will lead to incremental losses of more than $1 billion in fiscal 2019 and another $1 billion the following fiscal year.

The consolation: Cahall believes Disney could finish fiscal 2020 with some 54 million streaming subscribers across its three platforms, which "could engender a terminal value re-rating that more than offsets the temporary earnings hole."

ESPN+, which tacked on nearly 600,000 customers with its first UFC event, now counts some 2 million paid subscribers since its April 2018 launch. Hulu LLC finished 2018 with more than 25 million total subscribers across its subscription-on-demand and live TV virtual provider offering in the U.S.

Noting that Disney will own 60% of Hulu upon conclusion of its deal to purchase most 21st Century Fox Inc. assets, Chairman and CEO Bob Iger said he would discuss the streaming service's strategy in some detail after the deal's close. Although he believes consumers are better served by segregating the three products and offering them choice, Iger said the goal is to use the same tech platform for people to sign up for all three and potentially offer a bundled discount for subscribers who take multiple services.

Mentioning Netflix Inc., Iger said growth opportunities remain in the direct-to-consumer space.

"We think there's huge potential for Hulu to grow, as well as for the other services to grow, and plenty of room for other entrants in the marketplace," he said, adding that Disney's strong brands would serve as an advantage for its streaming services.

Iger likened the direct-to-consumer investments the company is making in both technology and incremental content creation to the equivalent of deploying capital to build its theme parks when resources could have been allocated to other assets.

"This is a bet on the future of this business. And we are deploying our capital basically so that long-term, the growth of this company is stronger than it would have been without these investments," he said.