Disney (DIS) from 30,000 feet

I’d only followed DIS from afar until the company acquired Marvel Entertainment, which I held in my portfolio, for a combination of stock and cash in late 2009.  I kept the shares I acquired and also bought more while DIS was depressed by critics doubting the wisdom of its move. I’m tempted to write about how wrong that view was, but that’s for another day (not soon).

As I studied DIS’s financials, I found that ESPN accounted for about 75% of the firm’s overall operating profit.  The movie studio, run by a former monorail driver at the theme parks, was a mess.  Income from the parks was depressed by recession.  The Disney brand was also almost completely dependent on female characters, making Disney attractions less appealing to half the adolescent population.  ESPN, on the other hand, was/is the dominant sports cable franchise in the US and was going from strength to strength.  For a moment–until I realized the marketing advantages of having the Disney name in the public eye–I wondered why the company didn’t just rename itself ESPN.

In addition, the simple percentage of earnings seemed to me to understate the importance of ESPN to DIS.  The movie business is typically a hit-or-miss affair and therefore doesn’t merit a premium multiple.  Same with the hotels/theme parks, because they have a lot of operating leverage and are highly sensitive to the business cycle.  So I concluded the key to the DIS story was the progression of its secular powerhouse–and its one high-multiple business–ESPN.  Nothing else mattered that much.  (Of course, I didn’t understand the full power of Marvel, or the turnaround in the Disney studio, or the subsequent acquisition of the Star Wars franchise, but that’s a separate issue.)

In 2012, ESPN began an effort to expand its business in a major way into the EU by bidding large amounts for broadcast rights to major soccer games in the UK.  Incumbent broadcasters, however, realized (correctly) that no matter what the cost it would be cheaper to keep ESPN out of their market than to deal with it once it had a foothold.  So they bid crazy-high prices for the rights. ESPN withdrew.

ESPN’s failure was disappointing in two ways.  A new avenue of growth was closed off.  At the same time, the attempt itself signaled that ESPN believed its existing Americas business was nearing, or entering, maturity.  That’s when I began easing toward the door.

The issues for ESPN–cord-cutting and the high fees ESPN charges–are very clear today.  What I find most surprising is that it took the market three years, and an announcement of subscriber losses by DIS, for the stock market to focus on them.  So much for Wall Street’s ability to anticipate/discount future events, even for a major company.

I don’t think ESPN is helping its long-term future by seeking to boost ratings by having personalities shout at each other in faux debates.  Nor does covering WWE as if it were a real sport.  I think they’re further signs of decay.  My sports-fan sensibilities aside, the real issue is about price.

Suppose every cable subscriber pays $4 a month to get ESPN, but only 15% actually watch sports–or would pay for ESPN if it weren’t part of the basic package.  If so, the real cost per user is closer to $30 a month, most of which is being unwittingly subsidized by non-users.  There’s only one way to find out if current users would be willing to pay $30 for ESPN, which is by removing the service from the bundle everyone must buy, reducing the basic cable charge by $4 a month, and offering ESPN separately.  That’s what the cable companies want–and what ESPN is looking to avoid.

We’re nowhere near the end of this story.  I don’t think the final chapter will be pretty for ESPN.

On the other hand, as I see it, just after the UK rebuffed ESPN, DIS began to direct its ESPN cash flows away from cable and toward building up its film and theme park businesses.  For me, this was the sensible thing to do.  And it confirmed my analysis of the situation with ESPN.

My bottom line:  for four years ESPN has been the cash cow that’s funding DIS’s expansion elsewhere.  Wall Street only realized this twelve months ago.   But DIS’s reinvention of itself is still a work in progress.  Until the market begins to view DIS as an entertainment company that happens to own ESPN rather than ESPN-with-bells-and-whistles the stock will continue to struggle.



selling: different styles

I’ve been thinking some more about what I wrote last week about selling in Disney(DIS) stock.  The thrust of my reaction to the sharp decline was, and still is, mild bemusement that selling only emerged as the company reported weak results from ESPN.  It’s not that disappointing earnings should not generate selling.  It’s that the handwriting had been on the wall about ESPN–and in vividly hued bold print–for some time before DIS’s 2Q15 earnings report.

Why no stock weakness earlier?  This would have been my strong expectation. I’m not talking about the results somehow being leaked to outsiders by the company.  Rather, I’d have thought that the market would have put two and two together and acted weeks or months ago on publicly available information about the cable industry–like Nielson reporting of subscriber losses at ESPN.

