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.

 

 

 

Disney (DIS) and ESPN: a lesson in analyzing conglomerates

DIS shares went on a fabulous run after the company acquired Marvel in late 2009, moving from $26 a share to $120 in early 2015.  Since then, however, the stock has been moving sideways to down–despite rising, consensus estimate-beating earnings reports in a stock market that has generally been rising.

What’s going on?

The basic thing to understand about analyzing a conglomerate like DIS is that aggregate earnings and earnings growth matter far less than evaluating each business in the conglomerate by itself and assembling a sum of the parts valuation, including synergies, of course.

In the case of DIS, the company consists of ESPN + television; theme parks; movies; merchandising related mostly to parks and movies; and odds and ends–which analysts typically ignore.

In late 2009, something like 2/3 of the company’s overall earnings and, in my view, 80%+ of the DIS market value came from ESPN.

How so?

At that time, ex Pixar, the movie business was hit and miss; the theme parks, always very sensitive to the business cycle, were at their lows; because of this, merchandise sales were similarly in the doldrums.  ESPN, on the other hand, was a secular growth business, with expanding reach in the global sports world and, consequently, dependably expanding profits.

ESPN profits not only made up the majority of the DIS conglomerate’s earnings, the market also awarded those profits the highest PE multiple among the DIS businesses.

At the time, I thought that if truth in labeling were an issue, the company should rename itself ESPN–although that would probably have detracted from the value of the remaining, Disney-branded, business lines.

Then 2012 rolled around.

More tomorrow.

 

Disney (DIS): the valuation issue

Long-time readers may recall that I became interested in DIS in late 2009, the company acquired Marvel Entertainment, a stock I held, for stock and cash.

corporate structure

I hadn’t looked at DIS for years before that.  I quickly learned that DIS was a conglomerate, that is, a type of company where the most useful analysis comes taking the sum of its constituent parts.

I knew the company’s movie business had been struggling for some time and the theme parks were being hit hard by recession.  Still, I was more than mildly surprised that ESPN (plus other media that we can safely ignore) made up somewhere between 2/3 and 3/4 of DIS’s operating earnings.  Why did they still call it Disney?

multiples

Given that the parks are a highly cyclical business and movies moderately so–meaning the PE applied to those earnings should be relatively low–and that ESPN was showing all the characteristics of a secular growth business–meaning high PE–I thought that ESPN represented at least 80% of the market capitalization of DIS.  (That’s despite the fact that the market would apply a higher than normal multiple to cyclically depressed results).

So DIS was basically ESPN with bells and whistles.

ESPN’s turning point

In 2012, ESPN made a major effort to enter the UK sports entertainment market.  To my mind, this wasn’t a particularly good sign, since it implied ESPN believed the domestic market was maturing.  Worse, ESPN lost the bidding, closing out its path to growth through geographic expansion.

It seemed to me that DIS management, which I regard as excellent, understood clearly what was happening.  It began to redirect corporate cash flow away from ESPN and toward the movie and theme park business, which had better growth prospects, and where it has since had unusually good success.

2014-16 results

Over the past two fiscal years (DIS’s accounting year ends in September), the company’s line of business results look like this:

ESPN +        revenues up by +11.9%, operating earnings by +6%

parks           revenues up by +12%, op earnings  +24%

movies        revenues up by +30%, op earnings +74%

merchandise   revenues up by +4.6%, op earnings +33%.

the valuation issue

ESPN has gone ex growth.  This implies these earnings no longer deserve a premium PE multiple.  To me, the fact that ESPN now treats WWE as a sport (!!) just underlines its troubles.

The other businesses are booming.  But they’re also cyclical.  So while improving efficiency implies multiple expansion, earnings approaching a cyclical high note implies at least some multiple contraction.

Because the two businesses are so different, I think Wall Street is making a mistake in treating earnings from the two as more or less equal.

calculating…

DIS will most likely earn $6 a share or so this fiscal year.  That will be something like $3 from ESPN and $3 from the rest.

Take the parks… first.  Let’s say I’d be willing to pay 18x earnings for their earnings.  If that’s the right number, then these businesses make up $54 a share in DIS value.

Now ESPN.  If we assume that the worst is over for ESPN in terms of subscriber and revenue-per-subscriber losses, we can argue that the future earnings stream looks like a bond’s.  If we think that ESPN should yield, say, 5% (a 20x earnings multiple), that would mean ESPN is worth $60 of DIS’s market cap.  If we’d still on the downslope, that figure could be a lot too high.

$54 + $60 = $114.  Current stock price:  $109.

my bottom line

My back of the envelope calculation for the parks… segment may be a bit too low.  I could also be persuaded that my figure for ESPN is too rich, but it would take a lot to make me want to move the needle higher for it.

Yes, most of DIS’s earnings are US-sourced, so the company could be a big winner from domestic income tax reform.

But if I were to be holding a fully valued stock on the idea of a tax reform boost, I’d prefer one with more solid underpinnings.  At $90, maybe the stock is interesting.  But I think ESPN–the multiple as much as the future earnings–remains a significant risk.

 

 

 

 

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.

 

 

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

DIS and ESPN

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.

Yet…

…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.

discounting?

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.