News of the Week

News of the Week

22 min read

Table of Contents

1. Disney (DIS) – Sports and Parks

a) Sports (Includes Amazon)

I talk a lot about this: Live sports content rights are wildly expensive. Most of the top-watched  content in North America is live sporting events, which illustrates the strong passion fans have for their teams. As a result, live sports as a category is the only remaining healthy part of linear TV. It is the last domino to fall in the cord-cutting revolution. The rest of linear is in obvious terminal decline. This will be too, eventually.

This situation puts Disney and its market-leading ESPN brand in a perfect position to control the remaining decay of linear television and transition to streaming. ESPN owns 30%-40% (depending on the source) of major sports rights in the USA and it will decide when to move those rights off of linear. That direct-to-consumer shift will likely come in 2024. This all sounds nice. It depicts Disney as being in a strong position, perhaps even the driver’s seat, to enjoy strong streaming market share as it pairs this asset with Hulu and Disney+. But there are two major issues standing in the way of this attractive scenario coming to fruition: money and distribution.

Again… Live sports rights are very, very expensive. For example, Disney will pay $700 million per year just for exclusive SEC college football rights. Disney’s balance sheet is clearly strong enough to outbid the Paramount’s and Fox Sports networks of the world. Today however, it needs to outbid wildly deep-pocketed mega-cap tech as well. Apple is bidding for more rights and Google secured NFL Sunday Ticket this year. The search giant has an appetite to invest more. Amazon is reportedly looking to accelerate investments across sports too. It would do so through an investment in Diamond Sports Group following that firm’s bankruptcy declaration. Diamond owns TV rights to 40 professional sports teams in the USA.

All three of these newer entrants can use live sports as a loss leader to reel in fans and cross-sell them other products and services. They don’t need to make money on these contracts; they can easily profit elsewhere and literally have tens of billions to spend. Disney needs to make money on these contracts and has less firepower to win them. That’s far from ideal. Yes, Disney has the omni-channel flywheel with its parks business to drive some cross-selling. Still, that flywheel pulls from its scripted entertainment and the beloved brands within that bucket – not from ESPN.

So? Disney needs to get ahead of this developing sports bidding war and partner up. And that needs to happen soon. I candidly find it annoying that the Diamond Sports news is coming before the ESPN news I want and expect to come. ESPN is still considered the defacto brand in sports and mega-caps still want their hands on it. That will not last forever as fans get accustomed to watching events on other streaming services. It is the reality today and a reality that Disney needs to urgently leverage before the value dissipates. The brand still has a temporary edge, which will not be an edge forever. They must partner with and sell a minority stake in ESPN to Amazon, Google or Apple to preserve any piece of that edge over the next several years. This will make winning content bids easier and less competitive for what is clearly the David and not the Goliath in this situation.

Mega-cap tech will also help mightily with the second issue of distribution. Disney loses consolidated distribution outlets as Xfinity and Spectrum become less popular. It loses that aggregated ecosystem of reliable traffic. How does it mimic that traffic? By partnering with mega-cap tech and their ubiquitous distribution networks. This will make nurturing an ESPN streaming brand far less costly, far less risky and likely more successful. I am impatiently waiting for news of a partial ESPN sale to come. Chop, chop.

b) Parks & IP

Disney got a lot of blowback from others for its plans to raise annual CapEx from $3 billion to $6 billion to support its parks and experiences segment. We already worked through why I think this is the correct decision. In summary, it pulls from a mere portion of the savings being generated in its film, administrative and general entertainment cost buckets. It shifts low-return investment dollars to this higher-return area. Simple enough. You can find more detail on the decision here.

This week, Disney announced a new Zootopia attraction in its Shanghai Park. For context, Zootopia is one of the top grossing animated films ever in China. Why do I bring this up? It points to all of the expansion opportunities Disney has within this sky-high return investment category. It shows exactly how this segment cannot just be a stable cash cow, but a reliably growing cash cow. Disney has about 1,000 acres of vacant land to develop (or 2 Disneylands) solely at its Shanghai park. It has significant brand power and pent-up demand for brands such as Zootopia in important markets like China. That’s why it’s opening and expanding Frozen, Avengers, Star Wars and Little Mermaid exhibits globally.

