business line analysis and sum-of-the-parts

This is mostly a reply to reader Alex’s comment on a post from early 2017 about Disney (DIS).

The most common, and in my opinion, most reliable method securities analysts use to project future earnings for multi-business companies is doing a separate analysis for each business line.  This effort is aided by an SEC requirement that such publicly traded companies disclose operating revenues and profits for each line of business it is in.

In the case of DIS, it’s involved in:  broadcast, including ESPN; movie production and distribution; theme parks and resorts; and sales of merchandise related to the other business lines.

There is plenty of comparative data–from trade associations, government bodies and the financials of publicly traded single-business firms–to help with the analysis.  And every company has, in theory at least, an investor relations department that answers questions put to it by investors. ( My experience since retiring as a money manager for institutional clients is that many backward-thinking well-established companies–DIS and Intel come to mind–can be distinctly unhelpful to their most important supporters, you and me.  (To be fair, I haven’t spoken with DIS’s IR people for several years, so they may be better now.))

Analysis consists in projecting revenues/ profits for each business line and using the results as the key to constructing a series of whole-company income statements–one each for this year, next year and the year after that.

The trickiest part is to decide how to value this earnings stream.  The ability to do this well either comes with experience or from having worked for a professional investor who’s willing to teach.


More tomorrow, or in a day or two if I don’t get my film editing homework done today.






…are collections of businesses, often with little operational connection with one another, linked together by common ownership.  Outside the US, the controlling entity typically exercises its influence by taking large minority interests in the subsidiary firms;  in the US it’s more common that the controlling entity owns its subsidiaries entirely.

The former structure allows greater reach; the latter makes it easier to dividend cash from one arm to another without incurring tax.

the conglomerate era

Looking back, it’s often strange to see investment suppositions that, to us, are patently crazy but which investors of another era held as gospel.

In particular, there was a conglomerate “era” in the US during the 1960s.  This was a time when Wall Street thought that there is such a thing as “pure” management, which could be applied by expert practitioners to all kinds of businesses, no matter what they were.   So, a management expert could run, say, a movie studio without knowing anything about entertainment, or head a department store chain without knowing anything about fashion or real estate or retailing, or a lead computer chip company without knowing anything about coding or chip fabrication or materials science.

What were these “pure” management skills?  Allocation capital was one.  Your guess is as least as good as mine about any others.

During that period–a decade before I entered the stock market, so I’ve only read about it–conglomerates traded at a premium to the sum of their parts.

Maybe 1950s-style conglomerates made some sense.  I don’t know.  But their executives soon worked out that they could use debt to make acquisitions that would give a (temporary) boost to ep that would get their firm a higher earnings multiple.  So companies like Gulf and Western, ITT, National Student Marketing and Textron turned themselves into M&A machines.  As long as investors believed in the supposed alchemy of management, the worst low-PE dross a conglomerate held its nose and acquired, the greater the gain from multiple expansion when those earnings came under the conglomerate umbrella.

This all ended in tears in the late 1960s, through a combination of higher interest rates, the dead weight of senseless acquisitions,and the inability of conglomerate managers to improve businesses they owned but didn’t know the first thing about, that caused the conglomerates to crater.

today’s view

Today’s view is that conglomerates should trade at a discount to the sum of their parts.  It has its roots–not in the companies per se–but in the idea that investors want to fashion portfolios for themselves, not buy pre-assembled packages.  Off-the-rack conglomerates should be worth less than bespoke portfolios.

One of my favorite examples of this belief (which I think is basically correct) comes from one of the old opium trading companies in Hong Kong, Swire Pacific.  At one time, Swires was a property development company + an airline.  The first component is income-oriented and buttressed by a steady stream of rental payments.  The other is a highly economically-sensitive industrial.

Income-oriented investors, the argument goes, must be compensated through a lower overall PE for having to hold the airline component of Swires they don’t really want.  Similarly, more adventurous investors have to be compensated for being stuck with an income vehicle they don’t want.

Therefore, the parts separated should be worth more than the two together.

In fact, when Swires announced it would seek a separate listing for Cathay Pacific, the stock rose by 40%.


Tomorrow, Disney as a conglomerate.





Disney(DIS)/ESPN: from growth to value

the maturing of ESPN

In the 2016 DIS fiscal year (ended in October), earnings from the Media Networks segment, which is basically ESPN, decelerated from its fiscal 2015 +6% pace to a slight year-on-year decline.

