- We all know about Disney, but is it a good investment? I’ll explain how to approach investing in the company.
- I’ll first describe the company and touch on the Fox acquisition.
- DIS is a great example of what Amazon or Netflix once were.
The Walt Disney Company (NYSE: DIS) is an intriguing stock. It boasts a PE ratio of just 14.19, a dividend yield of 1.69%, it has a strong brand, and the stock hasn’t gone anywhere in the past 3 years.
Figure 1: DIS in the past 3 years. Source: CNN Money.
Let’s see whether the 3 year underperformance is due to some structural issues or if it’s a great opportunity to buy a wonderful business at a fair price, the kind of business you want to hold forever.
Before getting started, let me just mention that DIS was one of Buffett’s biggest mistakes. Buffett invested in DIS in 1966 when the company was valued at just $80 million when he knew that it cost more just to build a few themes in the park, and pre-tax profits were $21 million. He invested $5 million and sold a year later for a 20% profit. The mistake comes from the fact that the $5 million invested back than would now be worth more than $5 billion not counting the dividends over time. So, even Buffett has made the mistake of selling great brands bought on the cheap.
Let’s see if DIS will do the same for current investors over the next 50 years.
Disney – The Company
I always like companies that have multiple separate segments because that always makes it tough to analyze for others and thus creates opportunities especially if there are segments that might explode in the future. We all know that Wall Street focuses on the next few quarters and not so much on the future and value.
Disney’s segments are Media, Parks, Studio Entertainment, and Consumer Products with Interactive media. The media network makes the most revenue, but the parks are the most profitable.
Figure 2: DIS’s 2018 full year results. Source: DIS.
So, if you were wondering why DIS’s stock has underperformed lately, above lies the answer. Revenue declined 1% and profits declined 6% year-over-year. The situation improved in the last quarter as revenue increased 4% and operating profit 1%, and we will see this coming Tuesday whether the trend will continue as DIS reports earnings.
However, let’s look critically at what is there. The Media segment with ESPN is in a tough spot as the media business is changing altogether. Parks and resorts are good businesses but cyclical in nature, so one has to keep that in mind. Studio revenues depend mostly on Star Wars and other releases, while consumer products are also flat. But the key lies in the unseen as whatever can be properly estimated is baked into the price already.
We have to ask ourselves whether DIS’s direct to consumer products in combination with the FOX acquisition will lead to some growth in the future or not.
DIS will acquire 21st Century Fox’s film and television studios, its cable entertainment networks, and international TV businesses. This will give it enough firepower to battle Netflix and Amazon. Further, the $52 billion acquisition is an all stock acquisition that doesn’t leverage the company but does dilute shareholders. Nevertheless, you never know what will come out of this in the long term, but I think it does have potential as there must be more service providers out there and DIS is a familiar name. DIS will also spend $20 billion on buybacks to lower the dilution hit.
The acquisition has been done at 11 times EBITDA which isn’t high in this market, and the expected savings of $2 billion should improve the acquisition metrics.
The key is that DIS now has a much bigger reach and can really push its direct to consumer business ahead and drive into the next 100 years.
Figure 3: DIS’s acquisition plan. Source: DIS.
What Kind Of An Investment Is Disney?
Now, you look at DIS and you see the famous brands, global parks, and resorts that attract many visitors, and movies that bring people to cinemas, but the stock price isn’t going anywhere and the valuation looks cheap.
There are two things that can happen. DIS can continue to see its Media empire shrink, the Fox acquisition might not work out as planned and just dilute earnings which wouldn’t be a good thing at these already low valuations.
The second scenario is one where DIS becomes a competing powerhouse with Netflix and Amazon on direct to customer services and get a far higher valuation, especially when the business becomes profitable. Given the stability of the other parts of the business, and their cash flows, DIS might be in a much better position to actually scale its content and monetize it. DIS’s current market cap is $150 billion, but if there will be big growth coming from streaming services, I wouldn’t be surprised to see the stock double on improved earnings, growth, and valuations. If there comes more hype, you can also see it triple in the next few years.
So, the upside potential over the next few years is huge and the downside isn’t that big. Let’s say that if the streaming business struggles and there is a recession, what you can expect is to see the stock drop 50% when I’m sure there will be others (read, Buffett) waiting to buy the company altogether.
The key component when investing in DIS is psychological. Can you invest in the unknown and if it doesn’t work out, fine, while you’ll win the lottery if it does? The problem is that nobody knows how long one will have to wait and that’s something difficult to sell to Wall Street. Buy and forget investors should really take a look at DIS now.