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Monthly Archives: November 2012
ESPN’s role in DIS
Still no internet/TV. Still no sign of Comcast trucks. Nor is Comcast willing to say how much longer the outage will last–today is Day 17. The whole neighborhood is switching to FIOS.
This is, of course, a trivial issue when compared with the devastation in low-lying areas of Long Island or with the low-income housing in NYC that still has no power (but whose residents are still being charged full rent–rebates to come in January???).
This post is prompted by a reader’s question about ESPN. It also addresses some assumptions I’m making about ESPN in saying I think DIS will be a good relative performer over the coming year.
limits to what I know
I’m very comfortable as an investor that I know more than I really need to about how the Disney part of DIS works. I think I know enough about ESPN, too.
This is an important distinction, however. In my mind–if nowhere else–there’s an unresolved question about the long-term growth prospects for ESPN. I don’t think this is a near-term issue. I don’t think it’s primarily about competition, either. In its simplest form, it’s how long can ESPN continue to grow revenues at twice the rate of nominal GDP, as it is currently. When does growth slow down?
ESPN’s importance to DIS
Today, ESPN accounts for 2/3 of DIS’s profits. What happens if ESPN stops growing at 15% a year and slows down to 10%? What does the rest of the business have to do to take up the slack? The answer: rev up growth to +25%/year. Is that possible?? Possible, yes; probable, no–in my opinion. Therefore, if ESPN slows down, Wall Street revises down its estimates of DIS’s long-term growth rate–and the stock adjusts downward.
ESPN doesn’t have to speed up for DIS to be a good stock. But it can’t slow down either, in my view.
sports programming
What’s unique about sports programming–and what makes ESPN so attractive–is that it’s the only type of mass media where consumers are regularly willing to pay higher prices for pictures of events in cutting-edge resolution, and for tons of expert (or even not so expert) commentary.
This is not only true in the US, where there’s a mad rush to buy the latest model TV set just before the Super Bowl (the Big Game, to those unwilling to pay to use the SB moniker). It’s the same in every country whose stock market I’ve ever been involved in.
programming rights
Not everyone can broadcast a sporting event. Most sports teams/leagues periodically auction off to the highest bidder exclusive rights to broadcast their games. For many profession teams (and icons like Notre Dame), these broadcasting rights can be their single most important asset, running into the hundreds of millions of dollars in value.
Many organizations break the rights down into a number of pieces to make them more affordable, and therefore encourage more spirited bidding. The NFL, for example, has separate packages for Sunday Night Football, Monday Night Football, Thursday Night Football, NFC Football and AFC Football–broadcast by NBC, ESPN, the NFL Network, Fox and CBS, respectively.
where ESPN fits in
ESPN is by a mile the dominant sports broadcasting distribution network in the US. It broadcasts all the major sports. It also fills a bunch of channels, in both English and Spanish, with 24/7 commentary and analysis. Over the years it has been consistently innovative, so it possesses an unparalleled internet presence as well–only commentary but fantasy league and broadcasting, too.
network effects
ESPN’s is a business where the rich get richer and the poor get poorer. As a distribution network gets larger and if a distributor can raise prices (which so far ESPN has been able to), the distributor generates more money to spend on content, including broadcasting rights. This gives it a huge, and growing advantage over smaller rivals. At some point, the amount of capital needed to enter the market, or even to maintain a presence, becomes prohibitively high and the weak links drop out.
For market leaders like ESPN, this is a great business.
a sign of maturity?
About two years ago, ESPN decided to make a major move into soccer. Two reasons: this would be the leading edge of ESPN’s expansion into Europe; and ESPN could become the leading distributor to a small but growing fan base in the US.
The heavy investment ESPN began to make implied to me that management saw this as the company’s most attractive long-term expansion opportunity. (Otherwise, it would have focused on something else.)
ESPN, however, lost out in the bidding for Premier League soccer rights in Europe to incumbents who recognized the threat ESPN posed. It was worth losing money to them just to keep ESPN out. Not a great solution to the threat of ESPN, but probably the best alternative available.
So, for now anyway, the geographical expansion is off the table.
spending up on the Disney side
Since then, DIS has agreed to buy Lucasfilms for $4 billion. It has added Cars Land to Disneyland and is overhauling Fantasyland at Disneyworld. It’s also installing new reservations/guest interface software at the parks.
…a coincidence that Disney capital spending is rising just after ESPN’s need for capital has decreased? Maybe. Another interpretation, though, is that DIS’s capital is going into the highest return projects–and that none are in ESPN.
my take
It’s not necessarily a bad thing if ESPN sees no new big untapped markets to enter. In fact, DIS’s generally conservative accounting philosophy implies ESPN’s near-term profits will likely be higher because the expenses of European soccer rights and of expanding its soccer coverage won’t be there.
But DIS’s shifting capital allocation priorities do bring up the issue that ESPN won’t continue to grow at the current rate indefinitely.
The only practical conclusion I’m drawing is that if what I’ve just said is right, I’ve got to be careful to set a price target ($55?) and remember to sell.
