Before I go any further, let me say - and I'm sure other articles may have started at the beginning like this - that the financial press can now place a moratorium on all articles concerning the theory that Disney (NYSE:DIS) is going to buy Netflix (NASDAQ:NFLX).

Okay, that's out of the way. Now, on to quarter three.

According to Seeking Alpha, Disney's management came in ahead of expectations by three pennies with adjusted earnings of $1.58 per share. Sales, however, of $14.24 billion, which were flat year-over-year, missed by $180 million. EPS was down 2%; it should be noted. Overall, not a great start.

Free cash flow for Q3 was better by 33%, however, at $3.3 billion, according to the release. For the nine-month frame, the growth in that metric was only 3%, and it should be noted that nine-month operational cash flow was actually down 9%.

Disney is known for its cash-generation abilities and its great dividend potential over time, so the cash-flow picture, aside from the quarterly free cash, was perhaps only okay this time around. But that can happen in any given three-month period. More disappointing were the segment operating income results for the media networks and studio divisions - down 22% and 17%, respectively. They were also down over the last nine months as well - 11% and 8% on the same respective basis. Plus, consumer products/interactive media was down 11% in profit generation on the nine-month. Guess that's understandable given the studio decline, but still, merchandising is an area that I like to see growing a little more strongly, even in non-holiday quarters (it also shows that Disney probably has more work to do on its interactive segment, which has been a problem spot in recent years).

If you're a Disney stock fan, this wasn't your quarter. I am, and it wasn't. The shift in cable-bundling/over-the-top subscription services is forcing weakness on the company's big asset, ESPN, and it is now that the story gets very interesting. It goes from one focused on stats to one focused on streaming.

For Disney to get into the streaming business, it needed to reinforce its position in the BAMTech asset we've heard so much about in past quarters. The company has done that: for a little under $1.6 billion, CEO Bob Iger acquired another 42% of the business. Given the 33% already owned, the company is now up to 75% ownership. Disney can now call the shots and create its own ESPN product it can distribute on its own, Netflix-style.

The company doesn't intend on stopping there, though. It also wants to create a new streaming asset that will cater to families.

Obviously, this is an important time in Disney's corporate history for a true evolution is going on. It was expected, but it is also necessary. Disney is a great content supplier, but as many have now pointed out, Disney needs to learn the ropes of creating, from scratch and via acquisition (i.e., BAMTech), a branded platform. This brings up a whole portfolio of questions/risks. Indeed, as I was reading through articles (and comments to articles), I came away with the feeling that this directional change could be riskier than it seems upon first study; again, though, it is necessary.

Here are some examples from my own perspective that I think shareholders need to consider. I believe Disney is still a long-term buy, but I also believe that the story has changed in certain respects.

Let me start with debt levels, cash flow and dividend growth. Right now, Disney has $18.8 billion of debt borrowings. I have a feeling that Disney is going to have to increase its debt level significantly over time as it builds out its streaming services. Is that bad? According to this article, it isn't. The debt the company has now isn't straining it. From the quarterly report, it can be seen that at the beginning of July 2016, the net interest expense was $70 million. At the beginning of July 2017, that statistic increased to $117 million.

Obviously, the net interest expense widened, but it is still inconsequential in the overall picture. Nevertheless, it's cleaner in my mind if Disney tries to keep debt levels down over time. I don't think that can happen now, and I think the company will become more conservative in its dividend increase evaluations. That doesn't mean the stock is a sell; it just means that, given Disney's priority on growth over income in the past, and given that producing content for new streaming services most likely will require big investments/acquisitions, it is worth placing such theory into the mix. There have been many articles over the years about Disney's dividend; there should be a few more analyzing that aspect of the investment idea with this change in strategy, especially with any attempts at quantification of risk of recession and the resultant impact. I know pointing out debt levels in the case of a company like Disney will be criticized, but it is something I think about. Going back to that linked SA article, I do agree with what it intimates: to management, there might not be any preconceived inconvenience to adding $10 billion, say, to the borrowings. Myself, I'm not so sure.

Has Disney found a new CEO yet? We don't know the answer to that; maybe the board already knows and has yet to announce the knowledge. But imagine you are the new CEO-to-be walking into this: a major realignment of the company's long-term goals, engineered by the company's very popular previous boss...what are you thinking at this point? Also, it would be odd if Disney doesn't have someone in mind yet (or at least a very, very short list of not more than two candidates). If the company did not have someone in mind yet, then the person who eventually is identified is going to need a lot of catching-up in the inner workings of this new model, if not in reality (I sometimes think Disney is taking too much time in finding its new CEO) than certainly from the perspective of management (and that is the only reality that matters). Is the board going to be confident in handing over the keys to the kingdom to a new CEO? Is it going to ask Iger to reconsider his retirement?

