The Walt Disney Company (DIS) declared a semi-annual dividend of 88¢ per share last week, unchanged year-on-year. Since Disney switched to paying twice-yearly back in 2015, the December one has always represented the “raise”. That means it looks increasingly likely that Disney’s fiscal 2020 (remember its financials run on a September-to-September calendar) will not see a rise in the annual dividend. Granted, it could raise its payment in July, but don’t bet on it. Assuming no change next summer, 2020 would represent Disney’s first annual dividend freeze since 2009.
Truth be told, I was slightly surprised by this. And judging by the reaction on financial media sites it seems I was not alone. (Like a lot of folks, I expected low single-digit dividend growth). That said, Disney taking a pause on the dividend growth front makes sense. Indeed, there are probably two things driving that decision by management – debt and its streaming services. I’ll touch on both briefly, starting with the debt load.
Unsurprisingly, the circa $70b acquisition of the lion’s share of 21st Century Fox has stretched Disney’s finances a little. Total borrowings stood at circa $41.5b at the end of September after netting out cash. The bad news is that a big chunk of that debt – roughly $8.85b to be a bit more precise – is due within the next twelve months.
In terms of cash inflow, Disney generates somewhere in the region of $10b in annual free cash flow. Even after backing out the $1.76 per share annual dividend commitment (worth circa $3.2b per annum in cash terms), it is clear the business throws off plenty of surplus cash. Quick math suggests Disney could eliminate its entire net debt position in around six years should it so choose.
So, significant debt reduction is easily achievable as per the above. The bad news is that Disney needs pretty much all its excess cash generation to meet near-term maturities. So why doesn’t it just refinance its debt? Well, the short answer is that management is committed to keeping Disney’s current credit rating. That requires debt to come down to around 1.75x EBITDA, which Disney will achieve in 2020 if it pays off those short-term debt maturities from excess free cash flow. For that reason the dividend freeze makes strong financial sense.
The 21st Century Fox deal comes at an interesting time for Disney. As most readers will probably be aware, the company recently launched its much anticipated streaming service, Disney+. That now sits alongside existing direct-to-consumer products such as ESPN+ and Hulu.
In all honesty streaming could present something of a double-edged sword for the company. On the plus side, it has two potential things going for it. Firstly, it obviously represents a new revenue stream in its own right. The company expects somewhere in the region of sixty to ninety million global Disney+ subscribers by the end of fiscal 2024. Assuming they each pay the full $6.99/month subscription price (too optimistic but let’s go with it for the sake of simplicity), that creates a revenue stream worth several billion dollars a year at the low end. That should result in a profitable new business line for Disney, even after subtracting expenses.
Secondly, Disney+ can drive consumer dollars to other parts of its business. Imagine a new movie based on Disney+ content, or a new line of toys hitting its retail stores. Indeed, this is probably the bigger prize as far as Disney management is concerned.
On the flip side, there are two potential issues as far as I can see. First, streaming undoubtedly eats in to existing lines of (very) profitable business. For instance, cable channels like Disney Channel, which has around 225m global subscribers, are bound to take a hit. If folks start consuming that content via Disney+, what happens to the advertising revenue and affiliate fees paid by pay-TV providers? Most likely that money source gets eroded.
Similarly, the money that Netflix and other third-party services pay to license content will also gradually disappear as Disney takes its content to Disney+. Bear in mind this is a multi-billion dollar revenue stream for the company, and at a 100% gross margin to boot. Second, it will obviously take a few years for Disney+ to reach its subscriber targets. In the meantime it loses money for Disney on a standalone basis. Alongside losses from the other streaming ventures like ESPN+ and Hulu, the hit could be worth a few billion dollars per year.
So, the short version is that Disney has some chunky debt repayments just as it enters a period in which new ventures may take a chunk from its bottom line. Disney can take that in its stride fairly comfortably given how strong the profit machine is. That said, it will have an effect on the shareholder return program. Disney has spent a cumulative total of around $38.5b on dividends and stock buybacks over the past five years. The latter now looks completely off the table for a while. Furthermore, I expect modest dividend growth to only resume in fiscal 2021.
If you enjoyed this article and would like to get new posts directly to your inbox, feel free to enter your email address in the sidebar and hit the “subscribe” button. Thank you for reading!