Is a Gaming Acquisition Sensible for Disney?

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October 16th marks the 100th anniversary of The Walt Disney Company. Since its inception, Disney has proven time and time again its ability to adapt, innovate, and redefine the landscape of entertainment, be it through animated classics, cinematic universes, theme parks, or streaming services.

Today, the company stands at yet another crossroads, evaluating where to go next after the ousting of former CEO Bob Chapek and a stock that has fallen to ten-year lows. Amidst speculation from Wall Street and recent high-profile M&A activity, one potential sector for expansion that jumps out is gaming.

Recent Struggles

Disney’s challenges today are numerous, and returning CEO Bob Iger has had his hands full since coming back last November, a role in which he will serve through 2026. Under Bob Chapek, who took over from Iger just as the pandemic was starting, Disney’s prospects initially looked bright.

He navigated the company through COVID and successfully continued the rollout of Disney+ to over a hundred million subscribers. Theme park revenues in 2022 surpassed 2019 levels as Chapek capitalized on consumer price inelasticity resulting from excess savings and a robust economy. Disney continued to top the domestic box office, a feat it has accomplished every year since 2016, albeit with lower receipts than before the pandemic.

Disney’s stock reached an all-time high of $202 in March 2021, finally breaking out of range-bound trading it had gone through since 2015. Since then, the stock has gone downhill continuously, back to 2014 levels and over 60% off highs. This is for a few reasons. One, streaming growth has slowed, and Disney+ subscribers have declined every quarter this year. Part of this is due to lackluster performance within Disney’s India streaming unit Hotstar, which contributed significantly to subscriber growth in previous periods.

Cord cutting has also had a large effect on Disney’s results. Its ESPN business is the company’s single largest profit center, deriving its revenue through cable bundles. Many consumers have cut the cord just to eliminate Disney content, as ESPN alone charges cable companies $10 a month to carry the channel. The recent standoff with Charter is just the latest in a long line of carrier quarrels over the service’s cost, and shows that Disney’s leverage has waned.

The theme parks have also faced challenges, owing to record high entrance prices, ideological disagreements which have ostracized certain park goers, and growing competition from other destinations like Universal Studios.

*Number of Disney+ subscribers globally, including Hotstar. Source: Statista*

Disney struck out across much of its film portfolio this year too. Pixar’s Elemental ended up with a $492M box office against a $200M budget, but fell short of company expectations. The first Phase Five Marvel film, February 2023’s Ant Man Quantumania, is one of the few MCU movies to not break even in theaters. Live action remakes including The Haunted Mansion, The Little Mermaid, Pinocchio, and Peter Pan were released to mixed or negative reviews, and while the latter two were released direct to Disney+, The Little Mermaid barely recouped its budget (including marketing) during its theatrical run. The Haunted Mansion was a complete flop, and didn’t even make back its theatrical budget.

Disney’s Financial Position

Disney probably has the most valuable collection of entertainment IP in the world. It has combined its properties with all of its verticals to great effect, reaping profits from their synergies. However, it seems like its content monetization plans have reached a temporary ceiling.

Live action and superhero movie fatigue have had a real impact on Disney’s box office performance, while underinvestment in the parks has led to attendance declines. Disney plans to rectify the parks issue with an ambitious $60B CapEx plan over the next decade, but constructing additional attractions will take a lot of time. Disney is also grappling with ESPN’s loss of leverage, an issue which may never be rectified.

It’s also worth noting Disney’s current financial position, which isn’t at its most robust. Following the $71B purchase of 21st Century Fox, Disney assumed $14B in Fox debt and entered into $36B in credit facilities with Citibank and JPMorgan. It also assumed numerous other liabilities from Fox including contracts with licensing and financing partners. In total, Disney’s liabilities increased from $44.4B before the transaction to $108.9B immediately afterwards. As of the latest quarter, liabilities are lower than their peak at $92.8B, but are still daunting.

Interest expense has predictably ballooned, from $682M in 2018, the last year before the Fox integration, to $1.9B in the trailing twelve month period ending FY Q3 2023. Its ability to pay interest on its debt still remains healthy, but on a free cash flow basis, 2022’s $1.1B in free cash flow was its lowest in at least two decades, as debt has been aggressively paid down.

A concerted foray into gaming could improve Disney’s prospects in the medium- and long-term, and result in the creation of a new major vertical for the company. As reported by Bloomberg, “Iger’s deputies are pushing him to consider a bolder transformation of Disney from gaming licensee to gaming giant.” Reportedly, this transition could include the acquisition of a huge gaming company like EA.

At a high level, gaming would complement Disney’s expansive film and TV properties, and would represent another venue for its characters to appear. Nintendo’s successful crossover of Mario into film was proof that a well-executed media strategy can reap huge rewards. Disney would be doing the opposite – starting with film and merging that with gaming – but it will still be targeting its same core demographic. The company’s licensed games sell well enough, and it would bring this operation in-house to capture all of its profits.