Much attention is paid to its media business, and for good reason. Linear is a dying business and streaming needs more time to help profitably supplant it. This other segment is a sleeping giant cloaked in the negative sentiment surrounding The Walt Disney Company. An expected explosion in FCF, streaming profitability and a needed asset reshuffling will all go a long way toward mending this sentiment. It should allow the Parks & Experiences segment to get the credit it deserves.

2. Amazon (AMZN) – Oh, Canada… Oh, AWS

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Amazon’s AWS will open a second cloud infrastructure region in Calgary. This will unlock broader access to its cloud services including data analytics and its AI tools in that country. Whether it’s investments across Southeast Asia or North America, AWS remains firmly entrenched in expansion mode. Is this approach warranted and what does it mean?

Signs of greenshoots across cloud-computing have been broad-based. Azure (Microsoft) and AWS both put up strong quarters with outperforming demand and upbeat commentary. AWS further talked up workload (or usage) optimization shifting to a newfound appetite for incremental workloads. Most of the optimization AWS saw throughout 2023 “already happened” with optimization demand “attenuating.” Sales cycle elongation has also normalized across the large cloud providers, while AWS signed more deals in the month of September vs. the rest of Q3 as a whole. Jassy told us that this momentum would prop up growth through 2025. Oracle’s cloud struggled a little bit in Q3 while Google was more average, but AWS and Azure are the two titans. Both are enjoying brighter days.

There’s additional evidence for general cloud sector health. More niche cloud players like MongoDB and Snowflake, among many others, had strong quarters. Both companies rely heavily on usage and cloud-based revenue. As we’ve covered throughout this earnings season, usage-based revenue is easier to boost or cut than subscription-based revenue. So? The fact that cloud customers are leaning into what they can better control is another positive sign of the sector having found its footing.

Just a few months ago, analysts were panicking about AWS growth slowing to 11% Y/Y amid raging macro headwinds and very tough comps. Those headwinds were always going to ease considering how early we are in the on-premise to cloud migration our world still is. Customers cannot optimize workloads forever. They eventually become… well… optimal. Comps were also inevitably going to get easier and they have.

So what does this mean? We talk a lot about margin potential within the marketplace. There are many tweaks happening within Amazon’s cloud business to boost profitability. We cover them all extensively. While all of those tweaks are important, AWS’s acceleration is perhaps even more important. The majority of Amazon’s profits come from AWS despite just 16% of its quarterly revenue coming from that segment. More revenue here, with the 30% EBIT margin, would add fuel to the margin expansion wildfire as marketplace/fulfillment profit levers are pulled. The stars are aligning for Amazon’s 2024 profits to continue vastly exceeding expectations. That’s what I expect… just like I expected in 2023.

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3. Uber (UBER) – B2B & Japan

a)   B2B

Uber is a consumer giant. It owns commanding market share positions across rideshare and food delivery throughout most of the developed world. It enjoys leading driver supply, 15 million loyalty program members (so lower marketing intensity) and verb status. But? It isn’t satisfied with merely being a consumer-facing transportation firm. Its sites are set far wider than that.

For review, Uber-for-Business is one of the firm’s many promising growth vectors. It’s a full service B2B offering that handles all employee transportation and meal costs for employee bases of large enterprises. It manages business travel, enforces spend limits in real time and offers meal and catering programs. It also boasts Uber One corporate membership options with added perks vs. the consumer subscription.

This week, Uber announced new receipt matching capabilities for Uber Business clients. It will offer this through new Brex and Ramp integrations to streamline expense reporting and organization. While this added layer of automation seems and is subtle, it’s just one tool in the expanding product kit. Uber for consumers laces more product breadth and utility into its product suite than competition can to drive engagement and retention. It makes sure consumers can get whatever they want whenever they want it through that program to reduce churn. It uses this base of retained users to greatly lower marketing spend per customer. This makes growth more efficient and its margin profile best-in-class. Now? It’s beginning to unpack this exact same playbook for enterprise customers. Not only should this drive broader traction for B2B, but it should also create top of the funnel delight for users who are new to Uber. That, in turn, could drive consumer-facing cross-selling. Another product lever. Another competitive differentiation lever. Another success lever. These things add up.

