Disney's (NYSE:DIS) quarter was better than we expected, with theme parks performing surprisingly well, and yet the stock has traded down in after-hours. Concerns over the BAMTech investment are likely at fault here, but we think it is pretty likely that DIS launches its entire bundle (ESPN networks, Disney networks, ABC, etc.) as a DTC offering at some point over the next 2-3 years. This is ultimately why DIS made the billion dollar investment, as a hedge against cable sub churn, and we think it positions the company to optimally monetize its media content regardless of how media consumption habits change.
Our breakdown of the quarter by segment can be found below:
- Media Networks: This was the segment that generated the most buzz this ER. The company officially announced its $1 billion investment in BAMTech, and plans to use the company's tech to launch a DTC sports content offering complimentary to the traditional multichannel bundle. MLBAM is quite good at this, and currently provides and/or has provided the infrastructure for HBO Now, The Blaze TV, WatchESPN, March Madness on Demand, WWE Network and PGA Tour Live. What this investment does is grant DIS optionality in the dynamic SVOD marketplace. DIS is not offering full ESPN content in its first DTC offering set to launch by the end of this year, and is instead only offering content that isn't already on ESPN channels. Reason being is that the multichannel bundle still offers the most value to DIS and therefore management has said it is a "top priority" to support it. While this DTC offering is complimentary, that is pretty much all it is. It isn't a billion-dollar needle mover. The content is stuff that is not already on ESPN, so we are looking at coverage of obsolete sports, low-level colleges and other content types that will attract niche audiences at best. The real benefit of the investment is a hedge against cable sub churn. If cord-cutting accelerates, DIS will likely launch all of ESPN as a DTC offering, much like HBO Now, to ensure ESPN content is still optimally monetized even if the multichannel bundle declines. In this situation, the interesting thing is whether or not DIS will bundle ESPN content with the rest of its content in an all-in-one DTC offering (ABC, ESPN, Disney, etc.) through BAMTech. Such an offering would be very interesting as it would offer a unique, varied value proposition to consumers. We think such an offering is likely to happen within the next 2-3 years as challenges to the multichannel bundle persist. In our opinion, the company just placed a billion dollar hedge against cable sub churn, and we think it is more than worth it to maintain flexibility in the high-growth, dynamic SVOD marketplace and hedge against cable sub churn. Beyond this deal, the complete DIS bundle will now be available in DirectTV Now, AT&T's (NYSE:T) streaming service set to launch in Q4.
- Parks & Resorts: This is where results were most surprising to us. The American theme parks showed impressive resilience during the quarter, with management citing domestic strength in this segment despite several headwinds which suggested lower traffic (alligator incident, mass shooting, construction, etc.). This resilience did not extend internationally. Disneyland Paris had a weak quarter due to multiple terrorist attacks, showing that domestically DIS has stronger consumer influence and brand power than it does internationally. As expected, Shanghai Disney had a very strong opening. As a whole, the Parks business is primed for strong growth over the next several years. An Avatar expansion to Disney World is expected to open in 2017, while construction has started on Star Wars expansions at both Disneyland and Disney World. Moreover, while legalities make a Marvel extension look nearly impossible at Disney World, the door is open for Disneyland to open a Marvel Land. With all of these extensions on the horizon and Shanghai Disney still in its infancy, the Park business looks to have solid long-term growth prospects.
- Studio Entertainment: As we and everyone else expected, this was the bright spot of the report behind the huge box office success of Captain America and Finding Dory. Carryover Zootopia revenues also helped numbers in the quarter. The Q4 line-up, which comps against one movie in Ant-Man, looks to provide even more growth behind The BFG, Pete's Dragon, The Light Between Oceans and Queen of Katwe. The Q1 line-up, though comping against record Star Wars Episode VII results, also looks promising with Rogue One, Doctor Strange and Moana. Fiscal 2017 as a whole will be down as it comps against record Fiscal 2016 results, but a second Guardians of the Galaxy movie, a third Cars movie, a new Beauty & The Beast movie, and a new Pirates of the Caribbean movie will likely keep numbers up from Fiscal 2015. Fiscal 2018 will be very strong, as it kicks off with a new Thor movie followed by Star Wars Episode VIII, a knock-off Star Wars movie with Han Solo, another Avengers movie and a fourth Toy Story movie. If history tells us anything, it is that DIS will continue to produce quality content and put up huge box office numbers into perpetuity. This is a growth business that will, despite volatile YoY fluctuations, trend up over time.
- Consumer Products & Interactive Media: As we expected, this business was slightly down YoY. The 1% drop in revenues is attributable to lower Frozen sales compared to the same period one year ago. This weakness was offset by strength from the Finding Nemo/Dory line and also got a little boost from Star Wars. Revenues in this segment will fluctuate with the Studio line-up quarter to quarter, but we think the next two years will be quite strong for this segment. Cars 3 will likely be a huge catalyst in 2017 while Toy Story 4 will be a huge catalyst in 2018.
Although we were slightly bearish heading into the quarter because we didn't see much upside in ER, we are actually cautiously bullish following this report as a result of a promising growth story over the next 2-3 years. We really like the BAMTech acquisition as it positions the company to monetize its rich media content regardless of how media consumption habits change. If consumers go OTT/DTC and ditch cable, DIS can launch its bundle through BAMTech as a sub model, much like Netflix (NASDAQ:NFLX). If consumers don't go OTT/DTC and largely keep cable, DIS has a side-offering for offbeat sports content and can continue to reap cable rewards.
We are also bullish on the long-term growth prospects in every other segment. Parks revenue will likely soar over the next 2-3 years, the movie line-up looks promising into 2019 and toy/accessory sales should boom with Cars and Toy Story. The valuation isn't terribly attractive at 15.5x forward estimates, but we actually think those estimates are light. We think FY17 EPS looks something more like $6.57, giving the stock a slightly more reasonable 14.5x forward multiple. This is a marked discount from where the stock has historically traded at around 16x forward earnings over the past 5 years.
The multiple is also only a slight premium to earnings growth, which we see at just over 10% over the next 5 years. If the stock can maintain this ~15x multiple into the end of the year, we can reasonably see the stock at $110 by year-end. A 15x multiple on our FY18E EPS of $7.45 would equate to a stock price just over $110.
Because we do think there is some valuation risk related to investor fear surrounding the BAMTech investment, we are not loading the truck with shares of DIS. We will, however, pick up a small amount of DIS here as we think the risk:reward profile is attractive with so many growth catalysts on the horizon.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in DIS over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.