Disney (DIS) shook the financial markets when it reported earnings for its third quarter of fiscal 2017 (which ended July 1).

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It wasn’t the company’s financial performance that shocked investors. Rather, Disney announced a significant strategic change that will change the way the House of Mouse does business in the years to come.

Disney is breaking away from Netflix (NFLX) and ESPN’s television network providers and building two separate in-house streaming programs, one for each of original content and live sports.

The markets did not appreciate this news. Disney’s stock is down approximately 5% since making the announcement.

However, there’s actually a lot to like about Disney’s new content strategy. Data suggests the company has the capability to realize significant financial upside and benefit from other ‘soft’ advantages after building out its in-house streaming capabilities.

This article will provide a quick summary of Disney’s third quarter financial performance before discussing the implications of Disney’s new content streaming strategy, particularly as it relates to long-term dividend growth investors.

Financial Performance Summary

Disney’s financial performance was typical of the media giant in recent quarters: stagnant revenue growth and a modest decline in adjusted earnings-per-share.

More specifically, the company’s third quarter adjusted earnings-per-share decreased by 2% from the prior year’s period, coming in at $1.58 (from $1.62 previously).

For the nine-month period, Disney’s adjusted earnings-per-share of $4.63 came in slightly better than 2016’s figure of $4.61.

Additional measures of Disney’s financial performance during the third quarter can be seen below.

Disney

Source: The Walt Disney Company Third Quarter Earnings Release

On a segmented basis, Disney’s recent financial performance has varied significantly between its operating units. This is a trend that continued in the third quarter.

Disney’s four reporting segments are:

  • Media Networks (which, importantly, houses ESPN)
  • Parks and Resorts
  • Studio Entertainment
  • Consumer Products and Interactive Media

Each segment exhibits different behavior based on underlying qualitative factors.

The Media Networks segment has experienced declining revenue and operating income because of ESPN subscriber reductions.

The Parks and Resorts segment has experienced a significant expansion as parks are opened in new international locations and additional sections are added to existing locations. More specifically, the Parks and Resorts segment has added a park in Shanghai in 2016 as well as an Avatar section at Disney World. Disney is also adding an important Star Wars section to Disney World in 2019.

The Studio Entertainment segment has a high degree of performance volatility, as it is dependent on the release schedule for Disney’s new movies. However, this segment has the potential to be the company’s strongest performer over the next ~5 years given its remarkable slate of Marvel, Star Wars, and Disney productions set to release during that time period.

Lastly, the Consumer Products & Interactive Media segment is the smallest segment, and has shown top and bottom line shrinkage as of late.

The following table shows Disney’s segmented financial performance for the three- and nine-month period ending July 1, 2017 compared to the prior year’s period. As you can see, there is evidence of each of the trends I explained above.

Disney

Source: The Walt Disney Company Third Quarter Earnings Release

Here’s what the company’s chief financial officer had to say about the company’s quarterly financial performance:

“Our results for the quarter reflect the underlying strength of our brands and franchises, and our continued investment in high-quality content. Our ability to successfully execute on our core strategy, coupled with our plans for new direct-to-consumer offerings, give us continued confidence in our ability to drive shareholder value.” – Christine M. McCarthy, Senior Executive Vice President and Chief Financial Officer, The Walt Disney Company

Altogether, Disney’s third quarter financial performance was in-line with the expectations of the investor community.

It was the company’s new content streaming strategy that really shocked investors.

The New Content Strategy

The new content strategy that Disney has announced is largely centered on bringing the company’s content streaming capabilities in-house.

Following details of the company’s investment in BAMTech (more on that later), here’s Disney’s CEO describing the seismic shift to the company’s strategy:

“Today we announced a strategic shift in the way we distribute our content. The media landscape is increasingly defined by direct relationships between content creators and consumers, and our control of BAMTech’s full array of innovative technology will give us the power to forge those connections, along with the flexibility to quickly adapt to shifts in the market. This acquisition and the launch of our direct-to-consumer services mark an entirely new growth strategy for the Company, one that takes advantage of the incredible opportunity that changing technology provides us to leverage the strength of our great brands.” – Robert A. Iger, Disney’s Chairman and CEO

Beginning in 2019, Disney has announced that it will no longer license its content to Netflix. Instead, Disney will be creating its own subscription-based streaming service for its original content, which the company’s CEO has stated will be ‘unlike anything else in the market’.

The scope of the original content that Disney will pull from Netflix is somewhat unclear. Disney executives have clearly stated that any pure-play Disney content (think Toy Story, Frozen, or The Lion King) will be pulled from Netflix, but the future of content created by Disney’s Studio Entertainment subsidiaries is, as of right now, quite vague.

There are two content categories that the investment community is particularly curious about:

  • LucasFilm content (Star Wars)
  • Marvel content, particularly the Netflix-specific content (The Defenders, Luke Cage, Jessica Jones, Daredevil, and Iron Fist)

On Disney’s third quarter conference call, an analyst inquired about the inclusion of these franchises on Disney’s new streaming service. Here’s the full response from Disney’s CEO:

“The disposition of the Marvel and Lucas or Star Wars films, we have not determined yet. We’ve had a discussion internally about how best to bring them to the consumer. It’s possible we’ll continue to license them to pay-service like Netflix, but it’s premature to say exactly what we will do. We certainly have that opportunity. There’s been talk about launching a proprietary Marvel service and Star Wars service, but we’re mindful of the volume of product that would go into those services, and we want to be careful about that.

We’ve also thought about including Marvel and Star Wars as part of the Disney-branded service, but there where we want to be mindful of the Star Wars fan and the Marvel fan and to what extent those fans are either overlapped with Disney fans or they’re completely basically separate or incremental to Disney fans. So it’s all in discussion. But we will say is that Disney Pixar will definitely part of this and not be part of any other pay window distributor in the United States. And disposition of Marvel and Star Wars we’ll announce at a later date when we’ve determined what to do.”

In addition, Disney will be creating a second in-house streaming service. Instead of being focused on original Disney content, this second streaming service will be focused on sports – those that were traditionally delivered through Disney’s ESPN television network.

While Disney’s original content streaming service

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