My conclusion was that the sharp fall in DIS shares on its earnings report might be evidence that Wall Street just didn’t know there were problems at ESPN, despite what I consider clear signals of trouble being visible for a considerable time.

I still think it is generally true that the stock market is becoming less efficient–and more like I perceive the bond market to have been throughout my time as an investor.

I’m no longer sure that DIS is evidence for my thesis, though.  Here’s why:

The key to successful investing in growth stocks is being able to sell them at the right time, meaning exiting as the firm is going ex-growth and before the rest of the world realizes this.

To me, the key signal is the breakdown of the conceptual “elevator speech” explanation of what gives the company in question its extraordinary growth potential.  In my experience, if we’re waiting for the first disappointing earnings report, we’re almost always hanging on too long.

The presupposition here is that the potential upside from my exit point is (far) less than the downside from being a holder of the stock when the disappointing earnings are released.  This assumes, of course, that I can recognize the point at which all the possible future good news–and maybe more than that–is already factored into the stock price.

My approach didn’t work so well for me in the case of DIS, where I failed to anticipate the fabulous success the company has had in its non-Marvel, non-Pixar movie business.

There is a second approach to growth stocks.  It argues that a well-managed company normally has more earnings growth tricks up its sleeve than any outsider is able to understand.  Therefore, it’s always too risky to sell when the conceptual story begins to unravel.  Better to wait for actual proof to come in through bad earnings.  Yes, one might lose 10% by selling after the bad report.  But that’s better than exiting at 40% below the stock’s peak.

In fact, I took this second approach myself, early in my investing career.

The difference in my thinking from last week and now:  my first thought was that information is not circulating on Wall Street as fast as it used to; my second thought is that investors may have the same information as always but they’re just using it differently.

Practical implications?  …they may be substantial.  My conclusion is still to look for more evidence.  My tendency is going to be to hang onto growth stocks for a bit longer than I might otherwise, though, figuring that others are going to do the same thing.   So the cost of waiting to find out if there’s another growth spurt left in a maturing company may be lower than it has been in the past. And I may no longer be committing the cardinal investment sin of underestimating the information the other guy has.

results from Disney (DIS): a lesson in how the market works nowadays


A relative in the movie business called my attention to Marvel Entertainment a few years ago.  When it was acquired by DIS in late 2009, I held onto the stock I got and added more in the mid-$20 range Marvel, of course, has been pure gold for DIS, even though DIS initially went down on fears that DIS had overpaid.  Naturally I sold the stock way too early, in the mid-$60s–acting more like a value investor than a growth stock fan.

My first thought on reading the DIS 10-K, as I acquainted myself with the company,was that the company really should have been named ESPN, since at that time the cable sports network accounted for 2/3 of DIS’s overall operating profit and virtually all of its earnings growth.

red flags about ESPN

Over the past several years, a number of key warning signs have popped up about ESPN, however:

–ESPN decided to expand into the UK, signalling to me that it considered its US franchise on the cusp of maturity

–but ESPN was outbid for soccer rights by locals and effectively terminated its international expansion ideas–not good, either

–DIS began to shift cash flow away from ESPN and toward the movie and theme park business, which I took to be a sign of corporate worries about ESPN’s growth potential, rather than simply diversification for diversification’s sake

–serious discussion has begun over the past year about the demise of cable system bundled pricing, which likely benefits ESPN substantially (I suspect we’ll find out how substantially sooner rather than later)

–since ESPN.com’s recent format change, I find myself almost exclusively using Time Warner’s Bleacher Report for sports information

–personally, although this isn’t the most crucial part of my analysis, I think the progressive dumbing-down of ESPN coverage, in imitation of sports talk radio, to gain a wider audience will backfire.

To sum up,, there has been an increasing collection of evidence that ESPN probably won’t be the same growth engine for DIS that it has been in the past.


…DIS shares were down by about 10% in Wednesday trading (in an up market) on the first signs in the earnings report of the factors I’ve just listed.


Where was the market’s discounting mechanism, which in the past has been continuously evaluating corporate strategy and factoring worries like the long list I’ve mentioned above into the stock price?

…only on the earnings report, not before

To my mind, DIS trading yesterday is another indicator that information isn’t flowing on Wall Street as fast as it once did.  That’s neither good nor bad;  it’s just the way the game is being played in today’s world.  What we as investors have got to figure out is how to adjust our own behavior to fit altered circumstances.

My initial thought is that it may be riskier than it has been to dabble in down-and-out industries like mining or oil until the final bad news has hit income statements.


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.


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.