Just saying that Disney is going to create new streaming services leaves out a lot of details. ESPN is the more obvious of the two - I don't use the product and I'm not a sports expert, but I think it's safe to say that ESPN is ESPN: pay for expensive sports rights, charge a premium to view the events. But Disney's fictional-content service (services, eventually?) is more ambiguous.

From the earnings-call transcript, here is Iger's response to a question on that subject:

"Well, what we're saying specifically is that the Disney-branded app will have the Disney and Pixar films. 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."

See, this is odd to me. When I first heard about the plan to create a subscription product, I figure everything from Disney would be in it. Pixar, Star Wars, Pirates, all of it. If I interpret the above correctly, then it would seem that Disney wants to create unique services, perhaps believing that several lower-priced tiers will add up to more than one omnibus streaming entity. The company could be correct on that, but how would it execute in terms of consumer response in a Netflix-branded world? One would assume that to compete with Goliath, you would have to bring everyone you have to the battle. Disney clearly wants to experiment first, solidify later. I can understand that strategy, but I wonder if maybe there was a better way of doing it.

Going back to ESPN, it also occurred to me that this mutation in strategy might make it easier to someday sell/spin-off that business. Yes, Iger is committed, but what about a new CEO? ESPN is basically a big-spending bet on non-fiction; the rest of the company comprises storytelling assets - mythology and merchandising. If Disney wanted to, it could swap its bet on sports for a bet on original-content production in the tradition of Netflix (i.e., spend until it hurts...and then spend some more, if the data allows). ESPN is a great singular investment; Disney proper is a portfolio of business models that interact with each other more closely. A sale of ESPN could bring in a lot of cash that could immediately be put to work creating different franchise episodic IP for Disney's service. While buying BAMTech might seem like a way to keep ESPN in the fold, I wonder if it is the first step in a future sale (which would be some time down the road, if at all).

While I just said that Disney's non-omnibus strategy surprised me, I will concede that investment in original content probably would necessitate some separation from the family-oriented branding model. A separate channel devoted to more adult-targeted stories, or the ability to block that out from younger children, would be logical. The goal on the part of Disney is to siphon off subscribers from Netflix in addition to overlapping; to do that, the company might want, as an example, to invest in low-budget horror movies/episodic. Or to strike its own Adam-Sandler-like deal with a comedian whose box-office prospects necessitated a switch in thinking on the part of agents/managers. Disney can do this...but will it want to? Will such thinking be proprietary to the next CEO?

Iger mentioned in the conference call that premium video-on-demand is not in the mix. When asked about that possibility, he said:

"We're not planning to put our movie, to use this service to encroach on a theatrical window, if that's what you're asking."

Bad move; don't exclude that possibility, Bob. If Disney, every once in a while, took one of its big properties and programmed it on the service a few weeks after release in theaters, then the service becomes unique and more valuable; it would strike a blow against Netflix. Furthermore, producing movies specifically for that purpose would work as well. Imagine if a lower-budgeted Marvel picture were made so that it would do whatever it could at theaters, then was ported over on an accelerated schedule to streaming - it would probably market itself and get the attention of potential subscribers. Even a big Star Wars film could lend itself to this method.

I do like the idea of allowing subscribers the ability to buy content from Disney as well with this new BAMTech-led initiative. From the call, Iger mentioned:

"We do hope to use this service to give people the ability to buy, to download-to-own or download-to-rent Disney movies in the window prior to pay, which used to be called the home video window. There is no reason why we shouldn't be doing that. But the priority here is this is a direct-to-consumer product, a subscription product."

This announcement from Disney's management will be analyzed in the coming weeks. I want to know how Disney's Hulu investment will fare post the development. How ABC will approach its own corporate mandate - will all outside producers of content have to sign over some streaming rights? - vis a vis its new corporate sister. It's possible competitive content creators will look at ABC differently.

My decision regarding the stock is that it is not a sell. There's just too much possibility here on the positive side of things to go bearish. Remember that Disney contains a significant quantity of brand equity; that isn't going away. It also has its parks division, and the cross-promotional opportunities there are numerous. I could imagine a kiosk signing park patrons up for the service near one of the rides; maybe when you book your Disney vacation, you can also book a couple of years on the ESPN over-the-top. The Disney Store could get in on the act. In addition, maybe Disney will sign people for limited-streaming services that are only for a short period of time, almost like an extended rental/pay-per-view - maybe you'll have access to all Star Wars content for six months and be done with it.

As Iger said in the conference call, there are all kinds of scenarios and optionalities to evaluate. For this reason, even with the new risks attached, I believe Disney is still a buy; just don't look at it as necessarily an income play until we see how the future dividend announcements shape up.

Disclosure: I am/we are long DIS, NFLX.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Disney's Q3: An Earnings Beat, A Strategic Evolution - Seeking Alpha