Disney’s March 2010 quarter: Alice was wonderful

the eps

DIS reported its fiscal second quarter (ended April 3rd) after the close last night.  Ex unusual items, earnings per share were up 12% year over year to $.48 vs. $.43 in the comparable period of fiscal 2009.

My take is that the company’s economically sensitive businesses are showing genuine signs of life, that are not yet clearly visible in the financials due to the accounting conventions DIS has chosen to use.  There’s nothing wrong with what DIS is doing.  In fact, as I see them the accounts are on the conservative side–which is a good thing.  The company is (understandably) reluctant to provide too much information that may ultimately end up in the hands of its competitors, however.  And I think it assumes Wall Street analysts know more about what makes DIS tick than they do–I’m not sure how DIS could hold that opinion after even one earnings conference call, but I think it does.  So it doesn’t provide a lot of help in explicitly connecting the dots.

In any event, Wall Street reacted to what I thought was a pretty encouraging quarter by pushing the stock down by about 3% in after-market trade.

segment results

studio entertainment

Alice in Wonderland, despite iffy reviews (51% from Rotten Tomatoes), was a huge winner for DIS.  The film has grossed $962 million worldwide, almost all of that in 2Q.  That ranks it as the #7 movie of all time.  DVD sales will begin on June 1st, earlier in the film’s life than usual, which will likely stimulate sales.

Iron Man 2 has been out for two weeks internationally and one week in the US and is so far outpacing IM1 by grossing $334 million to date.   Toy Story 3, another likely blockbuster, is also in the hopper.

On the success of Alice, DIS reported 2Q operating income from films of $223 million, up from $13 million in 2Q09.

Yes, there’s an accounting issue in this business segment–how DIS has apportioned production/marketing costs for Alice (my guess is that the company has been very conservative, wiring off almost everything against theatrical release–meaning the possibility of a positive surprise if DVD sales go well).  But the real question is operational.  Is Disney’s (non-Pixar) filmmaking, which has shown itself out of touch with contemporary America, getting itself back in touch.

parks and resorts

Operating income for the quarter was down by $21 million year on year at $150 million.  The decline comes from the Disney Cruise Line, where the company benefitted a year ago from having its fuel costs hedged vs. being unhedged this year.  domestic theme park results were flat, as were international–which strength from Hong Kong offset by weakness (what else is new?) in France.

Three points:

1.  DIS’s books have the week as the basic unit, not the month.  Because a calendar year is 52 weeks + 1 or +2 days, every once in a while the New Year’s holiday, which typically yields a whopping $60 million in revenue for the parks, falls in the December quarter.   The current fiscal year was one of those times.  So something like $40 million (my guess) in operating profit was shown in the December quarter that would usually be recognized in the March quarter.  About a third of this negative effect was offset by having the first week of Easter fall into the March quarter.

In other words, on an apples-to-apples comparison the parks and resorts were up about 10% vs. last year.

2.  DIS is steadily raising its prices with the aim of eliminating recession-induced discounting by next fiscal year.  The company could be posting higher short-term profit numbers by continuing bargain-basement rates.  But for the long-term health of the brand, it’s important that DIS reestablish premium pricing as soon as possible.

3.  Leisure travel bookings are like an accordion.  In good times, vacationers reserve far in advance.  In bad times, they look for the best prices and book at the last minute.  In March 2009 quarter, we probably saw the last of the pre-Lehman demise “good times” reservations.  In the March 2010 quarter we are likely seeing the last of the post-Lehman “deep fear” bargain bookings.

In fact, somewhat exasperated by an analyst’s (misguided) analogy with business travel (which leads the economy, while leisure travel lags), DIS blurted out that it was seeing a sharp uptick in bookings recently.

media networks

As usual, it’s a tale of two cities.  Here are the figures, in millions:

Revenues

Cable                     $2412       +9% yoy

Broadcasting       $1432      +1%

Operating income

Cable                 $1183       +3%

Broadcasting     $123      -24%

Cable is basically ESPN.  Broadcasting is ABC TV Network + Studios.

I think Wall Street mostly ignores Broadcasting, figuring the best it can hope for is that ABC will not turn into a black hole that damages overall results.  So the focus is on ESPN, where revenues look ok–but not great–and operating income was uninspiring.

Again, the situation is a little more complicated–and more favorable for DIS, I think–that it seems.  Points:

1.  Revenues from 12 big college bowl games played on New Year’s Day were part of first quarter results this year and second quarter last year.  On an apples-to-apples basis, ESPN revenues were probably up 12% year on year.

2.  ESPN is trying to build up a sports presence in the UK.  To do so, it has to acquire sports rights first and subscribers later.  Startup equates to losing a lot of money.  DIS isn’t saying how much, but I think it’s safe to assume that this expense is offsetting the operating leverage that existing operations should be showing.  If DIS were building a manufacturing plant, these costs would be “capitalized,” meaning they wouldn’t be recognized as costs until construction was complete.  DIS can’t–and shouldn’t/wouldn’t do this.  But the fact that startup costs are being expensed obscures the profitability of the existing business.

3.  Advertising revenues are now rising by about 20%.  There will be a significant uptick in affiliate revenue starting in the third quarter as contractual minimums are achieved–some months sooner this year than last.

consumer products

This segment was up by $36 million year on year to $133 million, based on strong sales of Iron Man and Toy Story merchandise.

interactive media

Revenues were up by $26 million and losses cut by $6 million to a $55 million deficit.  This is the company’s new media, internet, video game division.  It’s almost like the inverse of ABC–losses now, with the hope of big profits later on.  As long as the losses stay in the current range, about 3% of overall DIS operating income, Wall Street won’t care.

my thoughts

I thought the news from DIS was very encouraging.  It sounds like economic energy is building in the US in a way that’s benefitting DIS but is not yet seen in the financials.  Recognition will likely come in the next quarter or two.  Success of IM2 and TS3 are expected, but will nevertheless prompt Wall Street to take a somewhat more favorable view of the DIS film business.  And if another one of DIS’s traditional films turns into a box office winner, so much the better.  I also think earnings will surprise on the upside as accounting oddities even themselves out.

2 responses

  1. A very thoughtful “drill-down” into both Disney’s numbers for Q1 and why the Street is missing the big picture for this company. Once again, you’ve provided a solid justification for my avid following of your blog. Thanks.

    • Thanks for your comment. I’m not sure if you’ve seen this article from the Sunday New York Times about Robert Iger, the CEO of DIS. I knew the DIS story in the early Eighties, but didn’t think much of the management for most of the Eisner era. So I’ve only been looking at the company seriously since the Marvel acquisition brought me in.

      My initial impression, the really botched-up communication surrounding the acquisition terms, wasn’t favorable. But I’ve come to think that this is a well-managed and interesting company. The troublesome aspect of the NYT story is the suggestion that the good news is already out–and, by implication, already in the stock price.

      Although I don’t think the stock will be the rocket ship ride that Marvel was over the past couple of years, I think a number of good things that aren’t fully factored into the price could happen: talent from Marvel + Pixar are now the majority force in DIS’s movie business, so maybe they energize each other, as well as the rest of the film segment, and run off a string of really good movies; ESPN could be successful in its UK expansion; the economic upturn could prove a bonanza for the theme parks and for advertising on the media networks. And, although I think its highly unlikely, DIS could spin off part or all of the media networks business, turning the company into a growth part and a value part, which would in theory be worth more separately than together.

      At the very least, though, I think there are a couple of very good quarters still in front of us.

      At the very e

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