Two problems:  increasing costs for sports rights; and “cord cutting,” that is, consumer reluctance to pay increasing fees for cable service and cancelling instead.

Part of the issue is the proliferation of new sports content generated by individual teams.

Part is the high cost of ESPN programming to consumers:  SNL Kagan estimates that by the year after next, ESPN will be charging $9.17 per cable subscriber for its services, up from what I think is around $8 now.

Part is also ESPN’s preferred position in the basic packages offered by cable companies.  I’ve read analyses, which I’m not sure are correct, that maintain that although all cable subscribers pay for ESPN, at few as 20% actually use the service regularly.  If so, $100 per year per subscriber translates into $500 per year per user.

In addition, as a sports fan I’m offended by the faux debates and shouting matches that ESPN has begun in an attempt to woo viewers.  Covering WWE as if it were a real sport   …Really?

the move from growth to value

It seems pretty clear to me that ESPN is no longer a growth business.  Gathering realization of this by investors is the reason, I think, that DIS has underperformed the S&P over the past two years by about 25%–despite its movie and theme park success.

The important question for investors is how much deceleration at ESPN is factored into today’s DIS quote.  Is the worst that can happen already priced in?

worst case

I think I understand the worst-case scenario.  It’s that pricing for ESPN ultimately shifts from per subscriber to per user.  This most likely means a substantial decrease in ESPN revenues.  The big question is how much “substantial” is.  If it’s correct that only one in five cable subscribers actually uses ESPN, then revenues could be cut in half by the change, even if users are willing to pay double what they are laying out today.

That outcome may be extreme, but it’s certainly not priced into DIS stock, in my view.

I’m not sure what the right calculation is.  However, while the outcome of this important issue is so up in the air, I find it hard to imagine DIS outperforming.




breaking companies apart

corporate activism/raiding

Lots of activist hedge funds–or corporate raiders, as they used to be called–have been taking small stakes in publicly traded companies and then beating the drum for management either to articulate, or to change, corporate strategy.

Why do this?

…to make money for themselves and their backers, of course.  Also, the targets they’re attacking nowadays are very big.  So the prior tactic of taking control of the company through a takeover and forcing change isn’t possible.

How will change create value?

There are two main ways:

–a company may consist of several parts that have virtually no connection with each other.  A firm might, say, own office buildings and an airline, or make medical devices and lease airplanes.

Many times, these are family controlled firms that following the whims of the patriarch/matriarch.  They can also be small divisions whose growth had skyrocketed (think:  ESPN in Disney).  Or the firms might be holdovers from the 1960s, when, unlike today, the world believed there “pure” management skills could be applied to any field–and that, therefore, the best corporate form was the conglomerate.

People don’t think that way anymore.  We believe that the best companies are ones run by top management deeply skilled in one particular area.  Also, today’s professional stock market investors want to create a portfolio of stocks themselves.  They don’t like or want a corporate management that will create a portfolio of subsidiaries and offer it as a take-it-or-leave-it package.  The result:  a heavy discount applied in today’s world to conglomerates.

Put in a different way–n theory, and in practice, there are investors with differing investment styles and different investment objectives who will pay a higher price for some of the corporate components, provided they don’t also have to take the ones they don’t particularly want.  So breaking the package up creates value.

In the case of the airline/office building company I mentioned above (Swire Pacific of Hong Kong), announcement of plans for a separate listing for Cathay Pacific shot the stock price up by 40%.

–Sometimes companies are dysfunctional.  Internal political fiefdoms get created, preventing cash flows generated by operations from being reinvested sensibly.  Sometimes, companies are clueless about where their profits come from, so that some parts run horribly sub-optimally in order to make other parts look good.  This was the concept behind the activist interest in J C Penney–that the retail operations were being propped up by the property division, which was collecting below-market rents to the department stores.  The idea was to fix the retail and then break up the company into retail and real estate parts.

I once studied a publicly traded, family owned department store in Hong Kong.  I found the stores I visited to be completely unappealing, with dated merchandise at high prices–and stronger competitors a short walk away.  Yet the company, which owned all the property where its stores were located,  made a hefty profit each year.  How could that be?  When I began to work out how much rent the locations would command from third parties, I realized that profits would easily be 50% higher if the firm shuttered its stores and simply rented the properties to other.  But that would have meant that all of the relatives  who “worked” in retail would be out of jobs.  So the idea was a non-starter.

In most instances, management is unlikely to disturb the status quo without being educated/forced by outside parties.  That’s where the activists come in.

Sometimes activism doesn’t work, however.  That topic on Monday.