[Our detailed report analysis is available, but the summary of the DIS thesis is as follows.]
Shares of Walt Disney Corp (DIS) traded off about 6% earlier this month after releasing earnings, as the market considered near-term headwinds in the coming quarter (specifically in its Network and Studio businesses) as a reason to sell down the stock. We view this as a short-term hiccup in the face of some powerful trends over the next 1-3 years that DIS will begin to benefit from. We think DIS shares will grind higher over the next 12 months driven by:
- Best-in-class cable assets that continue to be treated as such as a result of large market transactions (e.g., the recent News Corp (NWS) / YES Network deal);
- Achievement of returns after a number of years of heavy investing in its domestic and Asian parks & resorts;
- Realization of Lucasfilm monetization opportunities ahead of the next 2015 planned Star Wars film release; and
- Continued solid cash flow growth fueled by lower capex spend and used to repurchase shares which management considers to be trading "below intrinsic value".
Media Networks Strength
When DIS reported earnings in early November, the market got spooked by management's expected increase in sports content costs that will flow through the P&L in Q1 of next fiscal year. This helped send the shares down from $50 to $47, as the market overreacted to a short-term hiccup which is the nature of the cable industry. The impact for costly sports content deals (such as with the NFL, the NBA, or the Big 12) are scary billion-dollar numbers at first, but DIS will benefit as the quarters progress with a growing subscriber base (driven by content) and higher ad rates earned by its networks. This is simply the nature of the industry. It's also important to note that DIS turned down a deal with the English Premier League as the returns just did not make sense for the company. This bodes well that management isn't chasing un-economical deals just for the sake of having global sports content. The NHL lockout, also, will only be a positive for DIS as viewers will be drawn to other sports (such as baseball and basketball) that DIS channels carry.
Parks & Resorts Incremental Value
The company has been seeing very good traction on the domestic side in this segment, with continuing growth in guess spend and room rates coming out of the recession. The company has been spending a lot of capex over the past 2 fiscal years on its Magic Kingdom expansion in Florida, and also on its Hong Kong Disneyland expansion. Management feels like there is much more to tap into on the Asia front to get growth trends up to current domestic low double-digit growth rates. European operations have been stable, but the outlook is very unpredictable. On the domestic front, the company's Florida expansion is the largest expansion of the Magic Kingdom in 40 years as it is transforming the looks of its Fantasy Land experience (which is the most popular part of the park according to management). In fiscal 2013 and 2014, capex spend should come down from the high of 22% of sales as it was in this past FY2012. ROIs that management gauges for projects on the Parks & Resorts side ranges from 10-15%.
Studio Entertainment - LucasFilm Acquisition
In October, DIS announced it will be acquiring Lucasfilm for $4.05 billion, with $2.025 billion in cash and the rest in stock (~40 million shares to be issued). Lucasfilm (owned and run by George Lucas) produces the Star Wars movies, as well as other films such as Indiana Jones, Willow, and a few others dating back decades. The firm also operates two other businesses including Industrial Light & Magic, and Skywalker Sound. Lucasfilm has not produced a movie since 2005 which was the last Star Wars film (Episode III - Revenge of the Sith). That year the firm generated $550 million in EBIT (to give you some reference, as not much financial information at all has been released on Lucasfilm). In 2012 (so with no big-time film productions), the breakdown of Lucasfilm revenue was 25% Film Business, 25% Consumer Products, 20% Games, 30% 2 other businesses (Light and Sound discussed above). The acquisition will be slightly dilutive to earnings in 2013 and 2014 (by a "low single-digit percent"), and then accretive after that.
The next feature film scheduled for release is the new Star Wars to be released in 2015. DIS's goal is to release a new Lucasfilm feature regularly every 2-3 years after that (as opposed to the standalone company which goes many years without releasing movies). Management is extremely excited about monetization opportunities with this brand, involving synergies with its Parks & Resorts, its Consumer Products, further video games, and of course the long-term revenue stream of rental and TV monetization prospects that come along with owning such quality content like the Star Wars banner.
Large Value Coming from Most Recent Comparable Transaction
The biggest value drive is the Media Networks segment, ranging from ~$90-100 billion in value with a 14-16x multiple. This multiple may seem large, but the most recent sizable deal in this space was News Corp recently acquiring a 49% stake in YES Networks for $3.4 billion. Bernstein research states this implies a 15x EBITDA acquisition multiple for the sports network…This bodes quite well for a network like ESPN which accounts for a sizable chunk of this segment's EBITDA.