DIS’s 4Q12: more earnings progress, but a stock price fall
I’m still using my phone as an internet connection.
Still no word from Comcast about when service will be restored. But I’ve seen my bill. No adjustment for half a month without service! This behavior contrasts so sharply with that of every other company I’ve seen that I’ve got to believe there’ll be a lot of negative fallout when people realize what Comcast is doing.
DIS’s 4Q12
After the close last Thursday, DIS reported 4Q12 and full fiscal-year 2012 results. The company earned $.68 per share during the three months ending September 29th, up 15% year on year, on revenues of $10.8 billion, up 3% yoy. For the twelve months of fiscal 2012, DIS posted eps of $3.07 on revenues of $42.8 billion. Earnings were up 21% yoy, on a revenue gain of 3%.
The stock dropped about 7% on the report.
Yes, 4Q12 eps growth was less than the rate of gain earlier in the year. And, yes, Wall Street never likes such deceleration. But I don’t think that was the main reason for the decline in DIS shares. Rather, during its conference call management told analysts that 1Q13 eps will probably be no better than flat with 1Q12. After that, comparisons will likely pick up …but DIS didn’t say by how much. The lack of guidance isn’t unusual. It’s the way DIS operates, and it’s fine with me. But in this instance, the uncertainty (temporary, I think) about fiscal 2013 eps growth caused the selloff in the aftermarket and on Friday.
On Friday, I rebought much of the stock I had sold a while ago at around $40 a share.
Why?
I’ve come to think that I’ve underestimated the growth that can come from the non-ESPN side of the business–the Disney side, meaning the theme parks, movie studios and consumer products divisions that together produce about a third of today’s total DIS operating profits. I especially like the acquisition of Lucasfilm.
Also, I think the weak 1Q13 is more a function of accounting quirks than fundamental weakness. Specifically:
a flat 1Q13
The factors behind this are:
—Hurricane Sandy, although DIS says the superstorm hasn’t prevented any Jerseyites from getting to Disneyworld so far. But certainly some stores and movie theaters were closed during the storm. And some customers hurt by Sandy will have less discretionary income for a while.
Whatever the effect, it’s likely to be small, negative and transitory.
—ESPN. The sports giant has signed major new contracts for sports content. It will take a while for ESPN to pass higher programming costs on to customers. Also, while the presidential election season is great for advertising in general, it’s not so good for ESPN.
—Disneyworld. The Florida theme park is undergoing its first major overhaul in 40 years. The parks are also in the middle of making a big upgrade to their computer systems. Much of these costs are being recognized as expenses right now, rather than being stored up on the balance sheet and being shown as reductions in income over the life of the assets. What DIS is doing is more conservative, which I approve of. But that won’t change the fact that eps won’t look as good as they otherwise would.
—the week as the major accounting unit of time. Readers of my prior DIS posts will be familiar with this issue. Most companies keep their accounts on a month-by-month basis. Hotels and retailers–and DIS–typically keep theirs on a week-by-week basis, which they believe gives them better control over operations.
The four 13-week units the latter companies use don’t match up exactly with the calendar year. For DIS, this means that the bulk of the lucrative New Year holiday–and the $30 million in operating income this entails–will end up being in 2Q this fiscal year vs. 1Q last.
—movies 1Q12 benefitted from Cars 2 and the rerelease of Lion King. There’s nothing comparable in the hopper for 1Q13, so DIS estimates a falloff of $150 million in operating income.
Except for the Studio Entertainment segment, all these are timing, or accounting presentation, issues rather than economic ones. And in the case of movies, no one can manufacture hits each quarter, so this is just a function of the way the business operates–and why it gets a lower earnings multiple than more predictable ones.
my take
I think the recent selloff is a mistake. My guess is that fiscal 2013 eps will come in at about $3.50, assuming Washington doesn’t drive us over the fiscal cliff. To my mind, that prospect justifies a price in the low to mid $50 range. But comparisons will likely be accelerating into fiscal 2014, creating the possibility of multiple expansion from the 15x I’m assuming. Not necessarily a rocketship ride, but still probably meaningful market outperformance.
dissecting the fiscal cliff
I’m back home, in the land of electric power and heat, but no internet or TV. I’m using my phone as a mobile hot spot, but I can’t seem to get a look at the layout of this page. Sory if the numbers below are hard to see.
Hurricane Sandy humor:
–a runaway Coca-Cola truck knocked down a utility pole on our street on Saturday, splaying live wires all over the place. Luckily it wasn’t the more important one the big tree knocked down during the storm. PSEG cleaned up in a matter of hours.
–I called/chatted with Comcast to find out about restoration of internet/TV service. The two people I spoke with were very nice but said they had no idea. Both confirmed that Comcast continues to charge customers for service even though there is none. You have to call them and ask for a refund!!! Why am I not surprised?
Today’s post:
“Economic Effects of Policies Contributing to Fiscal Tightening in 2013”
On November 8th, the Congressional Budget Office issued an update on its fiscal cliff analysis, titled “Economic Effects…”. The report makes several points:
1. “driving over” the fiscal cliff isn’t a good idea
The problem is the domestic economy is still very weak.