Potential Asset Sales

If Disney wants to purchase a company the size of EA, it would first have to fix its balance sheet; EA has an enterprise value of $35B, notwithstanding a likely 20-30%+ deal premium. In this context, it makes sense for Disney sell off some of its underperforming assets, such as its linear TV business, ABC, which it acquired when it purchased Capital Cities in 1996 for $19B.

The troubling part is that future offers may be anchored around media mogul Byron Allen’s $10B lowball in September, made to exploit Disney’s current circumstances; the offer included ABC, FX, and Nat Geo, which generated $1.3B in EBITDA in the last twelve months. While Disney has made back its investment and more in the network over the last 27 years, such a sale would only dent, not resolve, the debt issue.

ABC makes sense for a sale given it is not really integrated into the parks, cruiseline, or film businesses. It also wouldn’t affect the most lucrative portion of Disney’s IP portfolio, its properties, which range from Mickey Mouse to Pirates of the Caribbean. Similarly, other than its presence in the streaming bundle, a sale of ESPN would not affect its core capabilities either.

The issue with an ESPN spin-off or sale is the segment is probably worth ~$50B, making the number of likely suitors limited. One that comes to mind, though, is Apple, which has been making acquisitions and inking sports licensing deals to support its growing Apple TV+ portfolio. There has been speculation over Apple making a mega-acquisition within media and entertainment for years, and none have ever panned out. The company’s largest acquisition to date remains its $3B purchase of Beats in 2014.

Iger is also dedicated to keeping a majority stake in ESPN, though has floated the idea of “minority partners” who would have small equity stakes in the network. Potential partners here could include Amazon, Apple, and Peacock, to name a few. Selling a minority stake may allow Iger to get more from ESPN pro rata to a full sale, but won’t represent the large cash infusion Disney would need to buy a huge gaming company. Disney has been reluctant to dilute its stock via equity financing, but that may be the only avenue available if it wants to purchase a company like EA in the near-term.

Even if Disney were able to sell ABC or ESPN after what is likely to be a prolonged process, it then has to convince regulators that a mega gaming acquisition wouldn’t be anti-competitive. In the context of gaming alone it clearly wouldn’t, as Disney licenses, rather than owns, almost all of its gaming ventures. But in the current regulatory landscape, the company will likely face antitrust challenges despite not having a gaming business to begin with.

Gaming Licensing vs Acquisition

When Disney distanced itself from Netflix and began the process of onboarding original content to Disney+, it was first hailed as a brilliant maneuver. Boosting its nascent service’s content offerings would help it compete with the incumbent and turn it into a complement, rather than replacement, for Netflix. The $7 monthly initial price point helped with this, as Disney+ cost about half Netflix’s Standard package at the time.

This move came with a real cost – between 2020 and 2022, Disney’s content and licensing revenue fell from $11B to $8B. It also faced additional costs as it ended licensing agreements with streaming partners early, paying hefty early termination fees exceeding $1B in Q2 2022 alone. At the same time, streaming revenue growth was met with accelerating costs, with no clear trajectory to profitability. This seems anathema to its goal of paring down debt, as the company sought to pursue growth of its streaming services while operating the segment deep in the red. Today, the output of content is slowing and costs are falling, which may make Disney+ profitable soon but at the tradeoff of slower growth.

Disney doesn’t currently make its own video games. Instead, it licenses its IP to development partners, receiving a cut of the games’ lifetime revenue. Perhaps its most popular property is Kingdom Hearts, a franchise of great importance both to developer/publisher Square Enix and Disney itself. Other examples include its partnership with Gameloft, which just launched free-to-play racing game Disney Speedstorm and free-to-play life simulation game Disney Dreamlight Valley.

The company’s licensed titles were much more prolific in the 90s and 2000s. Disney has struggled to adapt to the live ops era, something it hopes to rectify with its upcoming free-to-play games which will undoubtedly feature many microtransactions.

Licensing has little cost and is a high operating margin activity. Disney has to do little more than give permission for its properties to be used elsewhere, while providing oversight to ensure the projects conform with Disney’s values. It committed to this shift after the 2016 closure of Disney Interactive Studios, its in-house developer, publisher, and distributor. After laying off 700 employees from the unit in 2014, the company decided to close it entirely after the cancellation of the Disney Infinity series. Avalanche Software, the studio that developed most of its games including Infinity, was sold to Warner Bros. Games in 2017.

The Case for Acquisition

Re-entering gaming also has its upsides. Acquiring a large games company would allow Disney to tightly control its output, unless it was a platform like Roblox which relies on UGC. Disney’s brand is synonymous with quality and “magic,” and the company is committed to safeguarding it. Acquiring gaming companies allows it more control over how its IP is used in games, ensuring that its characters and stories align with the core values of the Disney brand. Live ops is also easier to deal with in-house, especially for a company with such a wealth of IP that can be drip-fed into a game.

It could also facilitate the development of a ‘forever game’ for Disney, perhaps one that incorporates all of its properties into a grand multiplayer experience. In any case, it offers synergistic opportunities with Disney's other businesses – theme parks, merchandise, and streaming. Disney can develop games that tie into its attractions or streaming content, creating cross-promotional opportunities and engaging audiences across platforms.

