DIS: strong fiscal third quarter (ended 3July10)

the results

DIS reported a very strong third fiscal quarter of 2010 (quarter ended 3 July) after the close on Tuesday.  EPS were $.67 for the three months vs.  $.51 in the comparable period of fiscal 2009.  Quarterly revenues grew to $10.0 billion, up by 16% from last year’s $8.6 billion.


One of the more interesting aspects of following DIS is the out-of-the-ordinary accounting (totally above-board, but quirky) that is customary for its collection of businesses to use.

For example, if I were to ask you to guess where the largest dollar increase in operating income for the just ended quarter comes from, you’d probably say Studio Entertainment–thinking of the smash box office successes of Iron Man 2 and Toy Story 3, and the release of Alice in Wonderland to DVD. Good guess, but it would be wrong.  Net of writedowns of film clunkers, the increase here was $135 million.  The actual biggest jump comes in Media Networks, and derives from recognition of $381 million in previously deferred ESPN cable affiliate revenue.  What’s that?  Read on.

By segment, the 3Q10 results are as follows:

Media Networks          $1885 million, up $556 million

Parks and Resorts          $477 million, down $44 million

Studio Entertainment          $123 million, up $135 million

Consumer Products          $117 million, up 96 million

Interactive Media          -65 million, up $10 million

Total          $2, 537 million, up $688 million

Media Networks

ABC television was basically flat at $209 million in operating income, which I consider to be a good result.

Cable (ESPN + the Disney channel, but mostly ESPN) was up $561 million at $1,675 million.  That’s a 50% jump, year over year.  Of that, $381 million came from recognition of previously deferred revenue from ESPN.  Otherwise, operating income would have been up by 16%.

ESPN advertising revenues were up by 31%, mostly because its coverage of the FIFA World Cup was a fabulous success, but also because the NBA finals between the Lakers and Celtics was a compelling series and lasted seven games.  Ex these factors, ad revenue would have increased by a still healthy 17%.

Finally, to deferred revenues.  ESPN’s contracts with its cable customers provide for what are in effect bonus payments if the sports network exceeds specified levels of subscribership.  FIFA and the NBA meant that many of these levels were hit in the third quarter this fiscal year vs. the fourth quarter of last fiscal year.  DIS thinks it will collect $355 million less in these fees during the fourth quarter of this year than in the final three months of fiscal 2009.  IN other words, the big 3Q number represents a shift in the timing of ESPN earnings these payments, rather than a gigantic increase in the payments themselves.

The bottom line, though, is that ESPN continues to do extremely well, and the other, much smaller, parts of cable/broadcasting are managing to tread water in a tough environment.

Parks and Resorts

This business is basically flat.  The most important thing is that DIS is trying, successfully so far, to end the sharp discounts it was forced to give last year to lure patrons to its parks and resorts.  Per guest spending in Disney hotels was up by 4%, but occupancy was down by about 6%.  Similarly, guest spending in the parks was up by 5% and attendance down 3%.

The Easter holiday, and the accompanying spurt in park business, started in DIS’s second fiscal quarter this year instead of the third, where it usually is.  This means that the year on year comparisons in this business segment are actually slightly better–maybe a percentage point or two–on the occupancy and attendance side–than the reported numbers.

More accounting arcana:  Fourth quarter hotel reservations are down 9% year on year.  That’s about what DIS’s recent experience has been.  But the number is in fact much better than it seems.  Its hotel-theme park-resorts roots have led DIS to organize its books on a week-by-week basis.  Each “quarter” consists of 13 weeks.  But four periods like this add up to 364 days, meaning DIS has to periodically add an extra week to the fourth quarter of its fiscal year so that its accounting quarters and the calendar quarters match closely.  Last year was one of those 53 week years.

On an apples to apples basis, reservations are down about 1%, despite the lower discounts.  This won’t cause a big surge in income but it signals that this business is gradually improving.

Studio Entertainment

This segment needs little explanation.  Iron Man 2 took in about $600 million in worldwide box office in the third fiscal quarter.  Toy Story 3 has taken in almost $900 million, about half of that falling in this accounting period.  DIS also had unspecified, but “higher” film writedowns than last year.

Consumer Products

Cost-cutting at the Disney stores, plus Toy Story and Marvel merchandise.

Interactive Media

This is a catchall for DIS’s digital startups.  At least losses appear to be stabilizing.

what to make of this

This was a blowout quarter on an operating basis, that was generally aided by the quirks in DIS’s accounting–especially the ESPN results.  The company’s main businesses, ESPN, Pixar and Marvel, continue to perform very well.

The parks business is slowly turning itself around as the economy in the US improves.  The legacy DIS film business seems to be on a sounder footing.  And the company keeps on aggressively updating its structure–Miramax and Power Rangers out, Playdom (social gaming) in.

On a longer-term basis, then, so far so good.

DIS has been an outperformer so far this year, up about 10% relative to the S&P 500.  Continuing success at ESPN and films will probably translate into about 15% eps growth in the coming twelve months.  A rebound in the parks and resorts business would likely add a few percentage points to that.  With the stock trading at about a market multiple and the company buying back stock (it has already bought back all the shares issued to acquire Marvel Entertainment), my guess is that modest outperformance is likely to continue.  The obvious risk is that one business, ESPN, generates the bulk of the company’s earnings.

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