The CBO predicts that continuing Washington stalemate would cause a short but sharp recession in the US during the first half of next year. Growth would resume from the crunch, but from a lower level, in the second half. But this would be by a small enough amount that real GDP would still end up in the negative column for the full year.
More important, unemployment would spike upward to an estimated 9.1% a year from now, postponing the return to economic normality for the country (meaning reduction in the unemployment rate to 5.5%) until early in the next decade.
2. the status quo isn’t so hot, either
Continuing the current situation where Washington continually spends more than it takes in will ultimately force interest rates in the US–both for the government and for private borrowers–higher than they would otherwise be. Maybe a lot higher. At some point we’ll have a repeat of 1987, when domestic lenders refused to buy any more government debt and the long bond spiked to 10%. The CBO implies that this is only a remote possibility at present. But as the debt grows the problem becomes progressively harder to solve.
3. the long-term solution
(I haven’t seen anyone write about this.) For the CBO, two moves are important.
–broaden the tax base, don’t raise rates.
–reduce entitlement spending.
4. in the short term, however…
(short = the next two years)
…postpone part or all of the fiscal cliff elements. Address the deficit issues in an aggressive way in 2015, when the economy will presumably be healthier and unemployment lower. That way, we have a much better chance to get chronic unemployment under control. If so, we’re likely to reach full employment in 2018–a time when we can attack the government fiscal mess in a more serious way.
5. components of the cliff
The numbers are the boosts to real GDP that each would likely provide:
extend expiring income tax provisions for everyone +1.4%
do so, but omit high-income earners +1.3%
extend payroll tax reduction, emergency unemployment benefits +.7%
eliminate defense spending cuts +.4%
eliminate non-defense spending cuts +.4%.
my take
–The CBO analysis doesn’t take anticipatory effects into account. In other words, it doesn’t address the issue of whether the slowdown in growth we’re now seeing in the US is adjustment in advance to the worst-case (“driving over”) scenario. If so, the positive economic effects of breaking the logjam in Washington could be greater than the CBO estimates.
We can certainly see effects in the number of M&A deals being done before yearend—DIS/Lucasfilms is a good example. But there are lots of others.
–Whether income tax rates rise for high-income filers has very little economic significance. +/- 0.1% in GDP growth amounts to a rounding error.
–From a stock market perspective, the Obama-proposed increase in the tax on dividends is the key possible change that I see.
–Generally, I’m skeptical about arguments that depend on “fairness,” because I think the concept is so perspectival. In a lot of cases, “fair” equates to just “I get more and you get less.” Having said that, I think one of the most un-fair things in the tax code is Romney-esque carried interest, whereby high net-worth financiers turn ordinary income into capital gains. I wonder if that loophole will be closed.
why a post-election selloff?
it’s all about taxes…
…in a very “small ball” sense. Without action in Washington, G W Bush era income tax cuts will expire. Two tax reductions affect investors directly:
–dividends from stocks, now taxed at 15%, will become taxable as ordinary income–meaning at about a 40% tax rate for the highest income holders, and
–similarly, the capital gains on the sale on stock held for more than a year will become taxable as ordinary income, rather than at the current 15% rate.
If–and I think that’s really IF–these tax breaks disappear, three consequences follow:
1. stocks in general become somewhat less valuable to taxable investors,
2. within the stock market, dividend-paying stocks become somewhat less attractive, since for high-income holders the after-tax yield is cut by 30%, and
3. high-income investors having large gains in stocks they hold may be persuaded to sell before yearend. Contrary to normal prudent practice, investors holding stocks with losses may consider not selling them until the new year, where those losses may have greater value.
two counter-moves
IF the tax rule change, it seems to me that:
1. Roth IRAs holding income stocks become much more attractive, and
2. the mammoth tax losses that mutual funds and ETFs in existence prior to 2008 still have on their balance sheets become considerably more valuable.
adjustment implies selling
AAPL is probably the poster child for this. Suppose you bought AAPL a few years ago at, say, $100 a share. It’s now about $535. If you sold today your Federal capital gains tax would be $435 x .15 = $62.25 (remember, there may be state taxes as well). If capital gains were taxed as ordinary income, your tax could be $435 x .40 = $174. So, if you had a thought in your head about selling, you’d certainly prefer to do so in 2012.
talking heads are already pushing this idea
That really scares me, since these guys are in the vanguard of the army of dumb money investors. We all thank goodness they’re there, since their existence–like that of doctors, lawyers and dentists (sorry, if you’re one of them)–lessens the chance that we’re the dumb money ourselves. But generally speaking their “advice” is toxic.
what I’m doing
As usual, not much. I’ve got to think hard about sector funds instead of some individual stocks, and about establishing Roth IRAs. But my only concrete decision is to defer selling losers until January. In this, my assumption is that we won’t know about any tax changes before yearend.
If we do hear about higher taxes on investments this month or next, I’d expect a ton of tax-related selling to ensue. The best long-term growth stocks would likely be hit the hardest. That would probably be a very good chance to buy.