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b) Japan

Japan is perhaps the most tightly regulated major market in ride-sharing and transportation. It’s illegal there to use a personal car to offer rides. Uber’s product suite is effectively limited to using the app to call for a taxi in some situations like airport travel. UberEats also functions there with leading market share. Japanese regulation has pretty much prevented Uber from winning any share of the $17 billion taxi market. Based on some rough calculations, for context, the UK taxi + ride-sharing market is worth about $20 billion. This is a large opportunity considering the UK makes up a high single digit percent of Uber’s total business.

The handcuffs will be removed in April. Prime Minister Fumio Kishida told the public this week that Japan will lift its ride-sharing ban next year. It will not become a free-for-all, but regulation will become significantly more relaxed. Uber has been spending time and money lobbying there for several years and it now seems like those investments will pay off and this could be huge for the company.

Starting in April, non-taxi drivers will be used to supplement taxi supply during demand spikes. These drivers will be supervised by taxi operators and must work under one. Uber works with many of the operators in the country. That should be step one. Kishida also told the public that he plans to sign another law next year that would remove this requirement and make Japanese ride-sharing wide open for business. Frequent taxi shortages in that country lead to sky-high fares for the service. Uber should be able to rapidly improve service levels by easing supply constraints, surcharges and wait times. There are some fierce competitors across Asian markets. Uber is a fierce competitor too. With its existing lead in food delivery, it is poised to lead in ride-sharing too.

In other news, Uber also received a favorable court order in France during the week. A $500 million anti-competition lawsuit with Paris taxi drivers was thrown out.

4. PayPal (PYPL) – Buy Now, Pay Later (BNPL)

I shared a PYMNTS study last week showing PayPal’s top share position for BNPL in the United States. This follows a consistent trend of 3rd party data pointing to PayPal BNPL being the most or among the most popular in North America. This week, given the light news cycle, I wanted to dig into what this success could mean for PayPal and why we, as investors, should care.

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The first item is obvious. BNPL is very popular among younger generations. PayPal needs to do a better job of attracting younger consumers, and it has a clear edge within BNPL to make this product its top of the funnel generator. It’s important to keep in mind that BNPL is merely one tool in PayPal’s product suite. BNPL is not its entire business like for an Affirm or Klarna, but a small, small piece of its business. It has extensive customer data profiles entailing far more product touch points than with point solutions. It offers its consumers more, has existed for longer and so it knows its customers better than the rest. It has data on loan repayment, savings, broad credit chargeback history and more. Simply put, within BNPL, it has the largest and most relevant dataset. That matters a lot. Why?

It means its approval rate on BNPL transactions sits at roughly 90%. Depending on which data source we go with, for the industry as a whole, that approval rate sits around 70%-85%. More approvals mean happier customers and a more successful BNPL offering. Thanks to its extensive customer data profiles, PayPal combines this tangible advantage with best-in-class loss rates. Relatedly, delinquency rates for this specific credit bucket remain in great shape for the firm as well. This means the happier customers coincide with financially healthier merchants. These merchants (and PayPal) enjoy a 30% higher order frequency from BNPL users with 90% of the volume being additive, not cannibalistic to demand. This is because BNPL is used mainly for shorter-term and smaller purchases.

BNPL could provide a real source of separation from the pack in a checkout world that has been largely commoditized to date. PayPal’s brand does offer a material boost in the field, but this is surely a welcomed second factor. There’s one more demand boost that BNPL provides for PayPal. “Upstream Presentment” means showing PayPal checkout and BNPL options before the actual checkout page. When PayPal secures these placements, its checkout share meaningfully rises. The instances of winning these types of placements have predominately come from its BNPL segment.

Ok got it… so this is good for PayPal volumes and revenue, but what about margins? BNPL is also good news for margins. About 90% of BNPL repayment is done via debit sources. Debit-funded means higher transaction margin for PayPal vs. credit-funded. This is because it pays out less in 3rd party interchange fees to other financial service companies involved in the transaction. With transaction margin a key concern for the PayPal bull case today, this should provide some needed alleviation. Fattening up Braintree’s margins is sorely needed too, but we’ll take all of the margin tailwinds we can get here.

5. Nike (NKE) – Earnings Review