Importantly, it also helps diversify its business portfolio. As the entertainment landscape evolves, having a sizeable stake in gaming enables Disney to adapt to shifting preferences. Just as consumers moved on from linear TV to streaming, the time may come where gaming shares the mantle with streaming for hours played and watched. Netflix CEO Reed Hastings was prescient when he commented on this in 2019, saying that Fortnite represented a larger threat to his service than HBO.

Conclusion

Disney stands at a crossroads. With recent leadership changes, entertainment shifts, and stock price declines, the company faces challenges from investors demanding better performance. Disney’s financial position has also been impacted by its debt burden, largely stemming from the acquisition of 21st Century Fox.

While a large gaming acquisition could be transformative, it necessitates a focus on resolving Disney's balance sheet challenges. Selling underperforming assets, such as ABC, may be a necessary step in this process. However, potential buyers may try to capitalize on Disney's position as a forced seller, making asset sales a complex undertaking.

It appears Disney is faced with three choices in gaming: acquire a gaming company after selling off linear assets, acquire a gaming company using its existing financial position, or do nothing and continue to license out content. The third outcome is probably the most likely as it represents the status quo, and there is no indication Iger wants to move the needle that way beyond recent media speculation.

Regardless, a large gaming acquisition could make a lot of sense, but only if Disney can sell enough of ABC or ESPN to do so. Assuming a $50B purchase price for EA, an all-stock transaction at the current stock price would dilute its equity by 25% and be ruinous for shareholders. Already down 60% from highs, it would be extremely hard for Iger and the team to justify such a transaction at the current valuation.

With the right assets, gaming would be a much needed outlet allowing Disney to get past its current roadblock, which is a product of recent content oversaturation. Gaming has demographic crossover appeal, allowing Disney to reach both a young and older audience with content that otherwise may have only been consumed by the former.

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My Little Universe Explores New Gaming Frontiers

Platforms: iOS, Android, PC/Steam, Nintendo Switch
Developer: Estoty
Publisher: SayGames
Genre: Action/Adventure/Casual/Simulation/Indie

What you need to know:

My Little Universe (MLU), released on mobile over two years ago, has been growing steadily with more than 15M installs on Android and iOS.

In the two weeks since its launch on PC and Nintendo Switch, MLU has achieved a Very Positive rating on Steam with 88% positive user reviews, although it has a meagre 600 active PC players at any given time.
The game has also been bought by at least 100K people, according to SteamSpy.com. At a $14.99 price point, that's between $750,000 and $1,500,000 in gross revenue (depending on how one accounts for international currency differences) and does not include revenues from Nintendo Switch. That's not a very shabby performance considering the port wouldn't have been the most expensive of development efforts to help drive new revenues. Also, the mobile version has netted ~$10,000,000 in global IAP revenue over 2 years (averaging ~$100,000 per week).

MLU is a space-exploration adventure game in which players fight monsters and gather resources, then use them to upgrade gear and build the world around them.

The game had a smooth transition from mobile to PC, where we tested it. There are some minor bugs, but the game plays well and feels native outside of mobile. It has controller support and runs great on the Steam Deck. MLU’s free-to-play mechanics have been successfully converted too.

A fishing mini-game and other features to replace the paid options in the mobile version bring MLU closer to a PC/console style game.

The Verdict:

MLU’s port to PC and Switch has been stripped from ads and, judging by player comments and our personal experience, this was a wise decision given the platform migration.

The game features split-screen co-op mode, supporting both controller and a keyboard and mouse at the same time. The co-op, although a bit chaotic and buggy at times, makes for a pretty fun experience. Up to four players can sink hours into the game at once without hitting any gated content, making it appealing for couch co-op.

With its positive take on world building, casual gameplay, and cute graphics, MLU can be classified in the cozy games sub-genre, which has been gaining popularity since Animal Crossing broke out in 2020.

Compared to other indie games with similar mechanics, it is a bit pricey at $14.99 – the average for the market is around $10. This could be a big barrier for wider adoption, though it gives SayGames scope for discounts without eating into the margin too aggressively.

MLU can be enjoyed in quick snack-sized sessions or longer periods. Because of that, with the right marketing approach, we think MLU has what it takes to reach wider adoption on PC and console.

It might not be able to reach the same revenue as it did on mobile, but the port to PC and Switch is a huge step forward for Estoty and SayGames. It’s an opportunity to grab new players and gain more knowledge about an ever-evolving market to complement their core mobile business.
Further, SayGames is not the only hyper-/hybrid-casual publisher that is going cross-platform with its business. Just today, Homa Games announced the launch of 6 of its older hypercasual titles on the Nintendo Switch. It seems like such hyper-/hybrid-casual publisher are finding new ways to repurpose their existing game portfolios to drive new revenue. It is also a clear sign of how these publishers are willing to pull all the stops, evolve their core businesses, and be pretty ambitious about taking their fortunes to greater heights in backdrop of a declining hypercasual market.